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Defining Your Real Estate Investment Criteria

real estate investment criteria

Summary: Defining your personal criteria for real estate purchases is a vital step in successful real estate investing. In this post we discuss the importance of delineating your real estate investment criteria before searching and buying properties. We then cover the financial specifications and property features you should consider including in your criteria.

 

Defining your investment criteria is a vital early step to building a successful real estate portfolio. If you can determine what it is you are looking for and clearly communicate it to your team, you will save everyone time and effort and will have better investment outcomes.

The goal is, by the end of this post, you should be able to sum up what you are looking for in a few concise sentences.

 

How does having well-defined investment criteria help you?

Defining what you want protects you (from yourself!) because you won’t be tempted to buy just any deal. If you have well-defined criteria for your desired cash-on-cash return, for example, it will help you avoid becoming emotionally invested in deals that don’t make financial sense. It will also keep you from buying for appreciation or buying properties because they’re “sexier” (i.e. that vacation house that minimally cashflows versus a duplex that has far better returns).

When you know the size of and features of the property you want, you are also able to focus your search, become familiar with the market for your desired properties, recognize rent patterns, and become an expert in your type of property, rapidly. This leads to making more educated (and efficient) decisions when you make purchases.

In short, having well-defined investment criteria keeps you focused on buying the right properties rather than just buying for the sake of buying.

 

How does having well-defined investment criteria help your team?

When you have well-defined investment criteria, it helps foster a more productive relationship with your real estate agent. The reason is that it avoids you wasting his/her time (and yours as well). If you bring well-defined criteria to your real estate agent, he/she can focus on finding properties that meet your criteria, not on pursuing deals that you don’t find attractive. If you don’t provide well-defined criteria, on the other hand, then you may find yourself repeatedly refusing “unattractive properties,” leading your real estate agent to become frustrated by your perceived lack of follow through. Since your success depends on your real estate agent bringing you good deals, you risk losing out if your agent puts you on the bottom of their list of investors.

Without clear criteria both you and your real estate agent are shooting in the dark, which harms your relationship and decreases the odds that your real estate agent brings you a valuable property.

 

So what type of “criteria” should you have defined?

We would suggest delineating the following criteria and sharing it with your team:

  • Real estate investment strategy
  • Your goal cash-on-cash return
  • Your budget
  • Property size (e.g., duplex)
  • Desired property characteristics

Real Estate Investment Strategy

First, identify the investment strategy you will be pursuing in the market. As we’ve mentioned before, we suggest the Buy and Hold Strategy because it builds long-term wealth. This is in comparison to other strategies such as house flipping or appreciation plays.

Cash-On-Cash Return

The next criteria to define (and the most important one of all!) is the level of return/cashflow you want to achieve with your investment. Kenji and I, for example, aim to get at least 10% cash-on-cash return when we buy a property. Check out this post if you want to understand why cash-on-cash return is such a useful metric.

Budget

Your budget may be surprisingly difficult to define, but is vital to provide to your real estate agent so he/she is looking for the right properties. Although you might think it is easy to provide a target budget to an agent, we’ve found it difficult because our finances are constantly in flux. For example, while we may have $150,000 in cash in the bank and be focused on finding a property in Boston in the $500,000 dollar range one week, things can change quickly if we happen to find a deal in a different market or if one of our properties requires an unexpected large repair or even if something unrelated to real estate happens in our daily life requiring a cash infusion. Suddenly our Boston criteria has changed (or maybe we are now priced out of the Boston market for a year while we re-build our cash reserves). Therefore we advise you to keep in close communication with your your agents and keep them apprised of your goal budget in real time as things change.

Property Size

When buying residential real estate for investment purposes, the size of your property is defined by the number of doors. Investors generally focus on a specific type of property during their search – either single family homes, 2-4 multifamily residences or larger properties >5 units that require commercial financing.

We are huge proponents of buying 2-4 multifamily residences since they generally offer better returns than single family homes but also have lower risk in terms of vacancy. They also have a lower barrier to entry price-wise (and are within reach for most physician investors just starting out), when compared to >5 unit complexes or commercial properties. Interest rates for <5 units are also superior to commercial loans. To read more about why we prefer 2-4 unit multifamily residences over other types of properties click here.

No matter if you are looking for a single family home or a 15+ unit complex, if you can clearly define the number of doors you want, you will make it easier for you and your real estate agent to filter through properties quickly to find exactly what you’re looking for.

