Despite the sluggish market, it is still difficult to find a "steal" in this day and age. A good starting point for the negotiation is often 20% below the list price, with a target purchase price of 10-15% below market value.
But even after your bid is accepted and the property is under contract, its value still may be reduced via the appraisal (required for bank financing) and/or the home inspection (recommended, especially for new investors).
For example, whenever an appraised value comes in too low, the seller may be forced to reduce the previously agreed-upon property price or make some alternative arrangement. Similarly, a bad inspection report may force the seller to either make the needed repairs or adjust the price.
GENERAL PROPERTY VALUATION GUIDELINES
Investment property valuation is primarily determined by the property's income, location, and condition.
Property income is determined by adding all the monthly rents in each unit, and subtracting expenses such as the mortgage, property taxes, insurance, utilities, lawn care, water and sewer, etc. You'll also want to assume a 10% vacancy rate in your numbers, meaning that on average 10% of your gross income will be missing due to tenant turnover. If, after subtracting all the property expenses from the gross rental income, you are cash flow positive, then the property warrants further consideration. If on the other hand you end up with a negative cash flow number, walk away.
Remember that larger units with more bedrooms command higher rent, and thus have greater value. So all else being equal, you'll want properties with multi-bedroom units. An added benefit is that 2-3 bedroom units tend to have a more stable tenancy. Conversely, 1-bedroom apartments tend to attract more of a transient population, which means the turnover is typically greater.
From a location standpoint, rental properties in older, lower-middle income neighborhoods usually offer the greatest bang for your buck. Plus, your tenant universe is typically larger in these areas. That said, I try to avoid densely urban or very low income areas.
In terms of condition, the ideal target property will be older (50 years or more) and will have cosmetic deficiencies or simply look "tired." These fixer upper properties can provide great value for your dollar because of the "sweat equity" that you will build up as the repairs are made.
COSMETIC VS. STRUCTURAL
General property valuation rule: cosmetic problems = good, structural problems = bad! Structural issues will absolutely kill property value.
By "cosmetic," I'm referring to things like:
- Peeling or old paint
- Old carpet
- Broken light fixtures
- Damaged kitchen cabinets
- Torn vinyl flooring
- Accumulated junk or clutter
- An unkempt lawn
- Overgrown shrubbery
- Dirty siding
- Old appliances
- Decrepit bathroom fixtures & towel racks
- Old doorknobs
- Old outlet & switch plate covers
- Damaged mini-blinds
- Broken windows
- Any other "quick fix" you can think of
Structural issues, or issues where you must proceed with extreme caution, include:
- A severely cracked foundation or walls
- Galvanized piping
- Leaning chimney
- Outdated electric (i.e., knob & tube wiring)
- Severely sloping, cracked or warped floors
- Pervasive asbestos
- Rotting wood in the frame
- Lead paint
- A long-running leaky roof
- Buried underground oil tanks
- HVAC problems
- Mold
Note that I am not saying to avoid these issues in all cases. Run the numbers to determine the feasible range of prices you'd be willing to pay. If you can buy an investment property on the cheap, then perhaps you'll be able to afford a new roof, an electric upgrade, or even mold remediation and still come out ahead.
It all depends on the purchase price, your property valuation conclusion, your level of experience, and the strength of your stomach.
PROPERTY VALUATION "SQUEEZERS" TO AVOID
And finally, here's a list of things that'll kill property values...avoid them!
- Properties with serious structural issues or that are poorly constructed.
- Properties where all units are of the single-bedroom variety.
- Properties that show "economic obsolescence," such as those with very short ceilings, or those with many bedrooms but only 1 bathroom for example.
- Twins, condos, row homes, etc. The property prices on these types of structures usually do not appreciate as much as detached structures.
- Properties with wells and septic systems. These systems could create a lot of problems and added expense down the road.
- Property values are negatively impacted whenever the utilities are not separate. I've literally seen tenants crank the heat up to 90 degrees F in the winter but leave the windows wide open. The only utilities you as a landlord should be paying are water and sewer.
SUMMARY
To sum it up, investment property valuation boils down to the numbers, the location, and the condition of the property itself. Run the numbers to make sure that the monthly rental income will cover all of your monthly expenses, make sure that the property is in a relatively decent area, and make sure there are no serious structural deficiencies. If you find a property that meets these criteria – congratulations, you've found a solid real estate investment!
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