Questions to Ask Before Buying an Investment Property (Part 1)
Part 1: Developing Your Vision and Strategy
The thought of buying an investment property, especially for a first-timer, can be daunting. If you’re beginning your investing journey, you probably feel you lack skill and confidence. You’re even a little freaked out, realizing that not everyone in the industry has your best interests in mind.
Regardless of these fears, most investors tend to rush out and indiscriminately buy assets, assuming that all properties go up in value. But, if there is anything that I’ve learned from personally coaching over 300 of the investors in Steve McKnight’s Property Apprenticeship, it’s that not every investing story has a happy ending.
To give you a leg up, here is Part 1 of 3, which covers the top 15 questions to ask before you close your next deal:
1. In Ten Years, What Do I Want to Achieve as a Property Investor?
Most of the people I’ve coached say that when buying an investment property for the first time, they didn’t give much thought to the future.
I can relate to that. When I did my first deal, my long-term vision was nothing more than to have a portfolio of properties to produce passive income.
But the most helpful foundational investing truth I learned from Steve was this: Be an outcome-driven investor, not a speculator. Speculators acquire assets and hope for the best. Often echoing lottery ticket buyers, they contest, “You’ve gotta be in it to win it!”
Outcome-driven investors, however, are more calculated and deliberate. They begin with the end in mind, both long-term and with each individual property while applying a clearly thought out strategic plan to carry them to their goal.
Before you invest in real estate, clarify your win by asking some questions. How much passive income will you need to replace what your job currently pays you? What yield will you expect from your investments? How much capital will you need to produce your desired level of income?
Whether you plan to retire in 5, 10 or 30 years, the best time to answer these questions is right now.
2. Am I Buying Investment Property For Growth, Or For Income?
I can make this one really easy for you. If you’re young and have no assets, you probably need to focus on growth with your next deal. Be clear on the size of the nest egg you need in order to be financially free, and begin building toward it.
I’ve worked with young, cash-poor investors who dream of a five-year plan to financial freedom by incrementally adding positive cash-flow properties to their name. It may have been a workable plan 15 years ago, but good luck in the current market.
If you want to retire young, it’ll help to have either a wealthy aunt, or a solid cash cow business on the side.
However, if you’re a little older and you’ve built some growth in your asset base over the years, perhaps you’re ready to liquidate and convert to higher yield, income producing real estate. When Steve teaches this key principle at his conferences, it’s amazing how many people have an “aha-moment” that they could actually retire now, or in the next few years if they really wanted to.
This growth vs. income question is important to settle on the front end, because it naturally leads to the next important questions.
3. How Much Profit Must I Make On My Next Deal, And By When?
If you’ve ever traded shares, options, futures or currency, you’ve probably heard this most basic discipline: Know your entry and exit point before placing your trade.
The same applies to buying an investment property. Once you’ve established a long-term goal, you need to work backwards and set some benchmarks by asking:
How much must I accomplish in 5 years, in two and a half, and in one year, to be on track for fulfilling my goals?
Once you’ve established your one-year goal, you should be crystal clear on the level of profit your next deal requires.
4. What Will I Rely On To Achieve This Profit – The Market, Or My Skill?
Skilled investors can make money when the market is going up, or when the market is flat. Everyone else must rely upon generic growth – appreciation on the coattails of the overall market.
Of course, the sweet spot is when you can combine both your skills and the right timing. For instance, you subdivide and develop a block, while the overall market also grows by 10 percent.
Not only do you manufacture growth by adding value to the land, but you also capitalize on the generic growth of the overall market.
Before you can choose an investing strategy, it’s important to be clear on the limitations and constraints of your skills. As Warren Buffett’s business partner Charles Munger says, “People chronically misappraise the limits of their own knowledge…Knowing the edge of your circle of competence is one of the most difficult things for a human being to do.”
No matter what you’re relying on now, you should actively seek mentors and coaches to help you grow in competence. The higher your skill level, the more likely you can make greater profits in a shorter amount of time, and with the lowest amount of risk.
5. What Property Investing Strategy Will I Use To Achieve My Goal?
The last four questions have been building up to this one. See if you can work out which of the strategies listed below are more geared toward income, and which ones are focused on the growth of your capital base.
When investing in real estate, here are your basic strategic options:
- Buy and Hold – Acquire a property, put a tenant in it, and be either confidently bullish, or just hope for the best.
- Renovate – Find a distressed property that’s really ugly, and make it beautiful on a budget. Then either rent it out, or sell it for a profit.
- Subdivide – Split a larger block into smaller blocks in an area where land is in short supply. The idea is that the sum of the parts is worth more than the whole.
- Develop – Build some units or townhouses to attract your target market, and then reap your subdivision reward.
- Flip – Sign a contract to buy a property, and then sell your interest to someone else for a profit before it’s time to settle or close on the deal.
- Creative Cash-Flow Strategies – Vendor finance, lease options, vendor carry-back, and other options are creative ways to enhance cash flow.
In short, when choosing your strategy, be sure to tick these three boxes:
- My strategy will take me to my long-term goal.
- My strategy matches my skill level.
- My strategy is duplicate-able and scale-able.
In summary, if you take the time to think deeply through these five questions, you will be far ahead of nearly every other investor out there who is simply buying assets and hoping for the best. Passionately aiming toward a predetermined goal, and then sticking to a systematic strategy are the foundational skills that separate the mediocre from the great in nearly every endeavour.
In Part 2, we’ll help you narrow down your search for your next deal by answering five more questions you should ask before you buy an investment property.