If you’re just starting out in investing, you’ve probably been told that the best thing you can do to improve your skills is to get a real estate license.
The problem is that while a real estate license has its’ advantages, most of what you will learn has to do with contracts, state and city laws, ethics, and regulations.
And while this is useful information, you won’t learn one of the most important skills in real estate: how to evaluate an investment property for profitability.
The ability to look at a property and be able to instantly evaluate profit potential is invaluable and could save you time, money, and heartache.
Here are some skills that will help you think like an appraiser.
Evaluate A Property In Under 15 Minutes
If you know what to look for before you view a property, you can often do a quick evaluation of the property in less than 15 minutes. Of course, you’ll still need to do your due diligence, but careful attention to detail can clue you in on whether the property has potential, or should be given a pass.
Appraisers consider 4 areas when evaluating a property:
- Quality
- Location
- Aesthetic appeal
- Functionality
For example, when evaluating the quality of a property, an appraiser will classify the property according to one of six scales:
- excellent,
- very good,
- good,
- average,
- fair,
- low.
It’s pretty much like a report card for the investment property.
The determining factor distinguishing good for example, from very good depends largely on the quality of the materials and the difficulty in constructing it.
So, for example, wood floors would rate higher than carpet, and built in closets with custom fixtures would be better than your standard walk-in closet.
All of these factors add up and can give you a good idea as an appraiser of not only whether or not the property will price high, but will also tell you what you’ll need to do in order to add equity to the investment property.
Other important factors to determine are whether or not the building is up to code in terms of its’ infrastructure: electrical wiring, plumbing, heating and cooling systems, and so on.
Keep in mind that while you would need an inspector to be absolutely certain whether or not things are up to par (but rather an appraiser), there are certain things that if you pay attention, will tip you off to whether or not the property has been properly maintained.
For example, are there covers on all the electrical outlets? Are there stains in the sink or bathtub that hint towards leaks? Is there water damage or mold in the basement?
A poorly maintained property is like a sick person: you may not know what’s making them sick, but shadows under the eyes, a drooping posture, etc. will tell you something is amiss.
Quickly Determine The Growth Potential Of The Neighborhood
In terms of location, look around and note the condition of the surrounding properties. Do most of the properties look like they are being taken care of, or is it a mixed bag? Don’t be intimidated if half of the properties surrounding the one you are interested in are run-down, while others are neatly kept.
It’s possible that the area is starting to gentrify, in which case you might have a great opportunity. Speak to neighbors and store owners, and ask them where they see the neighborhood going in another ten years.
You can also tell by looking at who lives there. If there are a lot of millennials around, and trendy stores are popping up, then that’s a sign that the neighborhood is probably undergoing a renewal phase.
Here’s another idea.
Head to the city planner’s office and take a look at what the city has planned. If you learn, for example, that the city is planning on building a highway in a certain area, then you also know that any property a decent distance from that highway will eventually be worth a lot of money.
Why?
Considering what’s called the growth patterns of a neighborhood allows you not only to identify the profitability of a present property, but also helps you estimate the profit potential of a property in the far future.
If a highway is being built, then eventually there will be stores or other commercial property – perhaps warehouses or even simple storage centers- that will find their way there.
And though right now that area might be considered the outskirts of the city, eventually the growth of the area precipitated by the building of the highway will spread. Demand will increase, people escaping the city and looking for more space will settle in, and commercial property demand will increase.
A smart investor might buy up property early on and put an easy to run investment property there like general purpose warehouses or storage centers, and then 10-15 years down the line resell the same property for an office complex.
Growing cities grow about one mile outward per year, so you can create an investment plan, especially if you make sure to include a smart exit strategy.
Learn To Evaluate A Property According To These 3 Approaches
Appraisers evaluate a property according to three different methods:
- The cost approach
This approach asks how much it would cost to build a property of similar quality and style. If it would cost more, then the estimated value is higher. If it would cost less, than the estimated value is inflated and the property is not a good value.
- The direct comparison approach
In the direct comparison approach, the appraiser evaluates the property in comparison to other properties in the same location, with similar characteristics.
- The income approach
This approach evaluates an income property based on what profit it could potentially produce in the future.
Each of these approaches is invaluable to an investor/ appraiser in determining whether or not an investment property represents a good deal. Try running the numbers according to all three scenarios – not according to what you “guess” the property might make. Even it takes some time, you’ll also have a better idea of what kind of approach to take with the property.
For example, if the property is relatively low in value in comparison with similar properties, perhaps there are smaller improvements (based on the quality and location factors above) that might make it worth it. Or perhaps the property is worth less now, but due to growth patterns, will rise in price – or decrease even further.
Evaluating a property with an appraiser’s eye, as you can see, has numerous advantages. Not only do you save time and money, but you also train yourself to look for objective factors to predict profit potential.
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