Property Characteristics

Finally, you need to drill down to define property-specific characteristics that you can give to your real estate agent as “preferences.” We label these as “preferences” rather than criteria because often they are not “make or break” characteristics like a minimum cash-on-cash return, for example.

Though it is helpful to communicate these preferences to your agent when beginning a search, we recommend flexibility if your property does not have all of your desired characteristics. It is far more important that your property meet (or have potential to meet) your cash-on-cash criteria than have it be located in a highly-rated school district, for example.

Desired Area/Neighborhood

Low crime, quality schools, access to major freeways and shopping centers: all these types of features play into a desirability of a neighborhood. And the desirability of a neighborhood ultimately is related to rent and building appreciation and is tied to lower vacancy.

Due to the fair housing act, your real estate agent cannot lead you to choose one neighborhood over another. In your local market, this will likely not be a problem, since you probably know where you want to have properties and can identify areas where you would not. Also you have the benefit of being able to walk through the neighborhood of a potential property. When you are investing out-of-state, this can prove more challenging.  

Generally a Google search can yield information such as crime statistics by neighborhood. Apps such as Zillow and Redfin include school quality ratings. Vacancy data should also be reviewed when you are doing due diligence for a particular property.

While it may seem clear to a novice investor that you want all of your purchases to be “A properties” located in “good” neighborhoods” this is not always the case if your focus is on cashflow. Not surprisingly, properties located in more desirable neighborhoods are often sold at a premium and offer less cash-on-cash return, so you may end up choosing to buy more properties in more transition neighborhoods or areas outside of major cities. What you buy and where, ultimately, should come down to cashflow first and preferences such as neighborhood second.

Rent-Ready vs Fixer-Upper

Rent-ready properties are properties that can be immediately rented the day you purchase them. In fact, they often come with renters already in place. These types of properties involve less effort and money up front. For a busy physician, a rent-ready property may be the best fit. The downside with these types of properties is that they can require more maintenance work over time as older appliances, plumbing and other building materials or shoddy construction/repairs break down. However, you can avoid these pitfalls if you buy a property from a flipper or a turn-key company who has recently upgraded a unit prior to its sale. Note, you should expect to pay a premium for a recently renovated turn-key unit.

If you are aiming to achieve real estate professional status and only own a handful of properties, both rent-ready and turn-key properties share the additional downside of not requiring a lot of upfront work to justify your hours. If this is your situation, you should consider buying fixer-uppers so that you can put in the necessary hours managing the renovation to meet the requirement for this unique tax status.

Kenji and I like to buy slightly (or very) distressed properties that require upfront work. We stumbled into this pattern by accident, when we spent a large sum of money to fix up a newly purchased 4-plex and found that the return from our renovation far exceeded our goal return of 10% cash-on-cash. Not only did we receive higher rents for the newly renovated units, we also received significant tax savings because Kenji was a real estate professional (which essentially translates to the government paying for one-third of the repairs in our case). Moreover, because our contractor offered a one year guarantee of his work, we were able to avoid maintenance costs during the first year and minimized our costs going forward as all the plumbing, electrical work and appliances were new. As an additional benefit, we also found it was easier to determine when damage was clearly the fault of renters as everything was completely new and in perfect condition at the time they moved in.

The downside of buying properties that need significant work is that it requires a lot of time and effort. Significant repairs also require a competent construction crew, so making sure you have a good, trustworthy general contractor in place prior to a purchase is necessary. Finally, you have increased vacancy while your project is being completed, so you have to add that cost upfront. When you add vacancy time to the costs associated with construction, this can become a significant financial burden and will likely slow your growth trajectory. This strategy is therefore best utilized when you have a significant cash reserve and time to oversee the process (or a trusted person who can oversee it for you).

Unit size

Kenji and I prefer larger units with three+ bedrooms because we hypothesize that the tenants are more often families, who stay longer. These types of properties also generally have higher rental prices per month, which attracts a tenant who can afford that type of unit, who may have more financial stability. Moreover, units that have three to four bedrooms give us the option to successfully convert these properties to supported living down the road since supported living pays you per bedroom, up to four bedrooms per unit (we will cover supported living in a future post).

In general, we avoid five bedroom units for fear of having two families sharing a single unit, as higher occupancy can lead to increased wear and tear and higher utility costs. We also avoid one bedroom/one bathroom units due to the risk of high turnover in renters without families. A smart real estate agent once advised us that smaller units (less than 500 feet) rented poorly during the last downturn, so we avoid units that are under that 500 foot threshold of size when searching for properties as well.

