Best Practices for Buying Investment Property

Unless you’ve found a rock bottom deal with short term appreciation potential, this is not a flip market.  But it is a good market for investors who are willing to buy and hold.  Here are some basic guidelines for assessing the viability of investment property.

Step 1:  Calculate Expenses

Follow these steps to determine expenses:  1) Find a property you like; 2) Shop for comparables; 3) Average comps and establish a fair market value; 4) Factor for loss; 5) Subtract loss from value (this will be your offer price); 6) Assume a down payment of 10% and subtract;  7) Prepare an amortization schedule to determine your monthly financing costs; and, 8) List and add ancillary costs (utilities, maintenance, management).

Step 2:  Calculate Income

Follow these steps to determine income:  1)  Calculate rental income from all units;  2) Factor for vacancy and loss (7-10%); and, 3) Add any additional revenue (laundry, parking, fees/dues, etc.).  This is your total income. 

Step 3:  Determine whether or not this investment makes sense.  Simply subtract expenses from income.  If the result is a positive number, this may be a good investment.  Here are three properties I found to use for practice:

3721 Boundary Street 

1949 3 bed, 2 bath home in North Park.  There is a main house and granny flat in rear.  Asking $499,000, this property last sold on 5/31/05 for $750,000.  It has been on Redfin for 127+ days and is priced at $295 per square foot.

3227 31st Street

1923 3 bed, 3 bath home in North Park.  There is a main house in the front and a detached rental unit in the rear.  Asking $615,000, this property last sold on 11/10/04 for $733,000.  It has been on Redfin for 78+ days and is priced at $335 per square foot.

4384 Bancroft Street

1927 3 bed, 1.5 bath home in North Park.  Main house in front with guest house in rear.  Asking $325,000.  On Redfin 127+ days and priced at $248 per square foot.

Let’s say I’m interested in buying property #1.  First, I find the average of the comps which is $479,666.  I will assume a 2% loss which is $9,593.32.  I subtract the loss from the fair market value to get $470,072.68.  Being that I’m a rounder, I decide I am willing to offer $470,000. I reduce the offer price by 10% and calculate my monthly expenses which include a mortgage payment, water and trash totalling $2,617.51.  Now, I know this property has two potential rental units.  One is a two bedroom unit and the other is a one bedroom unit.  Based on fair market rents for San Diego, I know I can rent the larger unit for $1,355 a month.  The smaller unit will rent for $1,117 per month.  I will not be charging additional fees to my tenants and they will be responsible for their own utilities.  My total monthly income for both units is $2,472.  I subtract 8% for vacancies and loss and come up with a net monthly income of $2,274.24.  When I subtract my expenses from my income, I realize I would carry a loss of $343 each month.  I have to decide if this deal is worth restructuring or abandoning.  I decide the initial calculations result in a small enough loss that I can offset those elsewhere.  I know this property is in good physical condition and priced aggressively.  If I reduce my offer to $435,000 and transfer the costs of water and trash to my tenants, I can break even and feel confident that I will reap the benefits of appreciation over time.