While real estate is a great investment choice to both diversify your portfolio and create a new source of revenue, no two properties are alike. That’s why it’s critical to evaluate every potential property through multiple lenses to fully understand the potential risks and outcomes.
Each time I analyze a deal, whether it’s for a client or my own personal portfolio, the properties often require consideration in four areas. By adding the below steps to your evaluation process, you can further ensure that you are set up for a successful long-term investment.
1. Evaluate the local market
The market in which the property is located matters just as much — if not more — than the property itself. Analyze the surrounding metropolitan area to ensure there is a robust and desirable market to generate cash flow.
These factors can influence the long-term viability of an investment property:
- School ratings
- Net migration in and around the area
- Details of the municipal government
- Average resident happiness
- New constructions that imply economic growth (such as corporate headquarters, new hospitals, schools, industrial plants, etc.)
When you are evaluating the market, look for factors that indicate whether the area itself will continue to grow over time. Avoid shallow signs of temporary growth, such as a hot market without the infrastructure to support it.
Today’s real estate markets can be challenging to gauge based on price alone. Therefore, even if prices are rising, low resident satisfaction scores and low school ratings will almost always indicate that a property is not an ideal investment.
2. Analyze the area’s financial potential
If the market looks appealing, it’s time to take a deeper dive into the area’s economic strength. Are many investors entering the area? As previously mentioned, the new construction of hospitals, schools or corporate headquarters indicate confidence in the region’s growth potential.
Alternatively, does the area look like it is waning economically? Declining population levels caused by residents moving away or over-reliance on jobs in a single industry could indicate more economic turbulence than you should risk.
While there is no way to know for sure if an area will boom or bust, it is important to mitigate the risk through due diligence. Perform a sales comparison to gauge your potential property’s value against comparable local properties, and create a projected cash flow analysis.
3. Consult other real estate professionals
It is wise to assess an investment property through multiple lenses, including perspectives other than your own. Even professional investors can have an unintended bias for or against a property that will cause them to miss important clues.
Consult with other real estate professionals, including fellow investors and local property managers who understand the market and already engage with your tenant demographic. This is particularly important if you’re unfamiliar with the region.
If you consult with a property management professional, ask them these three questions:
- Do tenants tend to renew their leases year after year, or is there a lot of turnover?
- Is the neighborhood desirable or up-and-coming?
- Has the market been stagnant? If so, for how long?
4. Always conduct an inspection
In hot real estate markets, overly ambitious investors may be inclined to skip the property inspection. Sellers of in-demand properties may have more leverage with regard to contingencies, and therefore, buyers may be more willing to waive a property inspection.
Don’t fall into this trap. General inspections, especially when handled by reputable professionals, offer insight into the costs of upgrading or even simply maintaining a property.
Without a thorough inspection, you may uncover problems later that seriously impact your cash flow. Instead of considering a property that needs a lot of work or doesn’t have an inspection on file, look for properties that have recently had an inspection, or get your own inspection done before making an offer.
It’s better to have a report in hand before deciding on a property, even if it means losing out on a fast-moving deal with too many unanswered questions.
Every investment property is unique. The history of repairs, the market conditions of the area surrounding the property and the long-term growth potential of the region — as well as your own risk preferences — all factor into whether a property is the right fit for your portfolio.
Analyze these four areas thoroughly so you have a solid understanding of your expected return on investment. With preparation, education and analysis, you can successfully make real estate investing a part of your long-term, wealth-building strategy.