One of the traps that many new investors fall into is rushing to buy, and purchasing investments of marginal quality. Frequently, this also involves partnering with people of marginal quality to find the deals. The unfortunate part of all this is that it is unnecessary.
Quality deals and quality people are out there to be found. The trick is that they need to be found … you can’t expect them to come find you. The reason for this is because the best people spend their time doing business, not turning the crank to try and reel in more inexperienced customers.
What this ultimately means to us as investors is that we must put in the work to find quality. This consists of two distinct parts that are equally important. The first is that we must learn what quality looks like so that we can recognize when a good deal is available. The second is that we must be patient to wait until quality deals become available.
Learn What a Good Deal Looks Like
The first step in finding good deals is to understand what constitutes a good deal. As one would expect, this goes beyond numbers alone. The market area, and location within that market both play big roles in differentiating a good deal from a marginal one. All of these factors will influence the possibility of future market price appreciation.
Some of the factors that are universal in analysis of attractive deals is healthy rents and low land value relative to improvement value. The general guideline that we like to follow regarding rents is to target properties with at monthly rent that is at least 0.7% of the property value. (Known as the Rent to Value or R/V Ratio) The ideal situation is an R/V ratio of 1.0% or better. This provides significant room for the investor to realize cash flows after paying the costs of carrying the property.
The importance of pursuing properties with low land values is that it decreases the long-term volatility of market prices. The reason for this is because structure values typically regress toward replacement cost. However, land value fluctuates up and down based on supply and demand in the market area. Thus, when land value represents a high proportion of the total property value, the overall rate of value fluctuation is likely to be higher.
Be Patient
Once the fundamentals of a good income property have been internalized by the investor, the next logical step is to begin analyzing deals to see how many meet the guidelines. If the selection is small, then it is incumbent on the intelligent investor to wait until the exceptional deals become available. The people who benefit from market disruptions are the ones who are prepared to scoop up the deals that are created by the volatility.
