If you start a conversation with any real estate expert or enthusiast, you are guaranteed within the first five minutes to hear how important location is when buying investment properties. Indeed, most of them would go far enough to claim that “location, location, location” are the three most important factors in the industry.
So, let’s have a look at the reasons which make location a crucially important factor for the success of a real estate investment business.
Property Prices
Regardless of the investment strategy you go for, you have to buy a real estate property or a part of one. Where your investment property is located will determine the price you have to pay for it, and the initial capital is a major input in any investment decision. The purchase price will be a major determinant of your ultimate return on investment.
Optimal Investment Strategy
One of the beauties of real estate investments is the multiple options you have in terms of strategies. Location will help you decide on the best strategy in your particular market. For example, if you invest in a property in a city with high rental demand, you should probably rent out your newly purchased house to make the most profit. If, on the other hand, your place is a hot tourist destination, you can consider turning your property into a vacation home and renting it out on short-term basis on Airbnb or another similar platform. Yet another option if you see high demand from homebuyers is to do some repairs on the property and sell it for more than what you initially bought, i.e. fix and flip it.
Short- and Medium-Term Return on Investment
Whether you decide to go for residential real estate investing or commercial real estate investing, what you care about at the end of the day is how much money your property is producing, or your return on investment. The capitalization rate (or cap rate, for short) and the cash on cash return (or CoC return) are two of the most popular metrics of profitability in both residential and commercial real estate. The main difference between the two is that the CoC return takes into consideration the method of financing a property (mortgage or cash) while the cap rate doesn’t.
Cap Rate = Net Operating Income (NOI)/Current Market Value (CMV)
Cash on Cash Return = Annual Cash Income/Total Cash Investment
If you decide to go with rental properties, the location will determine how much rent you can ask for depending on the type and size of your property, which will define both your NOI and your annual cash income. Moreover, most property and rental expenses such as property tax, property insurance, property management, utilities, etc. vary from one place to another.
All in all, where your property is located will have a major impact on how much you make from it and ultimately your return on investment.
Long-Term Appreciation
One of the benefits of real estate investing is that you make money not only in the short run (through rental income) but also in the long term through appreciation. The truth of the matter is that while property prices increase in value over time in all US markets, different markets appreciate at different rates.
Whether you go for the buy and hold strategy as an individual investor or invest in a REIT, as a real estate investor you make money when property prices go up. Once you decide to sell your rental property or your shares, the appreciation that happened over time will determine how much your final return on investment will be.
Thus, before you decide where to invest in real estate, make sure to conduct careful research to find the best location for property investments. Study the supply and demand; check if it is a buyer’s or a seller’s market; pay close attention to the demand for rentals; and don’t forget to look into signs for future growth and appreciation.
