“Don’t stretch yourself too much with a mortgage. Buy within your means.. it’s not worth the sleepless nights.”Sarah Beeny
Setting your investment criteria is one of the most important things you will do when preparing to purchase an investment property. However, it’s vital that you understand that your investment criteria is only good if you stick to it. You must throw emotion out the door if you are going to find a deal where the numbers actually work.
Sometimes there will be multiple offers on properties which can create a bidding war. When you’ve reached your mark… STOP. Do not “fall in love” with a property. Never be afraid to walk away. Not walking away can be a costly mistake. As Kenny Rogers said, “You got to know when to hold ‘em, know when to fold ‘em, know when to walk away and know when to run.”
What can you afford?
If you are getting a loan, your lender has already determined how much you can afford. Your Pre-Approval letter will state that the lender will loan you a percentage of the purchase price (Loan to Value or LTV) up to a certain price.
Let’s say for example your lender approved you for an 80% loan to value loan on a $100,000 purchase price. This means the most they are willing to give you is $80,000, up to 80% of the purchase price of the home. Does this mean $100,000 is the max you can pay? No. It does mean that if you go over that price, the % of loan (or leverage) will go down. If you pay $110,000, the lender will not give you $88,000 (leaving the remaining $22,000 for your cash). They will instead give you only the $80,000 (leaving the remaining $30,000 for your cash).
Choosing the Area
Choosing the area is very important. Real Estate values vary from location to location. You cannot expect to get a house in Santa Monica for the same price as you would in Lancaster. Different cities have unique markets and submarkets. Knowing your price range can guide you to the areas that fit your criteria.
To narrow down your geographic criteria, consider several key factors that can affect the value of real estate, or your ability to rent it:
- Proximity to schools
- Proximity to hospitals
- Freeway access
- Proximity to dining and retail
- Pride of ownership in the neighborhood
- Crime Rates in the Area
- Proximity to Parks and Recreation
- Proximity to Business Centers
Houses vs Condos & Townhomes vs Multifamily Properties
Determining which type of property you should look for can depend on many things. Ultimately, there are benefits to every type, so make the right choice for you. In most markets, more homes sell each month than condos/townhomes or multifamily because there are usually more available for sale in any given area.
Some things to factor into your decision here are:
- Financing Options – What type of loan can you qualify for and what are the requirements of that loan? Does it require that you live in the property for a period of time? That’s often the case with FHA, VA, USDA, and other types of primary residence mortgages which are designed for personal homeowners and not investors. Make sure you understand the types of loans available to you and how much you will be required to put down. For example, don’t assume that a 3.5% down payment loan will be available to you as an investor just because it’s available to you for your primary residence. On that note, loans on multi-family often require higher deposits than even single family homes. These are questions to discuss with your loan officers BEFORE beginning your investment search.
- Exterior Maintenance – You can get a yard with a property, but then you also have to maintain a yard. Private outdoor areas are a nice perk as a homeowner, but add an expense to maintain as an investor. Whereas some condo communities offer green space, bbq’s, playgrounds, basketball or tennis courts, pools, and more, without the hassle of having to personally maintain them. There’s no right or wrong answer to exterior maintenance, but it’s something to consider when choosing which type of property to invest in.
- Costs – Most of the time, a similar quality condo will be cheaper than a home in the same area. This is for a lot of reasons: size, privacy, building vertical, etc. You can typically expect to save on price with a condo. However, condos have HOA fees to pay for common area expenses. In some HOA’s this can be several hundred or even thousand per month. Make sure you check HOA fees before buying a condo or townhome. HOAs add another level to your investment that we’ll discuss more in detail later.
- Reserves – The one perk to condos/townhomes is that the HOA typically covers maintenance on the exterior of the home including the roof, siding, landscaping, exterior plumbing, etc. This is included in your HOA fee (assuming your HOA isn’t broke and has a proper reserve to take care of such things). If after you pay the down payment and closing expenses on your first property, you won’t have much reserves left, a condo or townhome may be an attractive initial investment because you’d only need to have enough reserves to cover vacancy and interior maintenance. You won’t need a reserve for the roof or anything else that the HOA fee covers. This might mean the difference between tens of thousands of dollars in deferred maintenance expenses between a 25 year old house versus a 25 year old condo.
Should I buy a condo / townhome or a house / multifamily property?
Purchasing an investment property is a big step so it’s important to prepare yourself for the decision. Both have their benefits and their drawbacks. This section should provide some helpful things to think about before making the decision.
Benefits of Investing in a House / Multi-family:
- The entire property is yours–both land and house. You are free to remodel or make changes without the consent of others (with regards to city and county zoning ordinances if applicable).
- Houses / multi-family offer the ability to make value additions to the property like adding a bedroom, bathroom, or detached dwelling, which can increase the rental or resale value.
- Houses provide more privacy such as a private fenced in backyard, which may attract more renters in a given market.
- Houses have more parking options like in a private garage, driveway, or street parking, which can open the door to having multi-family living situations (roommates) and increase your rental income per property.
Drawbacks of Investing in a House / Multi-family:
- The homeowner is responsible for all property and lawn maintenance.
