Choosing The Right Investment Properties

There's more to creating a profitable real estate portfolio than just buying what's available.Here's how to make the best choices.

Ronald Phillip Ellison Jr. has been investing in real estate since he was a teenager. Back in 1988, the U.S. Department of Housing and Urban Development had a lot of properties for sale in the Detroit area. “My father helped me buy one for $3,000,” says Ellison, 34, who currently lives in Bloomfield, Michigan. “The rental income helped me pay for college, and I eventually sold the house for a profit of more than $15,000, including the money I put in it to fix it up.”

Ellison, a medical products salesman, continues to hold investment real estate today. He and business partner Timothy Hoke have formed a limited liability company and currently own 15 single-family homes, duplexes, and multifamily buildings. Ellison and others who have successfully acquired investment properties all had detailed home-buying strategies with clearly defined goals and objectives.

Real estate can be a great investment, but not every property is a big winner. To make money, short- or long-term, it’s important to buy the right property at a reasonable price. This may sound simple, but the details can be complicated. Here are some guidelines to follow:

SET GOALS. “When you seek rental property, you should know whether your primary objective will be current cash flow or long-term appreciation,” says Jocelyn Wright, a financial planner with Wealth Development Strategies in Houston. She explains that if your goal is cash flow, you’ll need to figure out how much you think you’re going to spend on repairs and whether you’ll have to borrow that money. “The more money you have to borrow to buy the property and make improvements, the higher your mortgage will be,” says Wright. And that will cut into your profits.

You may also want to focus on real estate that you can rent to low- to moderate-income tenants. “Properties in the inner-city may not appreciate as much as property in more desirable locations,” says Marilyn Broussard, a Waddell & Reed certified financial planner in St. Paul, Minnesota. Such properties are more likely to deliver income than long-term gain through appreciation.

Indeed, the most cash flow will come from low-income properties, according to Bob Bruss, a real estate attorney and syndicated columnist in Burlingame, California. “You’ll probably have more intensive management responsibilities there — along with generating current income,” he says. “In better neighborhoods, you’ll pay higher prices for property in relation to rents. Thus, you’re more likely to have negative cash flow … but you may have more potential for appreciation.”

Bruss provides a rule of thumb for property investors. “You should anticipate receiving 1% of a property’s purchase price in monthly rent if you want to cover expenses,” he says. “For example, if you pay $100,000 for a property, you may need $1,000 in monthly rent to avoid negative cash flow. If a property is likely to generate negative cash flow, it should offer upside appreciation potential in order to make investing worthwhile.”

Some investments are better suited to provide income rather than appreciation growth. “I once owned Section 8 property,” says Jeff

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