Real estate has a lot of upside potential for investors, like asset diversification in your portfolio, tax advantages, appreciation, rental income, and competitive returns. While achieving double-digit returns may seem advantageous when first getting started, achieving a 10% return on investment (ROI) on an investment property is fairly easy if you know what you're doing. If you're looking to achieve a higher return on a current or future investment property, here's what you need to do.
"You make money when you buy, not when you sell" is a popular saying in real estate investing. As cliche as it may sound, it's true. Investors looking to earn a return from a property do so by purchasing the property at the right price for its intended use. Whether you want to fix and flip the home or rent it long term, your end return depends on the cost of purchase, plus repair or operational holding costs. If you spend too much on the property, your return goes down.
It's easy to get caught up in a bidding war, get overly excited about a property's potential and offer more than it's worth, or overspend on a rehab, especially in a competitive market. The only way to avoid this is to let your numbers guide your purchases and have a solid, realistic idea of those numbers to begin with.
Run your numbers, and run them again
The only way to know if you're "buying right" is by running your numbers. Having a firm understanding of what the property is worth in the given market in its current condition is the best place to start. For a residential rental property, that means looking at comparable properties (comps) and analyzing them based on cap rate and rental returns.
If it's a fix and flip, or even a distressed rental, that means knowing how much you'll need to spend to get the property ready for sale or rent. If you're not confident with rehab estimation, ask for an opinion or quote from local contractors. Adding in an additional 10% of the expected rehab cost for reserves is a good idea and gives you a buffer if unexpected issues arise.
It's also good to know what the property could be worth on a pro forma projection, which could be its after repair value (ARV) or market rental rate if the property is vacant or underperforming.
Being realistic about these numbers while also adjusting for vacancy rates, economic variances, and unexpected costs (I set aside 10% of total rehab estimation or rental income each month for this) will increase the likelihood your projected or hoped return will align with the real return.
Don't forget to account for factors like utilities, ongoing maintenance and repairs, property taxes, insurance, and sales commissions. I use financial calculators and spreadsheets to help me keep track of all of the potential and likely expenses that are easy to forget. I then let those costs, with the current value, potential value, and rental rates, tell me what my return can be.
Manage the property like a professional
Once you've purchased the property at the right price, you have to manage the investment property like a professional. Poor management can result in unnecessary spending on things you aren't even aware of. Not staying on top of your contractors, attorneys, or property managers can result in delayed job completion, tenant turnover, or increased vacancies, all of which impact your bottom line. Sitting on a tenant who's not paying rent because you're "trying to be nice" eats away at profits and prolongs the inevitable.
Sometimes, adding ongoing or upfront costs like having a professional manager, general contractor, or management software may seem counterintuitive, but they end up increasing your return because of efficiency in management. If you don't have the experience or time to manage the investment professionally yourself, hire it out -- it will save you in the long run.
Reduce costs while improving income
Reducing costs while improving income is an art in real estate. Knowing when and how to increase rent while also finding ways to cut costs without decreasing tenant or potential buyer satisfaction is a fine line. Analyzing an investment property's performance on a regular basis and keeping track of where market conditions and expenses are will help you determine when and if savings or increased income potential is possible.
If you don't want to add bookkeeping to your resume, hire a professional that has experience with your real estate investment strategy. Most bookkeepers can communicate digitally, allowing you to monitor your properties and investments from the comfort of your home, making sure your money is being spent where it's needed most.
The Millionacres bottom line
If the goal of buying an investment property is to achieve a 10% return or more, use that as your starting point for negotiations, and don't budge. You may have to make a lot of offers before you get to yes, but eventually you will get that yes and be happy knowing you're consistently buying properties that can achieve your desired return.
Any investment I've net below a 10% return is because I didn't stick with my criteria when buying or got loose with one or more of the rules above. There are always unexpected risks that can throw a wrench in your deal, but in general, if you establish set buying criteria that align with your investment goals, have a well-thought-out investment calculator that accounts for all potential expenses using realistic numbers as your basis, and manage the property well, your ROI should be achieved.