The real estate investing market is filled with numerous types of investment properties. There are single-family homes, multi-family homes, condos, townhouses, apartments, etc. With all these opportunities available for property investors, choosing which investment property is the best to buy comes as probably the most important investment decision.
The investment property is the main determinant of your success or failure as a real estate investor. As the goal of every real estate investor is making money, the best investment properties are those that are profitable. Thus, buying a rental property by only focusing on the purchase price is a major mistake that a real estate investor must avoid in order to succeed in the market.
So, let’s have a look at the characteristics that make investment properties profitable:
1. Profitable Investment Properties Are in Excellent Locations
In real estate investing, one phrase that you’ll most definitely hear is location, location, location! Where the investment property is located affects everything related to it from the rental income the property investor can charge, through the operation costs and the cash flow, to the appreciation – all of which are other factors that determine the profitability of investment properties!
The best investment properties are in excellent locations. But what makes a certain location profitable? Profitable locations allow for a good standard of living, such as those with a reasonable investment property taxes and good insurance, as these are advantageous to property investors. Also, if the investment properties in a neighborhood are rented for a certain price, property investors will rent in that price range. Therefore, the best investment properties are in areas with high rental income – meaning you can charge higher rent!
In addition, even if a real estate investor finds the best investment property in a good location, he/she won’t be making money if he/she doesn’t find tenants! Thus, a good location is one that not only benefits a real estate investor but also attracts tenants. For example, if you’re renting out a single-family home, your target tenants will be families. Typically, families are looking to live in areas that are safe (low crime rate), child-friendly, with job opportunities, and near schools and health facilities as well as public transportation. So, make sure you look for investment properties in these locations!
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2. Profitable Investment Properties Are Positive Cash Flowing
The next important factor which determines the profitability of the investment properties is the expected cash flow. It goes without saying that the main goal of every real estate investor is making money from the investment property. To start making money, property investors must invest in positive cash flow properties. Positive cash flow is when the incoming cash flow outweighs the outgoing cash flow spent on managing and maintaining the investment property. If a real estate investor’s cash flow is negative, he/she is losing money instead of making money from the rental property – which is obviously something no real estate investor desires!
Therefore, before investing in a rental property, property investors have to conduct a real estate market analysis to identify positive cash flowing investment properties. Moreover, property investors must calculate all possible expenses, plan their finances accurately, and spend wisely. This ensures that the rental property will generate and maintain a positive cash flow.
3. Profitable Investment Properties Generate a Good Cap Rate, CoC Return, and ROI
The capitalization rate (cap rate for short) and cash on cash return (CoC return) are metrics used to estimate the overall return on investment (ROI) of the rental property. Before investing in real estate, property investors must determine the profitability of investment properties in terms of both of these metrics. Here are the formulas for doing so:
Cap Rate = Net Operating Income/Current Market Value
CoC Return = Annual NOI/Total Cash Invested
What are good cap rates and CoC returns? Different factors affect the answer, mainly the location, the size, and the risks associated with the investment, besides the investor’s target return.
Expert property investors agree that, in terms of cap rate, anything above 10% is profitable. As for CoC return, some consider 8-12% of return as good, while others would only recommend investment properties that promise 20% of ROI.
On average, investment properties must generate at least 15% ROI to be profitable. Moreover, property investors should be able to earn rent worth of roughly 1% of the purchase price. For example, let’s say you purchased a rental property for $250,000. In order to say that the rental property is a profitable one, the rental income should fall in the range of roughly $2,500.
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4. Profitable Investment Properties Require Minimal Maintenance
While investing in luxury rental properties can generate positive cash flow, they are very expensive to buy and maintain. Instead, the best investment properties are rather decent and require the least amount of time and money to maintain.
Furthermore, investment properties that need minimum maintenance require little turn-around time between purchasing and obtaining a renter. This makes the rental property profitable because the less time it remains unoccupied, the sooner property investors can start making money.
5. Profitable Investment Properties Have High Appreciation
You might purchase a rental property in an area that is profitable at the moment. Still, you should further think of how profitable this area will be in the coming years. An investment property with high appreciation is profitable because as its value increases, the real estate investor will be making money in the long term when he/she decides to sell it.
The best investment properties are in areas that are expecting major economic growth and where land is becoming limited. Locations where infrastructure development projects are planned and are major business hubs and tourist attractions also ensure high appreciation.
6. Profitable Investment Properties Work as Both Traditional and Airbnb Rentals
Before you start investing in real estate, one thing you have to determine is your real estate investing strategy – meaning will you be investing for the long or the short term? Regardless of which rental strategy you prefer, the best investment properties are those suitable for both! This is because the real estate market, local economy, and supply and demand all can change in the future.
As a real estate investor, you have to be able to respond to these changes. The best way to guarantee this is by investing in a rental property that can work as a traditional rental and an Airbnb rental, so you can easily switch from one real estate investing strategy to the other without facing financial burdens and affecting your profit.
Final Words on Profitable Investment Properties
Now that you know what characteristics make investment properties profitable, it’s time to apply your newly acquired knowledge! Don’t get caught up and make the mistake of buying the first available rental property. Rather, look for the best investment with the above-mentioned features to guarantee making money and a profitable investing journey.