- Utility bills are typically higher because houses have more space to heat and cool than condos. (Applicable if you cover some or all utilities.)
- Homeowner is responsible for all expenses and must budget for long-term repairs to the roof, plumbing fixtures, and household appliances.
Benefits of Investing in a Condo / Townhome:
- Condos are often located near shops, restaurants, bars, grocery stores, etc. and may be easier to rent depending on the market.
- Association fees share the expense of water/sewer, trash removal, and outside maintenance which can cost the homeowner less money out of pocket for large repairs.
- There are lower barriers of entry to buy a condo because you can typically get a condo for cheaper than a house.
- Condos come with common amenities such as pool, fitness center, club house, walking trails, etc.
- There is no need to landscape or worry about outdoor maintenance in a condo.
Drawbacks of Investing in a Condo / Townhome:
- Condo association fees cost money every month above and beyond your mortgage payment.
- There is always the possibility of having noisy or inconsiderate neighbors close-by which might make it more difficult to rent your unit.
- Condos typically have less living area and storage space, which might be a turnoff for certain types of renters.
- Condos provide less privacy due to many folks sharing common areas, which might be a turnoff for certain types of renters.
- Sometimes financing an investment condo or townhome can be more difficult than financing a single family home due to special requirements by the bank.
You should know and understand the many differences between investing in a house, condo/townhome, or multi-family property before purchasing.
What is a Homeowners Association (HOA)?
A Home Owners Association (HOA) is a collection of homeowners who, in addition to owning their own home, also have a common interest in community property. The most common examples of an HOA is in a condominium. Each member of the HOA, or home owner, owns their condo space in its entirety and an equal but undivided share of the common areas such as the pool, fitness center, streets, business center, club house, or other complex amenities.
An HOA can also be referred to as a Condo Owners Association (COA) or a Property Owners Association (POA), typically for a master plan community with large single family homes.
HOAs are governed by documents which are recorded in the county in which the property is located. These documents consist of but are not limited to the Covenants, Conditions, & Restrictions (CC&Rs), Bylaws, Articles of Incorporation, Rules and Regulations, homeowner handbook, etc.
Common examples of HOA rules and regulations are:
- No dogs bigger than 10lbs
- No eating in the common areas
- Speed limit on streets within association
- Quiet hours or restrictions on number of guests
- No hanging lights or decorations on balconies or doors
- No hardwood floors on upper-level condos
- No renting your unit (or only a certain percentage of condos can be rented at once, so there is a waiting list)
Violations of certain covenants, conditions, and restrictions could result in fines or even loss of your property.
HOAs are managed by a Board of Directors which are elected by the homeowners. Typically a board of directors will oversee a management company, but some associations choose to self-manage.
Read all the condominium documents thoroughly to be sure of what you’re getting yourself into. Ask for a copy of the two most recent fiscal years and an independent third-party reserve study. Find out what the dues are and how much they can increase year to year. California, for example, only allows a 20% increase per year without a vote.
Aside from an increase in dues, an HOA can also stick special assessments on you — like for a new roof or an emergency repair. If you get into an HOA that doesn’t budget accordingly for long term expenses, you are more likely to be in a situation where you will be special assessed.
How many bedrooms and bathrooms?
This might seem obvious but the number of bedrooms and bathrooms in a property plays a huge role in how easy it will be to rent, as well as what type of renter you’re going to attract. For example, having one full bathroom per bedroom, or at least an extra half bath, will open the door to renting to roommates. Properties with 3+ bedrooms will attract more families, who are often less likely to move each year. The type of renter you desire as well as the needs of the particular market you’re investing in will help you determine the minimum/maximum number of bedrooms and bathrooms to look for.
What Returns are you seeking?
If you are buying a home to live in, your enjoyment of the home should be considered part of your returns. Most people are willing to splurge if it’s their own home. There is value in your happiness.
However if you are buying an investment home, you need to primarily consider the financial returns you seek. How much are you looking to make? Are you trying to merely break even every month and look for your returns when you sell the home? Or are you hoping to rent it each month and cash flow?
Do a rent study before purchasing and survey several similar properties in the area. Try to survey properties in a 1-2 mile radius of the property, of similar age and condition, and properties with similar amenities (pools, green space, fitness, etc). Determine what these comparables are renting for per sq ft by dividing the rent by the size of the property. Then apply that rent per sq ft to the size of the property you are looking at.
You can calculate your monthly payment based on a certain price, interest rate and loan term. Then use the rent study to determine the monthly rent you can hope to bring in. Do not forget to factor in other monthly expenses like HOA Fees, Real Estate Taxes, Repairs/Maintenance (leaky faucets, light bulbs, filters, etc), Long Term Capital Improvements (Major components – New Roof, AC, Flooring, etc).
Make sure your rent can cover all expenses and the monthly loan payments. The money left over there is your cash flow or return. Determine how much money you need to make to offset anything you could be doing to invest; such as buying stocks or bonds.
Stick to the plan
Always remember, once you determine your investment criteria, stick to it! A plan only works if you follow it.