When you’re searching for properties, there can be anywhere from 10 to 1,000 different options available at any given time. How do you narrow that list down? Here’s 3 tips that will help.
First, know your budget. Don’t waste your mental energy looking at or getting excited about properties you can’t afford. We teach all of our students that one of the first steps in real estate investing is to get pre-qualified for a loan. It doesn’t have to be with the lender that you will use to get your actual loan (although that makes the process a bit easier), but you need to have an idea of your purchase price range.
If you have a business partner make sure to let your lender know as that will dramatically impact the price range you get pre-qualified for.
Once you know your budget, refine your search to only look at properties within your budget.
Second, you need to decide what type of properties you will be investing in. Are you interested in single family or multi-family? Budget plays into this a little because single family homes can definitely be cheaper, But if your budget allows for either, you need to pick one and focus on it. Generally, choosing between single family and multi-family is really a choice between effort and return.
Single family homes are way more common and take less effort to find, plus when you get one they’re way easier to manage. It’s one tenant who will usually stay longer because a home feels less temporary than an apartment. Your tenant will also take care of ALL of the utilities, even things like mowing the lawn and shoveling snow. With a single family home, it’s much more of a set it and forget it kind of thing.
With multi-family you’re going to be spending more time sifting through deals and competing with other investors to buy the property. When you get a property you’ll be taking on multiple new tenants all at once which can be a lot of up from work.
Multi-family properties will have both separate (electric and gas) and shared utilities (which you’ll usually cover) like water, sewer, trash, landscaping, and snow removal. You’ll generally have more turnover because you have more tenants who will tend to move on sooner.
Overall, if you’re willing to put in the extra effort, multi-family homes generally have a higher rate of return. In addition, you have more influence over the performance of a multi-family property when compared to a single family home.
Multi-family properties are usually easier to turnover for multiple reasons. The units are smaller and don’t need as much work to get them rent-ready, you can have your tenants give their keys to a neighbor to hold until the new tenant moves in, and if one unit is not showable because it’s in bad shape, you can show a neighbors unit instead so potential tenants can at least see the floor plan before committing to a lease.
Multi-family properties have built in diversification. If you ever have an issue with a single vacancy or a renovation that’s taking too long, you should have another tenant or multiple tenants who are still paying rent so you’re not stuck paying the entire mortgage out of pocket.
Single family homes can be great if you want your passive income to be VERY passive. Another benefit is that, if you’re using a conventional investment loan, you can usually do 15% down on a single family home which is way less up front cash than the 25% down required for a multi-family property.
The third and final aspect to consider when deciding what to buy is the condition or quality of the property. You may have heard people refer to A, B, C, or D properties. While there is no official scale for grading the property, it’s just a general guide for you to have an idea of what you’re getting.
“A” properties are new construction or newly renovated. Everything feels fresh and looks beautiful. “A” class properties are more likely to attract high quality tenants who take care of your property, you can charge more in rent, and your repairs will be minimal or non-existent because everything is new. The biggest downside is that you will be spending a lot more money to buy an “A” class property.
In addition, because the tenants are paying more, they will have higher expectations. You’ll even have to fix the little things. Another downside is that if a bad tenant causes damage to an “A” property, it’s much more expensive to get it back to “A” class condition. Overall, it’s usually harder to cash flow on “A” properties initially, but in the long run they’ll be awesome investments. “A” class properties could be perfect if you’re ok with long-term wins, if you don’t need the cash flow right now and if you want to keep things extra passive.
On the other end of the spectrum there’s “D” properties. Maybe you haven’t even seen these properties before. “D” properties are in neighborhoods where every 5th house is boarded up, crime is high, and the property is super old and run down. The only pro of a property like this is that you can pick them up for crazy cheap.
In St. Louis, you can find single family homes like this selling for $15,000-$20,000. That’s CHEAP! But you get what you pay for. If you’re a new investor we’d recommend staying away from “D” class properties. You’ll have a bunch of deferred maintenance that needs to be done before you can rent it, you’ll probably have issues with tenants causing damage and not paying rent, and you’ll spend way more money on repairs. It’s just not worth it. “D” properties might make great money if you get lucky and things work out well, but rental properties are supposed to provide peace of mind and financial freedom. “D “ properties will probably just add tons of stress to your life.
“B” and “C” properties are the middle ground and kind of overlap. We love these properties. “B” and “C” properties are still nice enough that you wouldn’t be scared to live there, but they’re probably not where you’d want to live your whole life. They’re usually rent ready or will be with some minor upgrades like new paint or carpet.
We think they provide the best balance of potential income, minimal risk, and ease of management. You can’t charge quite as much for a B or C property as you could for an A property of the same size, but you can get surprisingly close. Along with being cheaper to buy, you have a lot more room for negotiation because there are almost always more issues with older properties, and you’ll leverage the issues to get a seller credit at closing which reduces your cash out of pocket and allows you to stretch your money further.
Bonus tip: when it comes to the property condition. Ideally you want to buy properties built in 1978 or newer. This rule isn’t fool proof, but by 1978 they were no longer using lead paint, asbestos, or aluminum wiring. Plus, everything is standardized like window and door sizes, building codes were held to a higher standard and building technology and tools were more advanced so they’re usually built better all around. We both owned a few buildings built before 1978, but the farther away you get from that date, the more likely you are to have expensive issues. Now, older properties are not off-limits. There are some excellent properties built in the early 1900’s that are solid as a rock, but be sure to get a professional inspection on these properties and take it seriously.
So just to recap, when deciding your real estate strategy of what to buy, you need to refine your search in 3 ways. Determine your budget, decide if you are looking for a single family or a multi-family property, and figure out what property condition fits your style the best. The more you narrow your search, the more of an expert you can be and the easier it will be to recognize great deals when they pop up!
Your real estate coaches,
Dallas & Greg