Rent per month

Kenji and I have found that we prefer properties that rent well over >$1000 per unit. This is because some of our property managers charge a flat fee for leasing or a flat fee for property management. In either case if a sample unit rents at $600 a month versus $1200 a month, a larger portion of the money we earn per year is going to our property manager.

Likewise, Kenji and I also tend to avoid properties that rent for >$2,500 each unit. Our theory is that in a downturn these types of units will be much more likely to be vacant. Time will tell whether this bears out to be true.

Other details

Some other property characteristics that you can consider specifying include things like having a ranch-style set up with no stairs (better for elderly tenants and for supported living), buying properties no more than 20 years old (so you have less maintenance repairs or large replacement costs) and buying only duplexes (not fourplexes, as lower density units generally rent for more). When looking for properties, we have preferences when it comes to each of these criteria that we provide to our real estate agents so that they know what types of properties we will find attractive.

As I mentioned above, while Kenji and I have many “preferences” regarding property characteristics, most of these are not make or break criteria. There is an obvious danger with coming up with too many rigid rules; you may never find a property that meets your criteria, and you may miss out on deals that were otherwise quite good. So, you have to maintain some level of balance and flexibility when it comes to the more subtle features of properties. For example, we won’t turn away a property in which each unit rents at $600 if it meets our cash-on-cash criteria. Likewise, while we prefer three or four bedroom units, we have several two bedroom/one bathroom units.

 

How would we summarize our buying criteria?

When Kenji and I engage with a new real estate agent, for example, we share a version of the following with him/her:

“We use the buy-and-hold strategy and focus on cashflow (with a goal minimum of 10% cash-on-cash). Appreciation is an added bonus and not the focus of our investing. We prefer 2-4 unit multifamily residences (though we will consider single family homes) and do not mind doing some rehabbing if a property needs work. We prefer units that rent >$1,000 per month and have at least 3-4 bedrooms if possible. We prefer properties in good school districts, though clearly our cash-on-cash criteria is most important. Our current budget is “x” dollars for a down payment and “y” dollars for repairs.”

In summary, defining your criteria for real estate investing is an important first step which must be completed prior to finding a property. We hope this guide has helped you think about your personal criteria and map it out to avoid the pitfalls of investing without direction or goals.

 

Do you have any preferences you would add to our criteria?

Do you have different cash-on-cash minimums you accept when investing?

Tell us your stories and give us your feedback below.

 

Action Plan

  1. Define your type of real estate investing strategy you wish to pursue (e.g., Buy and Hold Strategy)
  2. Define your desired cash-on-cash return/cashflow per unit
  3. Identify the types of properties you prefer (e.g. 2-4 unit multifamily residences) and any other preferences you may have (rent-ready vs. fixer-upper, unit size, etc.)
  4. Present your criteria and preferences to a real estate agent who is well-versed in working with investors
  5. Screen and buy properties without compromising on your criteria
  6. Adjust your property preferences as needed according to what makes sense in that particular market, always staying true to your desired cash-on-cash return

Do you want to learn how to creatively fund your real estate portfolio and achieve financial freedom? Join the conversation! Follow our Semi-Retired MD  Facebook page and join our Doctors or Professionals  group!

Semi-Retired M.D. and its owners, presenters, and employees are not in the business of providing personal, financial, tax, legal or investment advice and specifically disclaims any liability, loss or risk, which is incurred as a consequence, either directly or indirectly, by the use of any of the information contained in this blog. Semi-Retired M.D., its website, this blog and any online tools, if any, do NOT provide ANY legal, accounting, securities, investment, tax or other professional services advice and are not intended to be a substitute for meeting with professional advisors. If legal advice or other expert assistance is required, the services of competent, licensed and certified professionals should be sought. In addition, Semi-Retired M.D. does not endorse ANY specific investments, investment strategies, advisors, or financial service firms.

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Hi, we’re Kenji and Leti

we provide coaching and mentorship for doctors and high-income earners

Several years ago, we were newlyweds working as full-time hospitalists. On paper, it looked like we had everything: the prestigious careers, the happy marriage, the luxurious rental home, the cars, etc.

But in reality? Despite having worked for several years, we had very little savings. Despite our high income, we had very little freedom in terms of time or money.

One thing was clear: we had to do something.

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