In the quest to establish a robust real estate investment portfolio, big cities are ripe with opportunity — and with risk. Consider these five factors to help you assess the viability of any urban investment property.
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Finding urban property to invest in is a challenge. With anemic growth, economic uncertainty and properties that are scarce or mired in red tape, it’s little wonder many investors are feeling discouraged. But investing in urban real estate is still well worth the effort.
To help you in your search, here are five top indicators that show when an urban property is ripe for investment, along with a step-by-step guide for researching urban real estate.
5 main factors for choosing an investment
For pros and beginners alike, here are five primary factors that will influence the attractiveness of an urban real estate investment:
1. Neighborhood real estate data and trends
Realtors paying board or association fees have full access to the Multiple Listing Service (MLS), a network of private listing services providing detailed information on public properties bought and sold. Analyzing this data provides an objective, apples-to-apples method for assessing investments, considering factors like:
- Total sales (in a city, neighborhood, street or complex)
- Average price per square foot
- Average selling price
- Average days on market
2. Follow the media
Neighborhood newspapers, blogs and magazines will often preview large infrastructure/commercial projects that can stimulate an increase in local property values.
- Transit: Governments invest aggressively in development studies and growing neighborhoods, so it pays to Google search for expansion announcements in your target area.
- Property or Land Developments: Larger developments can attract subsequent investments in a ripple effect. Read local Realtor blogs, newspapers and websites like Inman or Curbed to stay abreast of developer activity.
- Neighborhood Reviews: Look to local magazines or city council activity for clues and trends: Which areas are attracting families? Are multi-family complexes popular with millennials?
3. Spillover opportunities
This concept is simple: Hot real estate markets often spill over into surrounding neighborhoods, so it makes sense to widen your search to encompass nearby communities.
4. Socio-demographic stats
Urban investors will often access public resources (e.g., Portland, Oregon’s Portland Plan) to study crime stats, per capita income, vacancy rates, and other factors to predict a neighborhood’s future trajectory. Look for trends rather than one-time snapshots.
5. New businesses
Piggy-back on the research resources of big corporations. For example, the Starbucks corporate team researches demographic and income trends to choose new franchise locations that will yield a steady, long-term influx of customers. Also watch for antique stores, urban furniture stores, major brand outlets and pet services (because people need disposable income for pet care).
Choosing a Winning Investment: A Step-by-Step Guide
Now that we understand the factors that can impact an investment, let’s take a look at how real estate investors find promising properties.
1. Independent research
Google street view and images are useful, but only a visit by you or your Realtor can reveal a property’s surrounding environment and potential shortcomings. Are there a lot of properties for sale? Are local businesses struggling? Any promising spillover opportunities?
2. Monitor social media
Curate a specialized information funnel for an inside glimpse into what a specific area has to offer. Monitor neighborhood pages and posts to form a realistic sense of local investment opportunities, and follow bloggers who produce content related to your areas of interest.
3. Data collection & analysis
Relying only on reputable resources is paramount.
Look at data as a trend, not as a snapshot. Rather than the small details, monitor broader basics such as:
- Average list price
- Average sale price
- Average days on market
- % of stale listings (within a given time, usually one month)
- Average rental rates (for various housing types)
Simplify the process by using free resources and analysis subscription packages. Pay for (or create) a pre-populated spreadsheet to automatically calculate formulas based on your data. Key formulas to include:
Gross Operating Income (GOI)
Formula: Gross Rents Possible + Other Income (e.g., parking, laundry machines, etc.) = Potential Gross Operating Income – Vacancy Amount
- Estimates the income an investment property will generate.
- Where the vacancy percentage is unknown, use the rate from comparable neighborhood properties. (Canadian investors can use CMHC calculations.)
- Necessary for calculating Effective Gross Operating Income.
Net Operating Income (NOI)
Formula: Gross Rents Possible + Other Income = Potential Gross Operating Income – Vacancy Amount = Effective Gross Operating Income – Operating Expenses (e.g., utility costs, property tax, etc.)
- Required to determine an investor’s Return on Investment (ROI) as well as Market Capitalization Rate.
Market Capitalization Rate (Cap Rate)
Formula #1: Net Operating Income / Market Value
Formula #2: Net Operating Income x Estimated Market Value
- Estimates the purchase prices of similar income-producing properties
- Best for comparing the known Cap Rate of a particular neighborhood to Cap Rates of specific properties.
Estimate Market Value
Formula: Net Operating Income / Market Cap Rate
- The predicted price a property will sell given current market conditions.
List to Sale Ratio
Formula: Actual Sale Price / Final List Price
- The price a buyer pays for a property is a true reflection of a home’s value in the market.
- Track list-to-sale ratios to calculate genuine sales values within a hyper-local area.
Rent to Cost Ratio (RCR)
Formula: Monthly Rent / Purchase Price
- A rough estimate of a property’s expected cash flow after all expenses.
- Generally, a higher percentage equals a better return.
- Should be +0.7% or more (at least $1,570 of monthly rent for a $250,000 property)
Debt to Coverage Ratio (DCR)
Formula: Net Operating Income / Debt Service
- Confirms that a property’s income can cover its mortgage and operating expenses.
- A DCR of 1 is break-even (many lenders require a minimum DCR of 1:1 to 1:3 for a mortgage loan).
Return on Equity or Return on Investment (ROI)
Formula: Net Income / Total Down Payment
- Offers a snapshot of return rate for invested funds
- Provides a clearer picture of a property or a side-by-side comparison of various properties.
- Can be calculated with or without property appreciation.
- Higher returns usually result from higher risk
Price per Square Foot (PSF) or Rent per Square Foot (RSF)
Formula: Market Value / Property Square Footage OR Rental Rate / Property Square Footage
- Useful for side-by-side comparison of competing property investments.
- Can indicate if a property’s rental income is overpriced or underperforming compared to similar properties.
Finding the right urban real estate investment is a task that demands objective, emotion-free analysis. By examining property statistics, trends and activity in the urban landscape with a systemized approach, you can find a positive cash-flow investment property that will grow in value year after year.
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