Location, Location, Location

If money is made in real estate when acquired, then no single factor is more important than where the property is located. I know its clichéd but it is absolutely true. Generally speaking, the same factors that drive up home prices are what impacts rental markets.

When choosing a rental property, cheaper is not always better. A low price property may only bring in low rents and more than likely will lead to more headaches than the amateur investor wants to deal with. Ideally, finding a multi-family property built within the last 20 years, not located in a high density multi-family area, but rather mixed in among single family homes is perfect.

Many cities tend to keep multi-family dwellings zoned separately from single family homes. We were fortunate that our first duplex, which we lived in for nearly four years, was a new construction on a street with other duplexes but embedded within a community of predominantly single family homes.

Finding a city such as Killeen, TX that zones in this manner is unique but there are some. Regardless, if a multi-family property is sitting in an undesirable part of town, it will be very slow to increase in value or rents. Look for multi-family homes located adjacent to or just at the edge of desirable single family neighborhoods.

Whether single or multi-family, one of the biggest factors that determines rents and purchase price is schools. Homes zoned for well rated public schools will increase in value and rent higher. School zoning is the first thing we look at when purchasing a property.

We are always wary of fixer uppers, but an ugly duckling at the right price in a good location may be worth the gamble. Our second duplex was a bank owned property and had been vacant for a few years. It was in pretty rough shape. The worst thing that can happen to a home is to set empty!

It was located in a great neighborhood with good schools so we made a low ball offer and surprisingly the bank accepted. Took a week off from work and 10 hour days fixing it up but we’ve kept that property rented ever since and it has doubled in value!

There are several other location factors for investment properties that are mostly common sense. Multi-families located in rural areas with long commutes to employment, restaurants, grocery and retail maybe harder to rent. That doesn’t mean all rural areas are bad investments as it really depends on the type of property.

A one bedroom / one bath duplex apartment in a rural setting will have a very small market of potential renters. Younger, single people usually wouldn’t be interested in this type of home as it is farther away from work and entertainment.

Perhaps a single, retired person would be interested in renting a one bedroom in a rural setting. But how many single, retired people are looking for apartments at any given time?  The same one bed / one bath apartment in the middle of a city will demand a high rent and have a waiting list of prospective tenants!

On the other hand, a three bedroom, two bath multifamily in a rural setting that is a reasonable commute and zoned for good county schools may rent very quickly. Many families want to take advantage of the county school system and get their kids out of an urban area.

Some single folks may also be looking to take on roommates in order to save money and would be willing to move a little further out of town. The point is, consider the market for prospective tenants based on the location and type of home (square footage / number of beds / baths).

This is good old fashioned market analysis and must be completed before the purchase. Fortunately, analyzing rental markets is mostly common sense and there are tools available to help.  There are a lot of good apartment finder web sites that can be used to find comparable rents in the area to determine rental potential.

Additionally, there are many web sites that will provide school zone and demographic data to include income, family size and age for a particular area. With just a few quick internet searches, it is easy to determine if a particular area has a high density of families, retirees or single workers. 

The bottom line of all this is location, location, location determines rent, rent, rent which once you factor in the various expenses reveals how valuable an investment will be. There is a formula for this called capitalization rate which is simply the net income (rent after subtracting all expenses) divided by the value of the asset and expressed as a percentage.

For instance, if annual net rental income for a property is $10000 and the property is valued (or offered) at $100000 then the cap rate is 10%. Generally you want to be in the 8-10% cap rate range to make a good real estate investment. There are numerous ways to calculate cap rate, everyone seems to do it a little different. I recommend figuring it conservatively by using maximum projected expenses and minimum expected rents.

When considering a property, determining cap rate goes hand in hand with location, location, location and is an important first step before making an offer. Once the real estate investor finds a property that will provide the desired cap rate, everything else about real estate investing should fall right into place! Ok, maybe it’s not quite that easy, but choosing the right location is definitely the most critical first step!

Next week I’ll stick to investing by sharing some thoughts on our first investment property new construction.  It was certainly an adventure!

The commentary provided in this blog and in my book is for informational purposes only and is not intended to be a source of financial or investing advice.

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