How to Invest (Buying Investment Property - A Practical Guide)

 

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Investors buy income producing property for various reasons, but most are looking for either a short-term (2 to 3 year) profit or long-term monthly income.  These approaches require different strategies.  Here is an experience-proven method for selecting, purchasing and managing income-producing property.  This is not the only method that works, of course, but it does work well.

 

STEP ACTION
1 WHAT TYPE OF PROPERTY DO YOU WANT? -- Before you invest, you must decide what type of property you want, e.g., a single-family house, townhouse, duplex, 8-plex, 120-unit complex or a strip mall?  Examine your goals.  Do you want a fixer-upper you can buy at an under-market price, put some capital and time into, and sell at a substantially higher price?  Or, do you want to purchase something that is less of a challenge, has less risk, but stands to provide you with a relatively steady monthly income?  Answers to these questions define your purchase goals, and the type, location, age and condition of the property you will search for. 
2

THE MONEY -- Depending on your situation and goals, many questions are possible.  Here are a few of them:

  1. How much can you spend?  How much do you expect to earn?

  2. How much should you reserve for improvements?

  3. After the purchase, how long can you afford to own the property with minimal income, assuming you are buying a fixer-upper?

  4. What NOI and Cap Rate are you seeking?

  5. Do you have 1031 money to invest?  Have you selected an intermediary?

  6. How big is your down payment and how much do you want to finance?

  7. If your down payment is less than 20 percent, do you have collateral available? (Check your expected income less loan payment and other expenses; 30 to 35 percent may be prudent.)

  8. Have you selected and been approved by a lender?

  9. Do you need to sell something before you can buy something?

3 SELECTING A PROPERTY -- With your ownership and financing goals defined, it's time to select a property.  Discuss your goals with a realtor or consultant.  Are you going to manage the property yourself or hire a property manager?  If the latter, contacting a property manager at this stage can help you select the right property.  The more homework up front, the fewer (expensive) surprises after purchase.
4 CHECKING IT OUT -- Properties have many sides, some of which you can discover before purchase, others you will discover after purchase.  Here are some things you can do to increase your understanding of a prospective property, minimize your risk and build a budget for after-purchase improvements:
  1. Research the location.  What are projections for population growth and job market growth (manufacturing/retail)?  How much new-construction for multi-family is there?  What do locals think about the prospects for rental rate increases in the next 3-5 years?
  2. Visit the building and record your own impressions.
  3. Examine financial information provided by the seller.  This should be at least a pro forma and a copy of the rent roll.  Ask for a profit and loss (P&L) report and income tax Schedule D, if available.  The more you expect to spend, the more thorough you should investigate income and expenses.  Look for concurrence between rent rolls, pro forma, tax records and other financial data.  It is possible for a seller to overstate income on tax forms in order to mislead a buyer -- a little extra income tax paid for a year or so is nothing compared to the potential income from a profitable sale.
  4. Find the property on a map (see web links).  See where it sits in relation to shopping centers, schools, bus routes and parks.  What elementary and high schools serve your property?
  5. Is the property visible from a busy road?  Advertising by sign is much cheaper and more effective than any other means.
  6. Visit PVA to find out how much the current owners paid for the building and how long they've owned it.  You can also see what its current taxable value is.  Look at past records to see how quickly property values are increasing in the area.
  7. Gauge the culture of the property.  Visit the building on a week day and on a weekend night.  Talk to a tenant or two. 
  8. Look for maintenance indicators.  Are window blinds in good shape, etc?  Observe the grounds, hallways and parking lots. 
  9. Check out the crime rate and the types of crime in the area by exploring RAIDS Online, a "crime map" website partnered with the Lexington Police Department that provides constantly updated information: RAIDS Online.
  10. Call the police department's dispatcher and talk to the cops who patrol the area, particularly during evening hours.  Find the appropriate dispatch office number here:  http://www.lexingtonky.gov/index.aspx?page=72.
  11. Make a pros and cons list.  What does the realtor think?  The property manager?  The lender?  Your accountant?  You?
5 DECIDING TO MAKE AN OFFER -- Once you get serious about a property, check out the building in a little more detail.  Inspect each apartment, and/or hire a professional inspector to make an assessment.  Though costly, this gives you a quick sanity check of price vs. value.  For example:  Look at appliances, HVAC and electrical boxes.  Are floors solid, especially in the bathroom?  Carpet, vinyl, tile OK?  Check plumbing, window integrity, door condition and squareness (can show building settling).  Check roof, foundation, exterior walls, easements, property associations, and so forth.

The bank will probably order a professional appraisal, but you can have this done pre-purchase at your expense, but first make sure the lender will accept the findings in making a loan decision (you don't want to pay for two appraisals). 

6 ESTIMATING UPGRADE COSTS -- How much will it cost to bring the property up to snuff structurally and cosmetically?  Are you doing a quick upgrade in order to sell, or are you upgrading for long-term income?  These strategies usually have different to-do lists and price tags.  Have a property manager, general contractor or other qualified person give you an estimate.  Do you have the capital for upgrades?  Most banks will allow you to finance some extra money for property upgrades if the appraised value warrants.
7 MAKE AN OFFER -- Now that you've done your homework, it may be time to make an offer.  Before you actually purchase, you should protect yourself from possible financial problems associated with your investment property by incorporating (Inc. or LLC) and purchasing your property under your company name.  Good luck, and make some money!