The following is a guest post by FMF reader Apex. He has been investing in rental real estate for more than four years and is authoring a Real Estate 101 series, posting every Friday, based on his experiences. (To read the series from the beginning, start here.) The series is designed to give prospective investors the basic tools they need to succeed.
When you begin your search for properties you have to start somewhere. After you have seen a few properties you will start to find things you like and things you don’t. Perhaps homes of a certain age require more work than you want. Maybe certain neighborhoods are too expensive.
The more you look the more you will refine the criteria you think makes for a compelling investment. However, you can only do so much refining in the abstract prior to purchase. Once you have purchased a property you will now start to find out what is working as expected and what is not; what features make it easier to rent and which ones make it harder; what type of properties and neighborhoods attract the tenants you desire and which ones make it harder to get good tenants.
Everyone’s process of discovering what works best for them will be different. Your refinement might happen quickly or it might be more gradual. It might take some time and a number of properties to be able to identify those things that are important to you and to how you want to run your business. The most important thing is to identify what your criteria for success is and to work at refining your process to improve your level of success based on that criteria. I call this process finding your niche.
I found my niche after I purchased my second property, and it has guided my course for over three years. Operating my first property for a year had given me some insights that I used to adjust what I was looking for in future properties. When I found my second property and began operating it, the pieces of the puzzle that I had been trying to define all came together. Comparing it to my first property made clear the intangibles that I had overlooked.
Operating that property and others like it for over 3 years has only confirmed and strengthened the confidence I have in the niche that I focus on. This refinement reduces the type of properties I now consider, but that tighter focus has made the entire process of purchasing properties easier and faster. I now know what I am looking for. I know when I have found it, and I can pull the trigger quickly because I now have first hand knowledge about how that property will perform. Having a niche to focus on has proven to be the most effective way to expand my business. It has freed me from the uncertainty of trying to consider many different types of properties, most of which I will have had no first hand experience with.
Every real estate investor is different. I cannot tell you what your strategy should be because there are dozens of different ways to be successful investing in real estate. The best chance for you to succeed is to find a strategy that closely fits who you are. You cannot merely copy someone else’s model. You are not them, and the reasons it works for them, may not work for you. You must be comfortable with your niche.
If your primary motivation is ROI and none of the other aspects of real estate investing bother you in the least, then you need to focus on the type of properties that produce the best returns for the least amount of cash invested. If the amount of headaches you have to deal with is a big factor for you then you need to focus on the type of properties that need the least amount of work, rent easily, and attract the best tenants. You can decide to focus on small apartments with a caretaker who handles most minor tenant issues. You can focus on high-end properties that have high-class tenants with high rents. You can focus on cheap properties that cater to government subsidized housing so you know the rent will always be paid.
The choices available to you are vast. However it is important that you do not continue too far down this path without attempting to find out what your niche is. Each of these different options requires a different strategy. It requires different levels of expertise and effort. Failing to concentrate on a core strategy will dilute your ability to become skilled and efficient at any one of them. Your plan can evolve over time and can encompass more than one strategy, but to think that you can take on a myriad of different properties and succeed at running them all is likely to be a costly mistake, especially in the beginning.
I have narrowed my niche down to the following. I look for properties that produce good solid returns, not the best returns possible, but very solid. I combine that with high quality properties, preferably newer with minimal need for repair, in good neighborhoods in the suburbs. I specifically try to avoid 1 and 2 bedroom properties with single car garages. Instead I prefer larger properties, 3 and 4 bedrooms, with double car garages. I have found that these rent very easily and attract reliable, stable, long-term tenants that treat my properties with respect for the most part. In time this strategy will likely evolve, but that’s what it currently is.
