Residential real estate is increasing in popularity as a form of long term investment. However most people have little knowledge as to the differences between a good investment and an ordinary investment. Here is a simple guide to help you.

This formula is not meant as investment advice. It is based on my personal experience and knowledge of property investing. The formula will work well in most first world countries. However all countries are different and so you should check this formula against trends in your country.

As a professional investor I will often buy outside of this formula but I also do extensive research and have many years of experience as a full time investor. This formula is aimed at the person who does not have the time, resources, experience or inclination to do the amount of work that a professional investor will do.

1. Buy in a Medium to Large City

It is a fact of the western world that cities are growing in size and population. When it comes to investing the trend is your friend and so it makes good sense to buy in areas where the demand for residential property is increasing.

2. Buy At or Below the Median Price for Both the City and the Suburb that you are Buying In.

High price properties are luxuries and as such tend to fluctuate substantially in price according to the economy. However median price and below properties are filling a basic need and therefore come more into the necessity category. This results in a more stable, lower risk, market for properties in this price range.

3. Get a Thorough Pre-Purchase Building Inspection Conducted by a Qualified, Experienced Professional.

You should know what the required maintenance cost is going to be for the property you are buying and factor that into the equation when you are determining what the property is worth. An unexpected problem with the building can be expensive and quickly erode your profit.

4. Find Out What is Planned for the Area that you are Buying In.

The laws of disclosure on this matter vary from country to country. At the end of the day it is best to assume responsibility for discovering if anything is planned that may adversely affect your property price. This could include things like a highway being rerouted through or next to the house, a factory, airport or other noise or pollution producing construction being planned for the neighborhood, and so on.

5. Spend At Least 3 Weekends Researching Property Prices in the Area.

Most people will be very good at judging the market price of a property once they have spent a few weekends looking at properties in that area and observing what they sold for. Make sure that you take the time to also attend auctions and watch the bidding patterns. If you can accurately judge market value then you are far more likely to buy well.

6. Make sure that you can afford to pay the loan and the running cost of the property even if you only have a tenant 50% of the time.

You would have to buy very badly or be asking too much rent to have your house empty 50% of the time. One possible exception could be in holiday housing that was very seasonal but this is usually balanced by very high income when the house is rented.

Having said that, it is still a wise precaution to ensure that you can afford to cash flow the property even in this extreme case. There is nothing worse than having to sell a good capital growth potential property simply because you were overly optimistic when assessing the cash flow potential.

7. Be Well Insured.

Property insurance is cheap and is good risk management. Make sure that you don’t underinsure because you will find that most insurance policies will only pay a proportion of the normal amount, even on small claims, if they can show that you are under insured.

If your cash flow ability is dependent on your income from a job or business, which will usually be the case if you have a mortgage, then you should also investigate income insurance. A loss of job due to illness or accident can cause you to lose the investment if you don’t have your income protected.

In some countries you can also insure against loss of rent from a bad tenant. However the cost and benefits of these policies vary greatly and it is up to you to ensure that you are getting value for money if you take on one of these policies.

In Conclusion.

These seven simple rules can provide a good basis for helping you make a good property investment without having to be an expert, professional investor.

With most forms of investing the challenge to the investor is to tell a good investment from a bad one. However with residential property investing, as long as you follow a few basic principles you are most likely to be picking between a good investment and a great one.

Let’s face it, how difficult is it to buy residential property today cheaper than it was 10 years ago You wish you could. Property tends to show more consistent capital growth than any other class of investment and it also has less frequent price drops and less severe price drops than other forms of investment.

So let’s look at the five basic rules for making good purchase decisions.

Rule 1 Buy on a Business Decision Not a Personal Decision.

I’ve bought plenty of real estate that I would never be interested in living in but they made me plenty of profit. Beginner real estate investors tend to still think like home buyers and try to buy something attractive that they could see themselves living in. This is usually a big mistake.

You buy investment property with the aim of maximizing your profit. Sometimes this can be achieved with a tidy, attractive home and sometimes it can be achieved with unattractive, bottom rung property. If you make your decisions as business decisions then you will be able to buy what works best at that point in time.

Rule 2 Buy Property You Can Cash Flow.

Sometimes people are so busy chasing capital growth that they get in over their head. They have over estimated the rental income and under estimated the outgoings. Professional investors always keep their projections on the pessimistic side so that they don’t over extend. It doesn’t matter how great the future capital growth potential is if you have to sell out in order to pay the bills.

Rule 3 Buy At or Below the Median Price for Both the City & Suburb You are Buying In.

High end properties are luxuries and as such they are more volatile. When the economy tightens up the buyers for high end properties dry up the most and the quickest. Median price and below is where the ordinary people live. These homes are more in the necessity range than the luxury range and so their market is much more stable.

Rental income is also more stable in median price and below housing. When the economy tightens people find it more difficult to meet high rents so the renters seeking homes start looking more down market. The whole rental market shifts down a peg which means that the high end properties experience more vacancies. With the median and below market what they lose by their typical tenant moving down they pickup from the higher end tenant coming into their market.

Rule 4. Buy Property That Will Increase in Value Faster than the Average.

At first glance this might seem like an obvious but difficult strategy to apply but in fact it is relatively easy to do once you recognize what drives the property market.

First you have to accept that there is no such thing as the true value of a property. All value is psychological. It is a perception in the mind of the buyers and sellers. If you identify the type of buyers that are purchasing in a particular area then you can quickly identify the things that will influence their perceptions.

In areas where most of the housing is occupied by the buyers then the perceptions of value will revolve around perceived lifestyle. In areas where the majority of the housing is rental property then the buyers are investors and their idea of value will revolve around their perception of capital growth potential and cash flow potential.

There are some basic strategies that professional investors use to identify trends based around these concepts.

Rule 5. Learn How Professional Investors Use Finance as an Investment Tool.

Amateur investors tend to see finance as a necessary evil but professionals see it as a way to increase profits and reduce risk.

When you introduce financing into an investment it is called leveraged investing. The concept of a lever is that it produces a result far greater than the same amount of effort would produce without the lever. In investing, a leveraged investment can produce a higher rate of return on the cash invested than you would have received without leveraging.

For this reason professional investors become experts in the benefits and risks associated with the different forms of financing. By doing this they know what is the most suitable form of financing for a particular investment. Using standard financing a typical residential investment property can result in average returns on cash input of 20% to 25% per annum. By using the right forms of financial leverage you can increase the average returns on cash input to 30% to 35% per annum. This results in a massive difference over a 20 year period.

Understanding and following the 5 basic rules of real estate investing can greatly increase your profits and also reduce your risks.