If you ask any financial analysts or seasoned investors, a good chunk of them would consider real estate markets one of the best investments one can make today—and for a very good reason. Passive income, tax benefits, potential diversification—investing in the right real estate will likely get you the most impressive returns.
However, everything comes with a cost, and while real estate investment is an attractive source of income, the rising prices of housing and real property also require great financial capacity from potential real estate investors. In 2022, the average sales price of a house amounted to $540,000 after plateauing at around $380,000 since 2017.
With the increasing costs of housing and acquiring real property, jumping the gun on real estate investments without proper planning or knowledge about the market will result in more losses than gains. In this article, we will discuss everything you need to know about real estate investment and how to analyze them for opportunities that will maximize your investment.
Real estate market by the numbers
According to the Real Estate Global Market Report published in April 2023, the value of the real estate market in 2023 has grown to $3,976.18 billion in 2023 from $3,694.47 billion in 2022. It is expected to grow to $5,209.84 billion by 2027 at a compound annual growth rate (CAGR) of 7 percent.
Asia-Pacific was the largest market for real estate investments in 2022, with North America just trailing second behind.
→ Understanding the role of a real estate marketing executive
Types of Real Estate Investments
While the idea of real estate investment may seem complicated, it simply means investing money in forms of real estate (land, property, building, home, or other improvements or structures) to generate wealth, income, or cash.
We can categorize real estate investments for their tangibility, like real property investments with physical features like homes, apartments, and condominium buildings, and those with no tangible features like real estate investment trusts (REITs) or crowdfunding platforms.
There are three most common kinds of real estate market investments:
Residential properties
Residential properties as real estate investments include condominiums, apartments, homes, or vacation homes where people dwell to stay for either a short period or a longer period.
Real estate owners of residential properties earn through rent income for fixed-term tenants or by making a profit from buying and selling residential properties at an added value.
Commercial properties
Real estate investors in commercial properties earn rent by leasing commercial or office spaces or buildings to businesses.
A commercial building rented by a single company from a real estate owner or several businesses occupying select spaces from a commercial building is considered commercial property rental income by a real estate owner. Another example is a person who owns a building or a property for pay-parking and earns from parking income.
Owning physical properties like residential, commercial properties, or land as a real estate investor will give you the most control over your investment regarding management, profits, and tenants.
Real estate investment trusts (REITs)
If you don’t have the means or the knowledge to manage real estate properties directly but still want to invest in real estate, REITs are your next best choice.
REITs pool investors' funds to manage, operate, and finance real estate properties. If you invest in REITs, you earn dividends from real estate income managed by these trusts without personally dealing, managing, and buying physical properties.
Ryan Zomorodi, Co-Founder and COO of RealEstateSkills.com says, “Because you are entrusting your money to another entity for investment in real estate, you most likely have little to no control over where these companies invest your money or how much you get as returns or dividends.”
→ Understanding Family Dynamics in Estate Planning
Conducting real estate market analysis
Like any other investment, conducting an investment analysis is critical to know whether a particular investment will generate significant returns today or in the future.
In the case of real property, real estate market analysis delves into the following:
- Viability of the project
- Potential demographics and customer base of a particular property
- Accessibility of the location of the property
- Determine future development around the target property
- Determine potential risks and issues of a property
- Forecast demand of property based on future economic conditions
Conducting real estate market analysis will help property owners determine the market value trends of similar properties in their target location and help decide how much to rent or sell those properties for profit.
→ Effective Strategies for Small Business Owners in Estate Planning
Step-by-step guide on analyzing real estate investments
Whether you’re a first-time real estate investor or a seasoned one, conducting real estate market analysis for any potential investment opportunities is crucial. Here are the basic steps in conducting a real estate market analysis:
Define your objectives
Identifying your overarching goal is the first step to any project, business, or investment. What do you want to achieve with this real estate investment? Is it to maximize profit? Diversify your portfolio? Build capital appreciation of your assets?
Knowing what you want will help you decide where and what properties to invest in and when to do them.
Tom Nolan, Founder of All Star Home says, “Those looking to maximize profit may want to acquire properties for residential buildings in developed areas for maximum profit by increasing rent or selling prices of homes, apartments, or condominium units. Those looking at a long-term appreciation goal may want to look for properties in less developed areas that have the potential for appreciation in the future based on sufficient market research.”
Also, determine your use for the property you want to acquire. Do you want to:
- Buy and use a property for personal use
- Buy a property, wait for capital appreciation, and sell at a higher value
- Buy a property, pay for improvements, and sell at a premium
- Buy a property and lease out to tenants
Laying out your objectives will help map your plans from your starting point to your end goal.
Conduct market research
Conducting market research is a pretty broad horizon, but for real estate, here are some of the factors you need to consider in deciding real estate investment opportunities:
Historical data
Go around the area and talk to the locals. Ask around or ask anyone you know about the history of the location and the surrounding buildings—whether the area is prone to disasters and flooding or if safety incidents are occurring within the vicinity.