There are a few things that helped me to define my niche. I learned that properties that are harder to rent are a big turn off for me. Showing properties can be a considerable time effort. If I have to show a property a dozen times that is a big burden. The properties I own now typically rent with just a few showings, often on the first one. I have also found that smaller properties with fewer bedrooms tend to turn over faster. The larger properties attract families with children that care about the school district and do not want to uproot their families as often. This keeps my turnover and my workload down. Furthermore the larger units command more rent. On a pure ROI basis they might not perform quite as well as the smaller units but on a cash flow per unit basis they perform drastically better. Cash flow per unit is more important to me than cash flow per dollar invested. While my dollars are limited, my time is even more limited. Maximizing cash flow per unit is a big part of my strategy.
These are all factors that have gone in to defining my niche. The factors that will be important in defining your niche might be similar or vastly different. Only you know what those are. The quicker you can identify the factors that are important to you the faster you can define what your niche is. The better defined your niche; the more satisfied you will be with both your investment and with how your business is running. That personal satisfaction is going to be essential in allowing you to continue operating your business. Even if the business is profitable, if you are finding it un-enjoyable in a number of ways, you will likely not stick with it. The problem is probably not with real estate per se. It’s probably that you have not found a niche that is a good fit for you. Find that, and you will find success that will last.
Update: To read the next post in this series, see Getting It Rented.
If I were a real estate investor my niche would be the same as yours. The type of properties you describe are attractive and with landscaping that isn't just bare dirt and weeds, they also tend to be in areas with a lower crime rate and are fairly close to schools, parks, shopping centers etc. They are also areas that first time homebuyers tend to seek out, and those new buyers have lots of pride of ownership. They are the areas that we sought out back in 1960 when we were renters and had just arrived in California, and they still look nice today. The two car garages also help to keep the street free from too many parked cars.
Posted by: Old Limey | October 19, 2012 at 12:12 PM
I believe that each real estate investor is different. If you are avoiding properties with 1-2 bedrooms, I prefer to have this kind of property rented out. I believe that it is easier to find tenants for these properties. There are a lot of young professionals, couples, or start-up families, who are looking for homes with 1 or 2 bedrooms. In comparison, properties with 3-4 bedrooms in suburbs are more recommended for families. If I were a parent of a growing family, I would rather apply for a home loan than use the money to pay for rent so I feel that it is more difficult to find tenants for them.
Posted by: Cherleen @ My Personal Finance Journey | October 20, 2012 at 02:26 AM
I also lean towards 2 or 3 bedroom units. I love 2 bedroom units even more. Its been easier to get tenants for 2 bedroom units than any other size in my case. Young professionals in my area prefer this size to a 1 bedroom. Having said that, my 4 bedroom unit has never been vacant. This is because it is in the cheaper end of a very expensive gated community. People who cant afford the expensive home in an elite area would rather rent a cheaper home there to live with the rich. Its also low returns but high quality tenants.
Posted by: Soso@SafeInvesting | October 20, 2012 at 03:58 AM
@Cherleen and Soso
Both of your comments are exactly what this post is about. A niche is unique to each investor and fits both them and the area they are in. My example was to show how I found one that works for me. It's great they you also have found things that work for you.
Posted by: Apex | October 20, 2012 at 08:58 AM
Thanks for this post Apex -- I have three rentals and the same niche and experience as you, and I was going to post that I think that's optimal for everyone, but the other comments made me realize that it's probably because of the area where I live -- where there is a shortage of housing and it's quite easy to rent a large 4-5 BR house to an extended family (but in other areas with more vacancies or a younger population, it would be easier to rent smaller units). I wonder how much the niche is optimized for the investor or for the location?
Posted by: SteveD | October 21, 2012 at 11:07 PM
@SteveD
I suspect it's a good mix of both.
Even though this post received relatively few comments I think finding your niche is one of the more important concepts in real estate investing. The topic tends not to wow anyone but I believe most successful real estate investors have a niche.
It's actually a topic that is common in business in general. It's the idea of focusing on your core business. When a business tries to expand into diverse areas outside of its core competencies it often fails in those other areas. Real estate is not an exception.
Posted by: Apex | October 23, 2012 at 09:02 AM