Just yesterday I saw a comment on Facebook where someone said they just spent two and a half years worth of cash flow on a vacancy and wants to throw in the towel on this real estate investing gig. Apparently this was a person new to investing as they had one property and now with one hiccup wants to call it quits.
Greatest investment vehicles
This mindset is the very reason I do what I do and why I am so passionate about it. Real estate is one of the greatest investment vehicles we have at our disposal and contrary to what many will tell you it does take a great deal of diligence. Real estate investing is like golf. It is easy, but not necessarily simple. Like golf, you just hit the ball into a hole. A very easy concept that may not be so simple to accomplish.
The comparison is real estate investing is also very easy. Buy property at a price point that when a tenant pays you rent, the rent payment will cover the mortgage and all expenses with positive cash flow remaining. The true due diligence part requires a little more than the simple diligence most people put into it.
You Do Not Know What You Do Not know
Have you ever heard the expression you do not know what you do not know. I know on the surface it sounds a little strange, but think about it Until you hear something for the first time you simply do not know it and are not aware you do not know it. This really encapsulates the secrets of finding sustainable cash flow. Not actually secrets, simply something you have yet to discover.
When I talk with investors about the 7 things to look for to help insure your investment is not simply a good investment but one that will sustain cash flow and equity growth over time, they always say the same thing. Nobody has ever told me this stuff before.
Most people who invest in real estate know how to analyze numbers and understand cap rates and ROI ( This is the easy part) which makes them feel like they are able to make sound and intelligent decisions. The challenge often comes a year or two later when I hear them complain about the property no longer performing for them. When a property stops providing cash flow and or equity growth (appreciation) it typically means proper due diligence was cut short.
Investing is more than buying a property
As I see it the number one mistake made when people buy non sustainable investment is they were too quick to look at property. I see this every day. People start the process backwards and are unaware of it. They quickly want to look at property. They want to see how cheap they can get a property for and look for the spread between the purchase prices to rent prices. While this is pertinent to a good investment, it is one of the last things that need to be looked at. Remember real estate is all about location. Everyone knows this yet they overlook this when doing their due diligence. Location due diligence is job one! The best performing property in the wrong location will most always disappoint you.
7 things you should know when performing due diligence
A city that is growing in population maintains constant need for housing and creates competition in the rental market keeping strong rental rates.
Finding markets where the city has a desire to grow and the local governments have programs in place to attract new industry and businesses into the area will provide plenty of jobs for your tenants.
Remember how Detroit (Motor City) was a booming and thriving community until the auto industry packed up and started moving away. The city is still trying to recover from the loss of this economic powerhouse. It was a big industry, but the cities’ survival was dependent on this one industry and when they lost it they lost all sustainability to prosper or even survive. Insuring plenty of job diversity in an area you wish to invest in is paramount to maintaining sustainable tenants that will remain employed somewhere and continue to be able to pay rent.
An area where the unemployment is equal to or less than the national average insures you have a location that will maintain sustainable employment.
Path of progress:
Okay. so you found a city with all the above elements now to put your investments on steroids you want to invest toward the path of progress. As an example all of the city is growing to the north end of town that is where the demand is. The north end of town is where people will pay larger rents and when it is time to sell you can maximize your exit strategy and sell to the retail buyer who is also looking for this higher demand location.
For a home to be considered affordable you should be able to purchase a home for one third of your annual salary. Which means the area’s median income should buy and pay for a median price home for 33% of its gross annual salary. When you can find a market which requires less than 33% of the median income to pay for a median price home you have an affordable market. Currently there are great markets such as Atlanta Georgia where you can buy a median price home for only 20% of the area’s median income. This shows sustainable growth as the home values can rise by 13% before even being considered a balanced market. Now when you add job growth and population growth etc. the fundamentals will continue to grow exponentially.
Rent to purchase price ratios:
Locations where the rental rates in comparison to purchase price are equal to or greater than 1% of the purchase price. Known as the the 1% rule. If you buy a property for $100,000, the monthly rent should be at least 1% or $1000 per month.
Why have I not heard this before?
When I share these sustainable principles with people they always ask, why does no one else ever speak of this, why have I not heard this before. I believe it is simply they were not exposed to it yet. No one selling you a property will share it with you unless of course their property is located in such a location.
Most people concur once they understand these principles it indeed will provide for sustainability to an investment.