Chapter 5:

How to Find Investment Properties

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Up to this point, we have focused on preparing for your investment career. However, it won’t be enough to simply analyze deals. At some point, you’ll have to take the plunge and buy your first property. This chapter will focus on the best ways to find the best properties, negotiate the best deals, and make sure you get through closing in one piece.

In This Chapter You'll Learn:

How to Profit When You Buy
Your Shopping Criteria
Where to Find Real Estate Investments
The Buying Process

Make your profit when you buy.

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—popular real estate mantra

How to Profit When You Buy Your Investment Property

You won’t start your investing career by landing a big fat check; these types of checks will come after you’ve successfully implemented your investment strategies. The profits you make, however, can be made or destroyed at the time of purchase. So what does it mean to profit "when you buy?"

To make your profit when you buy, you must purchase a property at a price that will ensure your desired profits based on your ability to execute your exit strategy. In other words, you need to buy smart. If you vastly overpay for a property, no amount of wishing, hoping, or improving it is going to make your investment worthwhile.

While you can't predict with 100 percent accuracy where the market may go, you can figure out where it's at today.

Real World Example:

The house at 28 Cherry Street is currently listed at $145,000, and recent comparable sales show that similar nearby homes have sold for between $140,000 and $170,000. This particular home, however, needs about $25,000 worth of work. Therefore, if you pay $145,000 for it and put in $25,000, you'll have already spent $170,000—and that’s before closing costs, holding costs, selling costs, unforeseen overages, and any other fees that you'll end up paying. You will most likely be underwater (you’ll owe more than it's worth) with this property no matter how much work you do to it.

However, if similar homes were valued at $225,000, you would find that indeed, you made your profit when you bought the house for $145,000.

The same principle applies to rental investment properties. If your monthly expenses (including taxes and insurance) for 28 Cherry Street cost $1,200 per month, and the average rent is $1,100 per month, you’ll lose money each month. However, if average rents are $2,000 per month, and your total expenses are just $1,100, you’ll be profiting from the day you buy it.

It's often said by experienced investors that appreciation is the icing on the cake. In other words, don't count on the market swinging upward. You’ll make your profit when you purchase a property based on what it’s currently worth, rather than what it might be worth someday. If an investment doesn’t make sense without appreciation, don't invest in it. Doing so would be to make an investment on speculation, and while doing so may be profitable for some, it is a risky venture for both inexperienced and experienced investors alike.

Your Investment Property Shopping Criteria

Now that you understand why getting a great deal is important (to lock in your profits at the beginning), it's time to start looking for a property. Before you do, define your selection criteria. This section will focus on criteria, why it matters, and how to define yours.

Imagine that you want to use a new recipe to make dinner tonight. You take out a cookbook to find a recipe that looks good, discover a great-looking baked chicken meal, and prepare your shopping list of ingredients in order to make the meal for your family. You head to the store and begin picking up the items on your list: chicken, basil, olive oil, and other items fill your cart. Suddenly, you see the spaghetti and remember another recipe you once wanted to try with spaghetti. You reach for the spaghetti, but then you remember your shopping list. Spaghetti isn't on the list for tonight's dinner, so you put the distraction back on the shelf and continue on your way to make a perfect dinner for your family.

Real estate is no different. Your selection criteria list will be just like your ingredient list. It’s designed to keep you focused on shopping for the things you need so you don’t waste money on other good-looking things along the way. Real estate is an exciting field with a lot of different niches and strategies, so it is easy to get distracted by the next big thing or trend. Having a clearly defined selection criteria will help you stay focused and avoid analysis paralysis—and keep you on track to buy a great investment property. By defining your criteria, you’ll narrow down the choices in the market, thus eliminating the vast majority of deals (distractions). Instead, you'll focus on finding only the kinds of deals that you are interested in buying.

Creating Your Selection Criteria

In chapter 3, we looked at a number of different niches you can invest in, as well as multiple strategies you can use to invest. It's now time to choose your niche and strategy, and come up with a list of criteria to further narrow down your selection.

There are a number of different items to consider adding to your criteria list. These may include:

  • Town
  • Neighborhood
  • Property size (square feet)
  • Lot size
  • Property condition
  • Number of units
  • Cap rate
  • Cash flow
  • Appreciation potential

No one can tell you exactly what your investment property criteria should or should not include. Some of it will come down to personal preference, such as, "I only want to buy in Seattle," or "I only want houses with basements," but most of your chosen criteria will be specific to the type of investment. For example, if you are looking to become a buy-and-hold investor of small, multifamily units, your criteria will include small, multifamily properties and it will exclude old commercial buildings.

