Your Investment Property Shopping Criteria

It's time to start looking for a property. Before you do you need to define your selection criteria. This section will focus on what your criteria is, why it matters, and how to define it.Imagine that you want to use a new recipe in making your dinner tonight . You take out a cookbook to find a recipe that looks good, discover a great baked chicken meal, and make your shopping list of ingredients in order to make the meal for your family. You head to the store and begin picking up the items on your list. Chicken, basil, olive oil, and other items begin to fill your cart. Suddenly - you see the spaghetti and remember another recipe that you once wanted to try with spaghetti. You begin to reach for the spaghetti but then remember your shopping list. Spaghetti isn't on the list for tonight's dinner, so you put back the distraction and continue on your way home to make a perfect dinner for your family.

Real estate is no different. Your selection criteria list is just like your ingredient list in the example above. It is designed to keep you focused on shopping for the things you need, and not waste money on other good looking things along the way. Real estate is an exciting field with a lot of different niches and strategies - so it is easy to get distracted by the next big thing or trend. Having a clearly defined selection criteria can help you stay focused, avoid "analysis paralysis" and keep you on track to buy a great investment property. By defining your criteria, you will be able to narrow down the choices in the market, and you will then eliminate the vast majority of deals that are only distractions.  Instead, you'll focus on finding just the kind of deals that you are interested in buying.

Creating Your Selection Criteria

In chapter three, we looked at a number of different niches you could invest in, as well as multiple strategies you can use to invest. It's now time to choose the niche and strategy and come up with a list of criteria to narrow down your selection further.
There are a number of different items you will want to consider to add to your "criteria list." These could include:

• Neighborhood
• Property Size (Square Ft)
• Lot Size
• Property Conditions
• Number of Units
• Cap Rate
• Cashflow
• Appreciation Potential

No one can tell you exactly what your investment property criteria should or should not include. Some of it will come down to personal preference, such as "I only want to buy in Seattle" or "I only want houses with basements," but most of your chosen criteria will revolve around the kind of investment you are getting into. For example, if you are looking to become a "buy and hold" investor of small multifamily units, your criteria is going to include small multifamily properties and will exclude old commercial buildings.
By specifying, ahead of time, what criteria you are willing to look at, your search becomes much more manageable. In the same way, you are able to more effectively communicate your desires to others who may help you buy property. If you simply told people "I am looking for real estate," the most likely response would be "good for you..." However, if you instead mentioned that you were looking "to buy a small single family house in the Rockford neighborhood for under $150,000," you enable others to think of properties that might match that description and get you connected with the deal.

Understanding "The Rules" of Investment Property

Perhaps the most important part of the criteria you put together is the financial component. If a deal doesn't make sense financially, it's not going to be a strong investment for you. In chapter two we looked at some of the basic math surrounding real estate investing, such as income, cashflow, and return on investment. However, generally speaking, a listing is not going to tell you the important information you want to know about the financials of a property. Yes, you can generally determine the amount of income the property makes - but you won't know immediately how much monthly cashflow the property produces, how overpriced the property is, or what you should offer. Additionally - it's not going to make sense to get out your spreadsheet and do a full property evaluation on every single deal you glance at. This is when "rules" come into play.
A "rule" is short for "rule of thumb." Rules can help give you a quick way to evaluate a property's financials on the fly. As with any "rule of thumb" using rules is not an exact science and should never be relied on entirely to decide if a property is a good investment. However - they can help you quickly filter a property and decide if it's worth further evaluation. Let's take a look at a few of these rules:

The 2% rule states that your monthly rent should be approximately 2% of the purchase price. 

In other words, a $100,000 home should rent for $2,000 per month; a $50,000 home should rent for $1,000 per month. This is a very conservative estimate that is very simplistic but can help in deciding if a property warrants a deeper look. In most parts of the country, the 2% is very difficult to achieve, but the closer you can get to that, the better cashflow you'll receive.
Real World Example: An average three bedroom home rents for $800 per month in your neighborhood. According to the 2% rule - you should be looking to spend around $40,000 for that property ($800 / .02 = $40,000)

The 50% rule is a great rule-of-thumb that helps you to fairly-accurately predict how much your expenses are going to cost you each month for a property. 

The 50% rule simply states that 50% of your income will be spent on expenses -- not including the mortgage payment. 

As mentioned above - most real estate listings will let you know what the monthly income of a property is. By dividing that number in half, you are able to easily see how much you'll have left to pay the monthly mortgage (principle and interest). Any income left over, after the 50% of expenses and the mortgage payment are taken out, is your cashflow. The 50% of expenses includes all expenses, including repairs, vacancies, utilities, taxes, insurance, management, turnover costs, and the occasional "big ticket" repairs that must be saved up for -- aka. CapEx or Capital Expenses like roofs, parking lots, furnaces.
Real World Example: An apartment building brings in $8,000 per month in income. Using the 50% rule, we are left with $4,000 to make the mortgage payment. If the monthly mortgage payment on the property was $3,500 per month, you can reasonably assume a monthly cashflow of $500 per month.
The 50% rule is especially helpful in teaching that expenses are almost always more than one might think. One common mistake that new investors make is under-estimating how much the expenses are going to cost. The 50% rule helps to show that there are always costs that are unexpected, so plan for them.

The 70% rule is used by investors to quickly determine the maximum price one should pay for a property based on the after repair value (ARV). Though most-often used by house flippers, the 70% rule can actually be used for any strategy when you want to find a good deal. 

The 70% rule says that you should only pay 70% of what the after repair value is, less the repair costs.


Real World Example: A home which, after being fixed up, should sell for approximately $200,000, needs approximately $35,000 worth of work. Using the 70% rule, a person should multiply $200,000 by 70% to get $140,000 - and then subtract the $35,000 in repairs. The most a person should pay for this property, therefore, should be $105,000.
Remember, a rule of thumb like the ones above are used only to quickly and efficiently screen a property and decide if it's worth further investigation. Never use a "rule of thumb" to decide exactly how much to pay or if you should invest or not. If a property passes the above rules (or gets close) it may be worth a more detailed analysis on paper or via a computer spreadsheet. Don't confuse a rule of thumb for a license to skip doing your homework.