1. You are buying a cashflow.
With this, I mean that there is a price you can put on the sum of all net cashflows after paying all non-mortgage expenses and your taxes. The sum of this series of cashflows is actually called the Net Present Value, and is a fundamental term in real estate. Not surprisingly, the value of many investment properties is determined in a large part (or often completely by) the cashflow generated by the asset.
Cashflow = Rent + Other income - Taxes - Utilities - Management - Average monthly repairs
As you ca see, cashflow can often be quite small! Beware very expensive 'rental' properties that seem at first to have high 'income' but actually have next to no cashflow. Remember that you still have to pay for the interest and principle costs of your mortgage, depending on the level of financing you select.
2. Land Value (appreciates over time)
Land is the only thing that appreciates over time in the whole real estate world; it may not even appreciate - Japan recently left 15 years of depreciating land prices and general deflation. England and the United states are in the throes of massively depreciating asset prices. The interesting thing about land is that it CAN appreciate, simply because: NO ONE IS MAKING ANY MORE OF IT! The old addage of location, location, location is likely the truest thing in detemining the value (or future value) of real estate.
For example, when I see areas that are 5 minutes from downtown with large single-detatched homes on nice little 1950's style streets, I don't care what the neighbourhood is like. Eventually, that location will fetch a premium. This has a high potential for land proce appreciation.
3. Building (or asset) value.
I think the most ignorant thing I hear in the real estate investing realm is that "Hey dude, my house is, like, totally gonna go up in value." Well cowboy, let's get back on the cool ranch for a sec; as I mentioned before, land is the only appreciating asset. The catch? Houses happen to be on the land!
The actual real asset in an investment property is simply the means by which you genrate cashflow. It is a net liability, in the grand scheme of things. You buy a property and the asset has a value. It then depreciates over time - the government recognizes this and allows you something called Capital Cost Allowance (CCA), as your house will eventually degrade to being completly useless and condemned. I apologzie for the cynisism, and I know that there are many ways to maintain and perserve assets so they remain functional. The point is that just because you have a nice looking house, doesn't mean that it will appreciate. The rate of appreciation is determined by the land, not the house.
So what does this mean?
In an investment property, you would be best to find the most functional house in the nicest area that generates the best cashflow. In a perfect world, one might show up in your stocking at Christmas. In the real world, you will likely have to pick a combindation of these factors. I typically stay on the side that generates cashflow. I try and maximize the level of net cashflow to the price I am paying. I care little about the appreciation of the actual asset, so long as it's generating consistent and stable returns. These types are like the 'Line infantry' of my real estate army. Half of my portfolio consists of little townhomes that are simple to rent, efficient to maintain, and typically fetch a net annual return of 8% on their original value. Keep in mind that rents go up, wheras your mortgage value doesn't!
My next favourite type would be single family homes that are undervalued for silly reasons. Places close to downtown, places with large lots on quiet streets, places where people say "oh, you don't want to live there, it's a working class neighbourhood' Tell you what, I don't particularly care - I won't be living there anyway! These are the places that are functional AND have a particularly strong potential for land appreciation. Populations are only going up, and one day, these quiet naighbourhoods will be zoned for intensification. Start playing monopoly and collect the whole block!
More to follow,
AIML
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