THE MOST IMPORTANT FACTORS FOR INVESTING IN REAL ESTATE
Compared with other types of investments, real estate investing involves a relatively favorable risk/reward profile, with relatively low liquidity (ease of entry and exit). Let’s see some of the most important factors to consider when investing in real estate.
- Location of the Property
Why is it important? The age old punch line “Location, Location, Location” still rules and remains the most important factor for profitability in real estate investment. Proximity to amenities, peaceful conforming areas, neighborhood status, scenic views, etc. are major factors for residential property valuations. While proximity to markets, warehouses, transport hubs, freeways, tax-exempt areas, etc. play an important role for commercial property valuations.
What to look for? A mid-to-long-term view, about how the locality is expected to evolve over the investment period. Today’s peaceful open land at the back of a residential building may be developed into a noisy manufacturing facility in future, making the residential valuations less profitable. It is advisable to conduct thorough check about ownership, type and intended usage of neighboring areas, establishments and free land in the locality.
- Valuation of the Property
Why is it important? Real estate financing during purchase, listing price during the sale, investment analysis, insurance premium, and taxation — all depend on real estate valuation.
What to look for? Commonly used valuation methodologies include:
- Sales comparison approach: Recent comparable sales of properties with similar characteristics –most common and suitable for both new and old properties
- Cost Approach: All cost summation minus depreciation – suitable for new construction
- Income approach: Based on expected cash inflows — suitable for rentals
- Investment Purpose and Investment Horizon
Why is it important? Given the low liquidity and high-value investment in real estate, lacking clarity on purpose may lead to unexpected results including financial distress, especially if the investment is mortgaged.
What to look for? Identify which of the following broad categories suits your purpose and prepare yourself accordingly:
- Buy & Self-use: Savings on rentals, benefit of self-utilization and value appreciation
- Buy & Lease: Regular income and long-term value appreciation. Requires building a temperament of being a landlord — for handling possible disputes & legal issues, managing tenants, repair work, etc.
- Buy & Sell (Short-term): Quick, small to mediocre profit – usually buying under construction properties and selling slightly high once ready
- Buy & Sell (Long-term): Large intrinsic value appreciation over a long period; a solution for long-term aims like retirement planning, child’s education, etc.
- Expected Cash Flows & Profit Opportunities
Why is it important? The investment purpose and usage influence cash flows and hence profit opportunities.
What to look for? Develop draft projections for the following modes of profit & expenses:
- Expected cash flow from rental income — Inflation favors landlords for rental income
- Expected increase in intrinsic value due to long-term price appreciation
- Benefits of depreciation (and available tax benefits)
- Cost-benefit analysis of renovation before sale to get better price
- Cost-benefit analysis of mortgaged loans vs. value appreciation
- Be Careful with Leverage – Know the Pitfalls
Why is it important? Loans are convenient but may come at a big cost — you commit your future income, to get utility today for a cost of interest spread across many years. Understanding how to handle loans of this nature allows you to benefit from it to the maximum. While ignoring the risks can lead to major pitfalls.
What to look for? Depending upon your current and expected future earnings and paying capability, consider the following:
- Decide on the type of mortgage loan that best fits your situation (Fixed Rate, Adjustable Floating Rate, Interest Only or Zero Down Payment)
- Be aware of the terms and conditions and other charges levied by financiers
- Hunt around and bargain for a better deal using a tool like a mortgage calculator to find lower interest rates. Also look for lower insurance premiums.