It’s not always immediately evident if your latest investment is worth its while. When you’re adept at evaluating a property’s investment potential, you’re able to navigate your acquisitions with confidence. Building a world-class real estate portfolio isn’t easy – but these signs will help you know when you’re on the right track.
First Things First: Does It Meet Your Investing Criteria?
Every real estate investor needs clearly defined standards and criteria for their investments. These criteria depend on your individual investment goals, but in general, you want to have an idea of:
- The markets you want to invest in.
- The types of properties you want in your portfolio.
- The minimum acceptable metrics (cap rate, NOI, cash on cash returns, etc.)
- Your target or desired metrics.
Does the Market Show Potential for Growth?
Your market is the larger ecosystem surrounding your property. If your investment is to thrive, the market must also. This means you’re seeing trends of population growth, increasing median household income and job opportunities, real estate development and revitalization, and increasing property values and rental rates. These all point to sustained and growing demand.
Does It Pass the 1% Rule?
The 1% rule isn’t perfect. It is best utilized as a quick evaluation tool to determine the feasibility of an investment property based on what it costs versus what you could charge for it in rent. However, not all properties that pass this rule will automatically be good investments, and not all that fail will be bad. Still, it’s a quick calculation that offers helpful insight.
The 1% rule is very simply answering this question: can I charge at least 1% of this property’s asking price in rent each month? For example, a property that costs $150,000 should, as a rule of thumb, generate at least $1,500 in monthly income.
Again, this isn’t a hard-and-fast rule. But if you want to evaluate a potential property very quickly against the going rental rates for the area, it can give you an idea of what you’re in for. It’s not a deep-dive analytical tool. Think of it more like a property prescreening!
Does An Accurate Cost Assessment Sting a Little?
When you dig deeper into number-crunching, you know that you’ve made a good choice if an accurate assessment of your property’s ongoing costs – maintenance, insurance, mortgage, taxes, etc., – doesn’t scare you off. Compare these numbers to your potential cash flow as well as your emergency funds. You don’t want numbers to be too tight in case of the unexpected.
How Is Your Team Handling Things?
Your management team is the key to your success with any rental property. You may be concerned that these costs will throw your profit margins – and they will. But they’re also worth it! A great management team lowers your vacancy rates and increases lease renewals. They also curb repair costs through diligent maintenance. They empower you to scale your portfolio across markets and in numbers you’d never be able to manage alone.
Does Your NOI Make Sense?
Your NOI (net operating income) is your income minus operating expenses. This doesn’t include mortgage payments, interest, or capital expenditures. Include things like management and maintenance costs, property taxes, legal fees, and utilities. What the NOI shows you is whether your property will generate enough income to cover the mortgage and essential, non-operational expenses.
What's the Cap Rate?
Your cap rate (capitalization rate) is basically your return on investment in real estate. It’s the ratio between income from your property versus capital invested or current property value. Now, a higher cap rate isn’t necessarily a good thing. A high cap rate – that is, high returns – is associated with increased risk. It could indicate a volatile market. A low cap rate, on the other hand, means you’re not getting a great return on your investment. You want something balanced in the middle, indicating a more stable, less risky investment.