Opportunities Abound for Real Estate Investors

A couple of weeks ago, a Los Altos homeowner came to me for advice and help to find an investment property. With the market remaining soft in many neighborhoods and interest rates at historic lows, she is convinced the timing is right to invest in real estate.

We didn’t look in Los Altos, as she wanted to diversify her portfolio. Instead, she wanted to buy in Palo Alto—a city she likes and with good "upside" potential. But as soon as we started punching the numbers, she realized Palo Alto may not be a good candidate, after all.

There are fundamental differences between buying your primary residence and buying an investment property, with the single purpose of the latter to make profits. It is thus critical to determine upfront if the projected return of investment meets your expectations. Additionally, what makes a good home for you may not make a good rental property. You have to adjust your mindset and look with your investor’s eye when buying.

People make profits in investment properties in two ways—monthly rental yield and long-term appreciation. Homes with the best rental yield don’t always give you the best appreciation. For instance, lower-priced homes in general offer better yields than more expensive homes. In the case of this Los Altos investor, what she found was that despite the prospect for price appreciation, the annual rental return in Palo Alto may not be as good as less expensive homes in Santa Clara or San Jose.

Different types of residential properties also yield differently. Multi-residential properties may yield well, but the prospect for appreciation may not be as good as with single-family homes. While townhomes and condos are popular rental properties, their yields are often compromised by the homeowners association dues.

Keep in mind a few things when estimating your return. First, if you plan to obtain a mortgage, mortgage rates in general are higher for investors. Second, don’t forget other expenses, including the property taxes, insurance premium, utilities paid by you, and all the maintenance and gardening costs. You may also want to include a vacancy factor (percentage of time when the home is not generating income) in order to have a more realistic projection of income.

Given the range of choice, you would need to compare the return of different types of properties to identify the one that meets your investment objectives: Is monthly income or long-term appreciation more important? How much annual yield are you looking for? How long do you plan to keep the home? And what level of price appreciation do you want to see?

It is also important to get to know the rental market of your interested area, and how strong it is. Obviously, the estimated rental yield means nothing if you can’t even find a tenant.

Another thing I couldn’t stress enough is the need to adjust your mindset when looking for investment homes, especially by first-time investors. Remember you’re not going to live there. Your personal feeling about the home is not as important as what your research tells you the annual return would be. Certainly you need to make sure you’re buying a good home. But you would need to draw a line between something that most people like or don’t like, and your personal taste.

The state of the real estate market presents good opportunities to people interested in investing in rental properties. It is especially true for cash investors whose alternative would be to let the money sit in the bank. The recent drop in price in many neighborhoods has greatly improved the rental yields of most homes. If you have contemplated buying an investment property, now would be a good time.

But be sure to do all your homework, and wear your investor’s hat when you’re out looking!

Winnie Yip Fong, a Los Altos resident and local Realtor, writes a monthly column to provide advice and her insights into the local real estate market. Email her at winniefong.realestate@gmail.com for any suggestions or comments.