By specifying ahead of time what properties you are willing to look at (those that meet your criteria), your search will become much more manageable. In the same way, you will be able to more effectively communicate your desires to the people who may help you buy property. If you simply tell people, "I am looking for real estate," the response will most likely be, "Good for you..." However, if you instead mention that you are looking to buy a small, single-family house in the Rockford neighborhood for under $150,000, you’ll enable others to think of properties that match that description, which may ultimately get you connected with a deal.

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Understanding the Rules of Investment Properties

Perhaps the most important aspect of the criteria you’ll put together is the financial component. If a deal doesn't make financial sense, it's not going to be a strong investment. In chapter 2, we looked at some of the basic math that applies to real estate investing, which included variables like income, cash flow, and return on investment. Generally speaking, a listing won’t publicize all of the important information you’ll want to know about the financials of a property. Yes, you can generally determine the amount of income a property makes, but you won't know immediately how much monthly cash flow the property will produce, how overpriced the property actually is, or how much you should offer. Additionally, it's not going to make sense to get out your spreadsheet and do a full property evaluation on every single deal you glance at. This is when rules come into play.

Applying rules will help you quickly evaluate a property's financials on the fly. As with any rule of thumb, it’s not always an exact science and should never be entirely relied upon to decide whether or not a property is a good investment. Instead, applying a few rules will help you quickly filter a property and help you decide if it's worth further evaluation. Let's take a look at a few real estate rules:

2 Percent Rule

According to the 2 percent rule, monthly rent should be approximately 2 percent of the purchase price. In other words, a $100,000 home should rent for $2,000 per month; a $50,000 home should rent for $1,000 per month. This is a very conservative estimate that is very simplistic, but can help in deciding if a property warrants a deeper look. In most parts of the country, 2 percent is very difficult to achieve, but the closer you can get, the better cash flow will be.

Real World Example: An average three bedroom home rents for $800 per month in your neighborhood. According to the 2 percent rule, you should spend around $40,000 on that property ($800 / .02 = $40,000).

50 Percent Rule

The 50 percent rule is a great rule of thumb that will help to fairly accurately predict how much a property’s expenses will cost you each month. The 50 percent rule simply states that 50 percent of your income will be spent on expenses—not including the mortgage payment. As mentioned above, most real estate listings will identify the monthly income of a property. By dividing that number in half, you can easily figure out how much you'll have left to pay the monthly mortgage (principal and interest). Any income left over after the 50 percent for expenses and mortgage payment will be your cash flow. The 50 percent for expenses includes all expenses, like repairs, vacancies, utilities, taxes, insurance, management, turnover costs, and the occasional big ticket repairs (that must be saved up for)—aka capital expenditure or capital expenses, like roofs, parking lots, and furnaces.

Real World Example: An apartment building brings in $8,000 per month in income. Using the 50 percent rule, we’re left with $4,000 to make the mortgage payment. If the monthly mortgage payment on the property is $3,500 per month, you can reasonably assume a monthly cash flow of $500 per month.

The 50 percent rule is especially helpful in teaching that expenses almost always cost more than anticipated. One common mistake new investors make is underestimating how much expenses are going to cost. The 50 percent rule helps demonstrate that there are always unpredicted costs, so plan for them.

70 Percent Rule

Investors use the 70 percent rule to quickly determine the maximum price they can pay for a property based on the after-repair value (ARV). While this rule is most commonly used by house flippers, it can actually be used for any strategy when you want to find a good deal. The 70 percent rule says that you should only pay 70 percent of what the after-repair value is, less the repair costs.

Real World Example: A home that should sell for approximately $200,000 after repairs needs approximately $35,000 worth of work. Using the 70 percent rule, multiply $200,000 by 70 percent to get $140,000, and then subtract $35,000 for the repairs. Therefore, the most anyone should pay for this property is $105,000.

Remember, a rule of thumb like the ones above should only be used to quickly and efficiently screen a property to determine if it's worth further investigation. Never use a rule of thumb to decide exactly how much to pay or whether or not to invest. Don't confuse a rule of thumb for a license to skip doing your homework.

NOTE: Check out the BiggerPockets 70% Rule Calculator to run 70 percent calculations on potential deals.

Where to Find Real Estate Investments

Once your criteria is set, it's time to start looking for your investment property. No doubt you've seen "For Sale" signs in front of homes, but there are many other ways to find investment properties. This section will explore the various ways to find properties. The list is not exhaustive but a good start for new investors.