Gather historical data on the number of tenants that have come and gone from a particular property or unit. This will likely tell you if a property is viable for long-term leases and contracts.
Supply and demand
You can identify the supply and demand of specific properties in an area from historical data. Ask whether neighboring condominium units and apartments are always entirely sold out or if commercial units or parking spaces are all occupied. This might tell you that there is a need for more of those units in an area, which makes for an attractive real estate investment.
Significant developments and project plans in the surrounding areas
Knowing whether a particular area is a target for possible expansion or improvement is a good sign to invest in nearby real estate properties. Proximity to amenities, scenic views, and commercial areas significantly raises property valuations.
For example, suppose a reputable development company secures a plan to develop a vast plot of land into a city’s central business district. In that case, you may want to look around nearby neighborhoods to purchase land or homes for future sale or buy pre-selling condominium units in the developing area for future lease.
Identify properties and compare
After conducting sufficient market research, it’s time to narrow down your options and compare each property based on several factors. These factors may include:
- Property valuation
- Safety and Security
- Population
- Projected returns
If there are two similar properties in two locations with the same economic conditions, you should start delving deeper into the financial aspects of each property before making the final decision.
Conduct your financial study
One of the most crucial, challenging, but essential parts of analyzing if real estate is viable for investment opportunities is conducting financial studies. Investing in real estate does not come cheap, and being careful about how you spend your money and how much you may lose or earn from an investment is always a good idea.
Some of the financial metrics you need to look at when conducting a financial study in potential real estate investments are:
Return on investment (ROI)
To calculate your return on investment, simply get your investment gains or revenue and divide it by the total costs incurred in acquiring or developing the property.
Investment gains are the net effect of deducting the current value of your property minus the initial costs incurred. Say you acquired a property for $200,000 in 2013, which is currently valued at $500,000. Your ROI can be computed by dividing $300,000 ($500,000 less $200,000) by an initial acquisition cost of $200,000, which gives you an ROI of 1.5 or 150% in 10 years.
Cash flow projections
Bruce (Mingchen) Chi Co-founder, CEO of SuretyNow says, “While ROI is a great tool to determine how much you’ve gained from your investment, sustaining your properties day by day is just as important. Acquiring cash necessary for daily expenses would be challenging without proper cash flow.“
A cash flow projection allows a real estate investor to estimate how much money goes in and out of a particular property over a period based on assumptions. To create a cash flow projection, it is essential to set your timeline and identify your revenue sources, likely expenses, and fund sources in case you’re taking out a loan like homeowner loans for your investments.
Net operating income (NOI)
Net operating income is your income minus your expenses over a certain period.
According to Jim Pendergast, Senior Vice President at altLINE Sobanco, “Monitoring the NOI of your properties, especially rental properties, is essential because no one wants a losing business, and a negative or near-negative NOI means that you’re bleeding more than you earn. This should be a go-signal for you to study whether to decrease expenses, increase rent dues, or both.”
Capitalization rate
Capitalization rate is the measure of your net income versus the current value of your property. Not to be confused with ROI, a cap rate measures the value of your property relative to other similar properties in the market using current value instead of acquisition cost.
For example, an NOI of $10,000 and a current market value of a property amounting to $100,000 will give you a cap rate of 10 percent.
Depreciation and tax benefits
All expenses directly related to real estate operations are qualified tax-deductible items on the income tax return. This includes expenses that require cash outlay like property taxes, insurance, management fees, maintenance and repair costs, advertising, office and administrative costs.
However, one expense that does not require a cash outlay that is a deductible item from your taxable revenue is the depreciation cost of your property.
All real estate properties (except for land) must have an allocated estimated useful life to help determine your yearly depreciation cost. For example, a commercial building with an estimated useful life of 50 years costing $1,000,000 will have a yearly depreciation cost of $20,000 that you can deduct from your taxable revenue.
Examine the properties for potential issues
While this should be a part of your market research, it is important to double and triple-check potential issues that may arise when choosing a property to invest in. Considering the cost of acquiring a property, an unprecedented event may cause your investment to fall through and suffer significant losses.
Some of the risks and issues you need to be careful about when choosing a real property for investment include, but are not limited to:
- Unpaid taxes from previous owners
- Adherence to local authorities
- Undisclosed mortgage
- Undisclosed legal issues concerning the property
- Disaster and crime-prone locations
- Signs of damage, i.e., when acquiring an already existing unit or building
- Shifting demographics
- Political turmoils
Many of these risks and issues are out of your control, so you must be clear of any undisclosed problems with a property before acquiring it.
Wrapping up
Your market research, objectives, and financial studies must align in searching for investment opportunities in the real estate market. Real estate is just as risky, if not more, than any other investment that requires a significant amount of cash outlay in its acquisition and maintenance.
Analyzing the real estate market for investment opportunities requires a deep understanding of the market, the trends and patterns of real estate acquisition, and the location you wish to invest in. Its risks are just as significant as its cost and potential revenue, so those in real estate investing must conduct due diligence in determining whether these investment opportunities are viable rather than impracticable.