What Makes a Good Real Estate Investment?
If you are looking to make a good real estate investment the first thing is to establish what that means to you. One definition of this concept is that you should receive a better return on your real estate investment than if you were to have invested the same amount of money into another investment vehicle with similar risks. So how do you determine the “good deals”?
Investment Properties
Investment properties can earn income for you in a couple ways. The first is through positive cash flow. If you keep your expenses each month under the amount of rent that you receive on the property you end up with positive cash flow. For example, if you invested $70,000 cash into an investment property and receive monthly rent of $1,200, with expenses for the month of $750, you have a positive cash flow of $450 (or $5,400 per year). To determine your cash on cash return you divide the yearly cash flow by your investment. In this example your cash on cash return would be over 7.5%.
The second way that you can earn income on an investment property is through appreciation. You want to find a piece of property to invest in that is in an area where properties are expected to appreciate in value. For example if you choose a property that after doing research, you expect to appreciate annually around 1%, your total between cash flow and appreciation would be 8.5%.
This percentage is higher than many other investment vehicles, which would mean you made a good investment. However, you need to remember that before calculating your percentage of appreciation you need to first subtract from the number any expenses on property repair that would add to the value.
Many times these types of properties are found in moderately priced areas. A lot of times the “high desired” properties like waterfront condos or downtown lofts actually have negative or extremely low cash flows. Contrary to popular belief, these properties don’t tend to be the best investment properties.
Personal Properties
When it comes to purchasing a personal residence it can be harder to determine what a “good investment” is. One thing you will want to consider is the five year rule. It is recommended that if you do not plan on living in the house as your personal residence for at least five years it will not help add to your bottom line. There are many transaction fees involved with buying and selling a house, so if you only plan on staying for a year or two it is usually financially smarter to rent.
The rule of thumb is the longer you hold on to a property, the better real estate investment it becomes. As you make principal payments on the mortgage you begin to have more equity in the house, and as the years go on, the property will usually appreciate in value. When deciding to put your money into a real estate investment it is important to weight the options of an investment property or personal property, and to do the math.