Investing in property — either residential or commercial — can be lucrative, provided of course that you make the right decisions and avoid the wrong ones. To help you head in the former direction, here are five ways to tell if a property is a smart investment according to real estate professional Paul Kaulesar.
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Pay Attention to Location
An old saying in the real estate world is that the three most important aspects of a property are location, location and location — and this wisdom certainly applies to potential investment properties.
“The location of a property is so vital in the big picture, because it affects a whole range of factors,” commented Paul Kaulesar, who is currently one of the top producers for On Call Realty in Palm Beach, Florida. “Just some of the aspects that are directly influenced by a property’s location include housing costs, rental prices, property taxes, and desirability relative to other properties. For example, if two homes are comparable in many significant ways including selling price, then the one that is located closer to schools, parks, or other things that renters covet is going to be more profitable, and the occupancy rate is going to be higher as well.”
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Analyze the Cap Rate
The cap rate (short for capitalization rate) is determined by dividing a property’s annual net income (gross annual income minus net annual expenses) by its purchase price, and then multiplying by 100. For example, if a property’s projected annual net income is $24,000, and the purchase price is $150,000, then the cap rate is 16% (24,000/150,000 x 100).
“There are a couple of ways that investors can use the cap rate,” commented Paul Kaulesar. “The first is that it helps determine if the asking price of a prospective property is likely to generate positive cash flow at a desirable level. The second is that it can help investors determine the optimal selling price for properties in their portfolio, by analyzing the cap rate of recently-sold comparable properties.”
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Take a Long-Term View
Naturally, you will be focusing on properties that generate a positive cash flow from rental income. However, it is also important to take a long term view and realistically assess the appreciation potential as well.
“Even if investors currently plan on selling an investment property in a few years, the appreciation potential is going to directly influence the selling price at that time, and will be a chief consideration for buyers,” commented Paul Kaulesar. “Ultimately, however, this is something that differs from investor to investor. Some are comfortable investing in a property as long as they believe that the value will not decline in the short or medium term, while others are willing to generate lower rental income in the short-term if they believe the property will significantly increase in value over time."
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Go Behind the Numbers
As consumers, sometimes we come across a deal that “seems too good to be true” — which causes us to pause rather than pull out our wallet. For example, we may come across a pair of shoes in a store that should sell for $100, but are offered for $50. Is this an example of an amazing deal? Or is there something about the pair of shoes that the seller isn’t revealing?
In the same light, when you come across what seems like a good deal on an investment property, go behind the numbers to determine why. Is it because the property is falling apart and will require tens or hundreds of thousands of dollars in repairs and renovations? Or is it because the seller is motivated?
“There are a few ways that investors can go behind the numbers, including examining a property in person,” commented Paul Kaulesar. “It is also strongly advisable to work with an experienced local real estate professional, who will help with this analysis and bring to light things that investors may need to know before they enter into a transaction — not after.”
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Have Realistic Expectations
Many investors have generated significant profits, especially in recent years with historically low interest rates combined with rising demand in many parts of the country — including Palm Beach where Paul Kaulesar lives and works. And there is no reason why you can’t join the ranks of profitable investors. However, it’s nevertheless important to keep your expectations realistic.
“Realty TV shows have created a lot of hype around real estate investing, particularly in the residential space,” commented Paul Kaulesar. “However, investors should ignore the hype, and stay focused on the fundamentals like location, cash flow, cap rate, and projected appreciation. It bears repeating that working with an experienced local real estate professional is essential here. Otherwise, investors are likely to overlook key considerations or make assumptions — and instead of profitable and rewarding, their experience is likely to be costly and regrettable.”
This article does not necessarily reflect the opinions of the editors or management of EconoTimes