How To Invest In Property The Right Way

August 8, 2013

Since you most likely don’t want to live in a dumpster, (especially during the winter) you’ll most likely exchange money for a place to live. I know, this is a brand new concept to most of you. Or, if you want to get really fancy, you’ll buy a place to rent out to other people.

But how do you decide what property to buy? Do you just print out feature sheets of all the properties, blindfold yourself, and let a dart decide which place you’ll call home? Nah, that’s a sucker’s game. Here’s how to invest in property the right way.

First of all, you’ve got to figure out what your return on investment is. Figuring out your potential rent is a straightforward affair, all you need to do is look at comparable properties on Craigslist or your local paper and see what they’re renting for. The only potential downfall is overvaluing your property for reasons that only make sense in your head. Ask your realtor or a friend for a second opinion. A good rule of thumb is your monthly rent should be more than 1% of the purchase price of your place.

Next we’ll look at expenses. This is pretty simple, once you’ve factored everything that can possibly happen. Depending on the property you buy, you’re looking at condo fees, insurance, property taxes, maintenance and repairs, vacancy, and any fees a property manager might charge. Many potential landlords underestimate a renter’s ability to be hard on a property, so they’ll often assume less costs for repairs and vacancy. As a quick rule of thumb, I use 25% of gross rental income to be lost to regular expenses. Some years you’ll have more and some years less, but I’ve found the average works out to about that number.

This is all fine and good you say, but how about the good stuff. You promised the right way, which implies some deep dark secrets or something. Okay, fine. Here are mistakes I see landlords make all the time.

1. Assuming the market always goes up

Unlike the U.S., Canada’s real estate weathered the storm of the great recession. This is obviously good news for real estate investors, who cheer from the sidelines as their property becomes more valuable. But as investors have watched the market grow, they’ve accepted terrible cash flows because they’re just assuming property values will go up forever.

My rule of thumb is very simple. I assume a property will never increase in value. This accomplishes one major thing, and that’s discipline. Real estate can be a risky investment, and that’s my built in margin of safety. Rather than thinking of capital gains as something that happens every year like clockwork, view them as a nice bonus that you might get in the future.

In the meantime, just buy properties that easily pass the 1% rule from earlier. And if you can’t find any properties that fit the criteria, then maybe it’s time to move your money to a different asset class.

2. Renovations with no return

The second biggest mistakes small landlords make is they spend too much money fixing up a place that a renter is just going to trash anyway. Finding a renter who treats your place as nicely as you do is next to impossible.

Before you do that kitchen renovation, actually crunch the numbers. If it’s going to cost $10,000 and you can only get an additional $50 a month in rent, it’s probably not something you should spend money on.

Big landlords get this, and they know how to really maximize their investment when they spend on improvements. Painting is inexpensive (provided you do it yourself, and you can), and gives a place a nice new look. Rather than redoing the whole kitchen, a savvy landlord might just replace the flooring or the countertops. It’s easy to renovate a place so it’s up to your standards, but just remember that owning rental property is a business, and that business should be motivated by the bottom line.

3. Neighborhood

You’ve heard the same advice about buying the worst house in the best neighborhood a million times now, so it must be true. I guess it is, but there’s a better way. You might not like it, but remember, this isn’t a vanity contest.

All you have to do is buy a property in a neighborhood that’s a little more fringy. Why would I recommend that? There are two reasons.

Like every market, real estate is driven by supply and demand. If more people want to invest in the nice part of town, that’ll depress prices across town. Depressed values usually mean greater cash flow for the investor, along with capital gains if the market goes up. Also, more people rent in the poorer parts of town, increasing your pool of potential renters. Your rental property may look like a crack shack, but do you care if it’s churning out a nice return?

Investing in property is hard. You have to deal with dirtbag tenants, constant repairs, paying a mortgage, along with a million other things. Hopefully these tips can help you profit on your next rental.

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  • Mrs Pop @ Planting Our Pennies August 8, 2013 at 10:45 am

    Renovating with no return is something I never got. We like to have nice, clean units and not be slum lords. (Our property is what you might call fringy – I call it a blue and no-collar area of town.) But we try to only make renovations when they are really necessary to keep the shape in a reasonable condition. For example, when the heating element in the older oven went out last week, we didn’t go out and buy a brand new oven when a $40 part fixed this one and made it fine again.

    • Marissa August 11, 2013 at 1:24 am

      And that’s how this stuff should be done. Most people don’t get that, tho.

  • Sean @ One Smart Dollar August 8, 2013 at 12:02 pm

    I think up until five years ago most people didn’t really think about the housing market actually goes down. Things have changed and now it’s a must to invest in real estate at a time that isn;t showing inflated prices.

    • Marissa August 11, 2013 at 1:24 am

      Agreed. A lot of Canadians are looking at investing down south.

  • Todd @ August 8, 2013 at 12:49 pm

    Whoa–monthly rent should be more than 1% of the purchase price? That would be mean rent in a $450k home in San Diego is $4500 a month. That’s outrageous. It’s definitely not happening here.

    • PK August 9, 2013 at 10:59 am

      To be worth landlording, certainly – remember, the homes people buy for purchase (read: to live in) are often higher quality than the homes worth renting out. If you’re going to become a landlord in SD, don’t buy million dollar homes that rent for $3,600… buy marginal homes outside the city using the 100x rule Nelson mentioned.

      • Marissa August 11, 2013 at 1:23 am

        Completely agree, the only exception would be if you’re looking at an executive rental.

      • Todd @ August 12, 2013 at 11:35 am

        Thanks for expounding on the thought. Even still, a marginal home in the lower-end neighborhood is at least $300,000 here. The community that lives in those neighborhoods can’t afford $3k a month.

        Maybe San Diego is unique. The County Treasurer stated to me that San Diego hasn’t lost nearly the amount of value other regions did, and that’s in part artificial. The inventory of new homes is almost nil, so prices are higher than they should be.

    • Marissa August 11, 2013 at 1:23 am

      Read PK’s comment.

  • Mark Ross August 9, 2013 at 11:01 pm

    You made great points there, especially the renovating part. It’s really not worth it if you spend too much and get little to nothing in return. Excellent post, this can help a lot of aspiring real estate investor. Thanks!

    • Marissa August 11, 2013 at 1:22 am

      Nelson gives great advice. Thanks for stopping by!

  • Buck Inspire August 11, 2013 at 5:01 pm

    Great advice for being disciplined and analyzing if your home improvement will give you a good ROI. How did you figure using 1% above your purchase price for rent?

  • Kostas @ Finance Blog Zone August 12, 2013 at 10:39 am

    Love the advice with no expectations. I have seen a few guys taking on the estate market by investing into buildings that need renovations only to find out that the selling price wouldn’t be worth it after all those additional investments!

  • Adam Garcia August 12, 2013 at 2:52 pm

    I never considered adopting the mindset that my investment property will never increase in value to discipline my spending. That is an interesting frame of mind when buying investment property.

  • Michael @ The Student Loan Sherpa August 12, 2013 at 8:55 pm

    I don’t think I’ll be investing in property, but instead of selling my first home, I may keep it as a rental.

  • SuburbanFinance August 12, 2013 at 10:36 pm

    Thank you for your Post. I have always been interested in investing in Property. You’re post had given me ideas that I can use whenever I am ready to get my own.