Porcupine Real Estate Blog
Investing 101: What to Consider When Buying an Investment Property
Investing in real estate is not just for wealthy individuals. In fact, starting a real estate investment portfolio is often the best way to build your own source of passive income and long-term wealth. And the best part? You don’t have to be independently wealthy to do it. Not sure where to start? We’ve compiled a list of our most frequently asked questions:
What is the best way to determine if an investment will have a strong return?
There are two methods many investors utilize:
- Cash yield or cash-on-cash return: This is your annual net income divided by total cost of acquisition (down payment + closing costs). This is often in the 10-15% range, depending on a lot of factors, including amount of leverage (financing). An all-cash acquisition will give you a much lower cash ROI than if financing is used.
IRR: Sophisticated investors also look at projected IRR (internal rate of return). This is a more detailed number that includes depreciation and usually is carried out over several years to include debt pay-down, future selling price, and expected appreciation.
- Cap (capitalization) rate: Cap rate is different than cash yield and is based on estimated annual net operating income in the first year divided by purchase price. For example, if you buy a property for $200K and your monthly net operating income (revenue - expenses) is $1,000 ($12,000/year) then your cap rate is 6: (12,000/200,000)*100 = 6%. Most investors use cap rate as a quick filter to calculate worthiness of a prospective investment. Most cap rates are around 5-6% right now (April 2020).
Cap rates are the same whether you buy a place cash or use leverage (financing). That is because the NOI is calculated before debt service.
Note that a higher cap rate often correlates with a higher-hassle property. Stable properties in nice neighborhoods have lower cap rates, whereas (in general) the higher cap rate properties have more turnover and are more management intensive. It's a tradeoff.
Net operating income is easy to calculate based on expenses (property taxes, insurance, utilities, maintenance, property management, etc.) and expected revenues (rents minus a vacancy factor). It’s best to consider what your expected cap rate is, and you can find this by analyzing it across many properties to see what area cap rates are in today’s market. There are many other factors to consider, such as deferred maintenance costs, area/location, expected vacancy, future rent increases, and more. We’ll help you look at the whole picture when evaluating a property.
When evaluating the property financials, you'll look at scheduled rents and then add a vacancy factor. Next, you'll look at the ongoing expenses and recent past expenses for ongoing maintenance. These will give you an expected NOI based on yesterday's numbers. Then we drill down to see if there is room to raise rents and also whether there is a big capital expenditure (known as CAPEX) expected in the near future, such as a new roof or boiler, or if you will want to replace old windows with newer vinyl windows.
For each listing in MLS, there will typically be a multi-family rider disclosure that shows these details. You'll use these and then put the numbers into a simple spreadsheet to calculate your expected NOI and cap rate across properties. It doesn't matter which tool you use, only that you are consistent in using the same analytical approach across properties (apples-to-apples comparisons).
Ultimately, you will want to look at the investment not only through Pro-forma financials but also subjectively regarding your comfort level with the building’s location and condition.
Should I buy a property with cash or finance it?
We suggest you use mortgage debt; it will get you a bigger/better building, it may increase your deductions against the rental income for tax purposes, and it can provide a little more protection against possible lawsuits. There are many resources online to look at the pros/cons of financing vs. cash purchases. NOTE: We do not give tax or legal advice. You should always consult a tax professional for tax ramifications and an attorney for legal advice.
Which city is best for investment: Manchester, Concord, or Nashua?
All three cities are comparable. Prices and rents are higher in Nashua than in the other two cities because so many people commute to jobs in Massachusetts. All three cities are currently (April 2020) enjoying very high occupancy rates, near 99%, and vacant units typically rent quickly. There are some new apartment complexes coming in the next year, which will likely cool demand a bit.
Concord is a much smaller town than Manchester or Nashua. It has higher property taxes, but rents are comparable to Manchester. There is a law school there and lots of government/state jobs.
Manchester has a requirement for an inspection by the city every three years, called a “Certificate of Compliance.” They check health/safety issues like door locks, heating system, smoke detectors, no broken windows, etc. The other two towns do not have this requirement.
Within each market, especially in Manchester and Nashua because of their size, there are submarkets, pockets, or neighborhoods where you can expect higher or lower cap rates than other parts of the same town. This is why we shouldn't characterize the cities as better or worse and why you should work with an experienced agency like Porcupine Real Estate.
How are you, as my real estate agent, paid?
All commissions in New Hampshire are paid by the seller. In effect, we work for you for free until the transaction is complete and closes. Because of this, we ask for a mutual commitment when working with clients. We will give you excellent service and always put your interests first; in return, we ask that you agree to use us exclusively as your buyer's agent. We don't want a situation where we invest a lot of time and energy up front and then you, for example, call a listing agent directly for information, which could preclude us from fully representing you.
What other factors should I evaluate when looking at an investment property?
Here are some criteria that are important to consider when looking at a listing:
- Does it have off-street parking? (very important)
- Are the utilities separated: heat, hot water, gas meters, electric meters)? (hugely important)
- How old are roof, boiler, and windows?
- Unit mix, i.e. how many bedrooms in each apartment?
- Other factors like: heating fuel source, any knob & tube wiring or asbestos, flat roof vs. pitched roof, size of yard, vinyl siding or something older, does basement have dirt floor, how long have tenants been there, and more.
Our agents are experienced investors who can help you throughout the entire process, from identifying a property to closing the deal. Contact us today to start your journey toward owning an investment property.