Multiple Listing Service

The Multiple Listing Service (MLS) is a collection of properties for sale by different real estate brokers across the country. When you search a site like realtor.com or redfin.com, you’ll be searching the MLS. This information is widely distributed for the most eyes to see.

Newspaper

Although it’s quickly fading from use, the classified section of your local newspaper is a good place to look for homes that are for sale by owner. Oftentimes, real estate agents will also put their listings in the newspaper, so it can be a bit challenging to determine what in the classifieds is also listed on the MLS and what is not.

Word of Mouth

Some homes are simply sold the old fashion way—by word of mouth. By letting everyone know that you are in the market to buy (and defining your criteria, as discussed above), you’ll place yourself in the best position to find deals via word of mouth. You can do this by directly networking with peers, hanging at your local real estate club, or visiting the BiggerPockets Marketplace.

Craigslist

Craigslist.org is a free classifieds website that millions of people use to buy, sell, trade, or give away nearly anything you can imagine—including real estate.

Outbound Marketing

Outbound marketing means finding sellers and bringing them to you. You can do this by way of advertising, direct mail, or a number of other marketing techniques. Marketing is such an important topic, that we’ve dedicated the entirety of chapter 7 to it.

LoopNet

LoopNet is a marketplace for commercial properties. From small multifamily properties to large apartment complexes, shopping malls, fast food restaurants, and beyond, LoopNet is the place to search for publicly listed commercial properties for sale.

The Process of Buying Property

When you buy a property, you don't simply write a check to the seller and grab the keys. The process of buying and selling real estate is a complex and often lengthy venture with many moving parts. This section will walk you through the steps from beginning to end.

Step 1: Decide on your investment strategy/niche (see chapter 3).

Step 2: Define your selection criteria (see earlier in this chapter).

Step 3: Decide on a financing method. Make a clear plan of how you will purchase the property. If you plan to use a bank loan, you’ll need to be pre-approved. If instead you plan to use cash, you’ll need to have that money liquid and ready to use (see chapter 6).

Step 4: Begin looking on the MLS, on commercial search sites like LoopNet, in the newspaper classifieds, at direct mail, yard signs, and other avenues to find properties for sale. At this point, you should connect with a real estate agent (remember they are generally free for the buyer, paid out of the seller's closing costs). If you deal directly with homes that are not listed on the MLS, you probably don’t need a real estate agent but should instead contact the sellers yourself.

Step 5: Run each property through a list of criteria filters to quickly screen out the duds. These filters should include your criteria and the rules we discussed earlier in this chapter.

Step 6: Make an offer on the property (or properties) you want to pursue. You may offer less than what you are actually willing to spend, or you may offer your bottom line. Typically, an offer is made using a purchase and sale agreement, which your real estate agent will most likely put together for you. If you buy a property that is not on the MLS and you don’t use an agent, you can usually get a boilerplate purchase and sale agreement online, at a paper supply store, from an attorney, or free from a local title and escrow company. We strongly recommend that any agreement be reviewed by your real estate attorney.

Step 7: Negotiate the deal with the seller and, if possible, come to a mutually accepted agreement on price and terms. For a great article on negotiation, listen to BiggerPockets Podcast 260: The Ultimate Guide to Negotiating (for the Negotiation-Averse) With Former FBI Hostage Negotiator Chris Voss.

Step 8: Perform your due diligence, which includes inspections of the property. The property details are then handed over to either a title or escrow company or a local attorney (depending on your state). During this time, you will submit the necessary paperwork for your financing, begin lining up contractors (if work is needed), check on the validity of the property’s disclosed financials, and prepare for closing by handling whatever other issues come up. This process will take anywhere from several days to several months or more, depending on the situation. Bank financing is generally the reason this process takes longer, so if you are using all cash, closings will be much quicker.

Step 9: You sign papers at the title and escrow (or attorney's) office. Later that day (or within several days, depending on your location), the paperwork will be recorded, and you'll officially be the new owner.

Moving On

By now, you should understand the importance of a clearly defined set of shopping criteria, which should include both personal and financial requirements. This well-defined criteria list will help narrow down your choices and help weed out bad investments, allowing the best chance for a solid, profitable investment that best meets your needs. At this point, you should also have a clear, basic understanding of how the buying process works—from the first thought to receiving the keys.

In the next chapter, we will dive deeper into the world of real estate financing and look at 12 different methods available for financing your next investment.