Thinking of buying your first real estate investment property? Good start. Real estate investing is one of the best ways to make money and grow wealth. However, for many people, buying an investment property is one of the biggest financial commitments they can make. This is why it’s important for any beginner real estate investor to do enough research and gain the necessary knowledge before entering the housing market to avoid making any mistakes.
While there are numerous readily available resources to learn how to start investing in real estate, we still see new property investors make the same mistake over and over again – which is: not conducting a real estate market analysis before buying an investment property! This is absolutely the #1 mistake every real estate investor must avoid if he/she wants to succeed in the housing market. The reason for this is simple: making this one mistake will lead you to fall into many hazards that no property investor ever desires. Thus, if an investment property has caught your interest, make sure of conducting a real estate market analysis (also called comparative market analysis) before making the purchase to ensure that you’re making a smart real estate investment decision!
Let’s go further into details explaining what a real estate market analysis exactly is and demonstrating how it helps a property investor purchase the best investment property, in addition to listing other common mistakes that result from not conducting a real estate market analysis.
What Is Real Estate Market Analysis?
A real estate market analysis, in simple words, refers to information (or a report) on investment properties similar to yours that were recently sold in your neighborhood or surrounding area. It is the process of evaluating the real estate investment to explore its expected profit and risks to determine whether or not it’s a good real estate investment decision. This report provides a property investor with a comprehensive picture of the target investment property, its location, and the larger economy before making the decision of investing in real estate.
Conducting a real estate market analysis is not an easy task for a beginner property investor. However, put your worries to rest as you can always hire a real estate agent to do this for you. Real estate agents are professionals who have more knowledge about and experience in the housing market than the average real estate investor. Therefore, conducting a comparative market analysis before buying an investment property comes as a second nature to them.
The Importance of Conducting a Real Estate Market When Buying an Investment Property
A real estate market analysis contains a few basic sections, each providing a property investor with key information needed for analyzing and evaluating any real estate investment. Here are the major sections to cover when conducting a market analysis before buying an investment property:
Location of the Investment Property
The first section defines the location in which you’re planning on investing. Location is a key factor in determining your real estate investment success and profitability. In a nutshell, to have a profitable real estate investment, property investors must buy investment properties in high demand locations. Why is not assessing the location of your investment property a mistake?
Well, when you’re evaluating a certain location, you assess its physical and environmental features, in addition to the neighborhood features. Factors such as natural resources, climate, and transportation facilities are sometimes an essential part of the community’s economy, industry, and desirability – all of which affect the profitability of a real estate investment.
In addition to these factors, neighborhood features can ultimately determine the feasibility of an investment property. Some questions to ask when evaluating whether investing in a certain neighborhood is wise are: Is it near the city center? Is it near a college or a school? Is it close to vital services? Is its reputation good or not? These all should matter to the real estate investor as these are factors that attract tenants! Keep in mind that different locations attract different target groups of tenants. So, if your goal is to attract students, you should buy an investment property near a college or a university.
Overall, the location at which property investors should aim has to appeal to potential tenants in order to increase their chances of succeeding in the housing market. Moreover, accurately defining the previous factors allows a property investor to identify competition and the current supply and demand in the subject area.
The Target Investment Property Itself
Many people enter the real estate investing business to make money; however, in order to achieve this goal, you need to buy an investment property that guarantees a profit! These are called positive cash flow investment properties. As you already know, the housing market is filled with different types of investment properties. So, the question to ask here is: How can you identify positive cash flow properties from negative ones? A property investor can easily do this with the help of real estate market analysis.
A comparative market analysis (CMA) allows you to analyze a number of similar investment properties in the same location to identify which one is the best and most profitable, and generates positive cash flow. Moreover, in the process of conducting a real estate market analysis, property investors are advised to hire an investment inspector to further evaluate the target property’s conditions before buying it.
Not doing so is a mistake as inspectors assess and pay close attention to elements like roofing, full exteriors and interiors, structural elements, plumbing, electrical, heating, and air conditioning – things that a beginner real estate investor might not think of. Furthermore, the inspector will tell property investors whether or not the investment property conforms with the local practice and informs you of any repairs and maintenance issues which would ultimately save you a lot of money.
Expected Profit from the Investment
The real estate market analysis involves different calculations that every real estate investor should compute before buying an investment property. These include:
- Return on Investment (ROI): The amount of return that property investors can gain in relation to the amount of the money they invested.
- Net Operating Income: The amount of annual profit generated from operating an investment property. Here, it should be mentioned that the older the investment, the more operating costs it has. Therefore, it’s crucial for property investors to consider the investment property’s age before buying it.
- Cash on cash return: How much cash the real estate investor will get from the investment property in relation to the amount of cash actually invested – typically calculated when property investors finance investment properties with a loan (mortgage).
- Capitalization Rate: Relates the price of the investment property to the income it’s expected to generate – calculated when a real estate investor purchased the property fully in cash.
- Rent Ratio: The ratio of the monthly rental income to the cost of the investment property.
A property investor should care about all these numbers! Not calculating or ignoring the importance of these numbers before making a purchase is a huge mistake as it will mislead the real estate investor.
Note: Mashvisor’s investment property calculator is the best in town to quickly and easily calculate all these numbers. Click here to start calculating and find the best investment property in your housing market based on accurate results!
Housing Market Economy
The real estate market analysis also evaluates the economic characteristics and trends in the location in which you want to invest. The reason why this economic analysis is important is that it provides an understanding of the underlying population, business conditions, and the future demand for a specific type of investment properties. For example, a growing population is a good sign as it means there are job opportunities, and thus more potential tenants in that location.
Not only that, but a real estate market analysis also gives property investors information regarding interest rates, current and proposed changes to tax policies, inflation, GDP growth, and unemployment rates. All of these play a role in the growth or decline in the economic base surrounding the target investment property. This is another reason why not conducting a real estate market analysis before buying an investment property is a major mistake!
Other Common Mistakes to Avoid When Buying an Investment Property
As you can see, conducting a real estate market analysis is a vital step before buying your first investment property. Making the mistake of ignoring this process leads to making other common mistakes which otherwise could be avoidable, such as:
- Not looking at enough investment properties before buying.
- Overpaying for an investment property.
- Getting “emotionally attached” to an investment property and buying based on emotion.
- Buying investment properties in an area with a depreciating market.
- Not taking into account all expenses associated with the property.
The Bottom Line
Buying an investment property is one of the most important challenges that you’ll face as a beginner real estate investor. In order to guarantee you make the best investment decision before making the purchase, you must conduct a thorough real estate market analysis! This will help you evaluate the location in which you want to invest, the actual investment property, and the economy, and to make the necessary calculations. Making the mistake of avoiding this process will lead you to put your money into an investment property that won’t make a profit.
For more information and a guide to making money in real estate, make sure you check out Mashvisor’s blog section! In addition, sign up for Mashvisor to get full access to the best investment property calculator and get accurate results when conducting a market analysis.