My first rental property was a money sucking and loss making property, what you could call “a money pit” in the investor’s lingo.
Interestingly I only heard the term” money pit” after I started my property investor career.
The first rule for success
I had violated the first rule for success in the real estate – buying right.
There is an axiom in real estate investing and its “the money is made when you buy”. This holds true for many real estate investor. Violate this rule and you could end up broke and lose your property.752FHX833HGP
The real estate market is now in its down cycle with house prices plummeting and house value underwater. Foreclosures and repossessions are at an all time high. However, if you are investing for the long term and want to create wealth, this is the best time to buy undervalued properties.
If you are starting out as a beginner investor, you will learn how to buy right and side step the errors and trials I made during my early years. In addition, if you are under water from making a bad investing decision, this article will help you avoid further losses as you progress as an investor.
Sir John Templeton, legendary investor and founder of the fidelity funds group says, “Buy at the point of pessimism and sell at the point of optimism”. This is your time to buy, not just buy but also buy right.
Let us now dive into what it takes to buy right.
Mindset of a real estate investor
The first thing you must do to buy right property as an investor-is to have a mindset change. This is because buying your personal house and buying an income producing property take two different set of mindsets.
An investor buying a property is looking for; value in a property. He is looking for income and potential for capital appreciation. On the other, hand a homeowner is looking to buy, in a nice neighborhood with good schools in a nice area.
An investor is looking for a property in a location that attracts renters; that is within commuting distance from their work, close to shops, clubs and so forth. Do you get the picture?
Develop a system
The second factor you need to have is to have a system for finding the right property- your workhorse value scout. What is your workhorse value scout? They are like your homing radar to spot the right property. They help you assess the feasibility of an investment property. The main values you need to evaluate your potential investments are the cost per square foot and gross rent multiplier
Cost per square foot is the average cost per foot you are paying for the property.Here is how to use this (CPF) cost per square foot;
Let us a take a property with an asking price of $100,000, a 2 bed, 1 bathroom property with total square foot of 2,000 square feet. The cost per square foot here is 100,000/2,000= $50 per sq foot.
This number is important because you can compare the average cost per square foot in your target market. You can get this information from your local county property appraiser or land property registrar in some countries. You are looking to buy properties that are below the average or near the average CPF.If you compare this number with the average cost per square foot and it is above the average then you might be overpaying, hence you can renegotiate.
A word of caution here, in using the cost per square foot, always compares “apples for apples and not oranges for apples”. What do I mean, compare properties with similar size and in the same area , for example a 2 bedroom 1 bath property to a 2 bedroom 1 bath apartment, not 3 bed 2 bath to 2 bedroom 1 bath property.
The next value you need to use is the…
Gross rent multiplier
The gross rent multiplier is another value you can use to see if a property is over or under priced. It is not a precise tool but this can give you a quick indication whether you a buying a loss maker. The GRM calculated, by dividing the average price of recently purchased or sold house by the annual gross income from renting a comparable house in the area.
Gross rent multiplier = market value recently sold property/ annual gross rental income
Let’s use an example: A property that recently sold in your target market for $100000 with gross annual rent of $5000 has a GRM of 20.
The GRM is just a guide to estimate the approximate value.
Here is my own experience of using this two work scout values… I generally tend to offer around 25 percent below the cost per square foot and 75 percent of the GRM. There are other factors, I consider such as; cost of financing; vacancy rate and the condition of the building. When you find potentially promising properties, you can then do your due diligence on the properties and select the best property that will yield positive cash flow.
Action Guide
If you are new to real estate, investing here is what I would advice:
- Choose an area not too far from home and start looking. You don’t need to have any money. This is just to begin to train your mind to see opportunities in real estate investing
- Start collecting those free realtor newspaper and checking the property prices for rental property in your area.
- Spend a few minutes daily browsing the real estate classified websites, I’ll supply you a list in a minute
- Find out the top realtors in your area, call them and introduce yourself as someone who is interested in investment properties. Ask for the average house price for the type
- Get registered with a realtor so they can help you search the multiple listing service MLS
- Analyse the properties you find with the average cost per square foot and gross rent multiplier
- Draw up a list of areas and properties you find reasonable. Start viewing and analysing them.
- I suggest you view at least 100 properties , choose 3 and make an offer on
- Do not worry if you get a counter back offer. If you feel pressured to make an offer use my common get out clause “I need to speak to my partner about this”
The bottom-line is take action, fail quickly, correct and keep on trying.
It was hard for me doing my first deal, however I learnt from my mistakes and went on to buy properties that have been yielding cash flow and returns on my money.
You make money in real estate, when you buy right. Your keys to making money when you buy is to sniff out the right deals….you can accomplish this by knowing the average cost per square foot, gross rental multiplier and buying below these averages.
Happy investing
Useful links
Creative real estate online. This website is one of the largest community of real estate investors. I have met JP Vaughan and her husband in their annual conventions. You will find tons of useful articles and i find the forum very useful
Rich Dad.com This is the website of entrepreneur Robert Kiyosaki , author of Rich Dad Poor Dad. you can join the rich dad community, and play the cashflow game to simulate and develop an investor’s mindset