With most forms of investing the challenge to the investor is to tell a good investment from a bad one. However with residential property investing, as long as you follow a few basic principles you are most likely to be picking between a good investment and a great one.

Let's face it, how difficult is it to buy residential property today cheaper than it was 10 years ago? You wish you could. Property tends to show more consistent capital growth than any other class of investment and it also has less frequent price drops and less severe price drops than other forms of investment.

So let's look at the five basic rules for making good purchase decisions.

Rule 1: Buy on a Business Decision Not a Personal Decision.

I've bought plenty of real estate that I would never be interested in living in but they made me plenty of profit. Beginner real estate investors tend to still think like home buyers and try to buy something attractive that they could see themselves living in. This is usually a big mistake.

You buy investment property with the aim of maximizing your profit. Sometimes this can be achieved with a tidy, attractive home and sometimes it can be achieved with unattractive, bottom rung property. If you make your decisions as business decisions then you will be able to buy what works best at that point in time.

Rule 2: Buy Property You Can Cash Flow.

Sometimes people are so busy chasing capital growth that they get in over their head. They have over estimated the rental income and under estimated the outgoings. Professional investors always keep their projections on the pessimistic side so that they don't over extend. It doesn't matter how great the future capital growth potential is if you have to sell out in order to pay the bills.

Rule 3: Buy At or Below the Median Price for Both the City & Suburb You are Buying In.

High end properties are luxuries and as such they are more volatile. When the economy tightens up the buyers for high end properties dry up the most and the quickest. Median price and below is where the ordinary people live. These homes are more in the necessity range than the luxury range and so their market is much more stable.

Rental income is also more stable in median price and below housing. When the economy tightens people find it more difficult to meet high rents so the renters seeking homes start looking more down market. The whole rental market shifts down a peg which means that the high end properties experience more vacancies. With the median and below market what they lose by their typical tenant moving down they pickup from the higher end tenant coming into their market.

Rule 4. Buy Property That Will Increase in Value Faster than the Average.

At first glance this might seem like an obvious but difficult strategy to apply but in fact it is relatively easy to do once you recognize what drives the property market.

First you have to accept that there is no such thing as the true value of a property. All value is psychological. It is a perception in the mind of the buyers and sellers. If you identify the type of buyers that are purchasing in a particular area then you can quickly identify the things that will influence their perceptions.

In areas where most of the housing is occupied by the buyers then the perceptions of value will revolve around perceived lifestyle. In areas where the majority of the housing is rental property then the buyers are investors and their idea of value will revolve around their perception of capital growth potential and cash flow potential.

There are some basic strategies that professional investors use to identify trends based around these concepts.

Rule 5. Learn How Professional Investors Use Finance as an Investment Tool.

Amateur investors tend to see finance as a necessary evil but professionals see it as a way to increase profits and reduce risk.

When you introduce financing into an investment it is called leveraged investing. The concept of a lever is that it produces a result far greater than the same amount of effort would produce without the lever. In investing, a leveraged investment can produce a higher rate of return on the cash invested than you would have received without leveraging.

For this reason professional investors become experts in the benefits and risks associated with the different forms of financing. By doing this they know what is the most suitable form of financing for a particular investment. Using standard financing a typical residential investment property can result in average returns on cash input of 20% to 25% per annum. By using the right forms of financial leverage you can increase the average returns on cash input to 30% to 35% per annum. This results in a massive difference over a 20 year period.

Understanding and following the 5 basic rules of real estate investing can greatly increase your profits and also reduce your risks.


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