Having real assets in your investment portfolio is not only a way to ensure financial stability, but a proven means to produce substantial personal wealth. There are many benefits to real estate investing and savvy investors can make a profit in any market situation.
Knowing the benefits of real estate investing is one thing, knowing how to do it is another. All investments carry a certain amount of risk. As a result you will want to properly prepare and know what to look out for, as well as follow some basic steps to help diminish unforeseen consequences.
Conduct a thorough evaluation of your financial situation/goals
Before taking the leap and making the decision to invest, look at where you are now and where you want to be financially in both the long and short term. Here are some questions to help get you thinking; What are your goals? What are your resources? How much time do you have to dedicate to your rental properties?
These are important questions to ask. They not only help determine how much you can afford, but what type of investments make the most sense for you to pursue (single family, multi-family, commercial, etc.).
A certified financial planner can assist in developing a plan outlining your current situation, your goals, and the means to achieve them via a diversified investment portfolio.
Determine the type of real estate best suited for you
After you know where you stand, you need to decide on the type of real estate in which you are going to invest. Most new investors start with single family homes as they are usually more affordable, but there are some benefits of multi-family investing that should be explored. Multifamily units take much more research than single family homes and they are more difficult to get an accurate value as sales data is typically harder to find. They require quite a bit more money down as their sale price is usually higher and lenders on multi-family require more of the investor’s money as part of the transaction. Some say they carry a little less risk and potentially more profit due to fact that you have multiple sources of income in one property. The thought by many is that there is economies of scale, and if one unit is vacant, perhaps 4 more are filled and paying.
Commercial real estate is another option that brings significant benefits such as longer lease agreements, tenant assuming many of the repair/renovation costs, property taxes (for triple net), etc. Commercial properties are a little more difficult to manage for the beginner and the use of real estate professionals is likely needed, which will cost additional money.
When weighing your options, keep in mind that investment properties typically require a down payment of 25%. This size of down payment often limits who can participate. For example, if you’re looking at a property for sale at $2,000,000, you could anticipate a down payment of $500,000.
Whether in person, on the web, or during virtual tours, you will look at a lot of properties. Focus on finding the right property not the perfect one. If you spend too much time focusing on the property you would want to live in rather than one that will provide maximum return on your investment you are headed for trouble. Remember, this is a business decision. You do not need to fall in love with the property.
During your search, take time to research the motivation of the sellers. The more motivated the seller is, the more likely you may see a significant savings on your purchase. Know who you are buying from before making an offer and ask a few important questions like who is selling (bank, owner, broker)? How long has it been on the market? Is the owner attached to the property?
Purchasing property from an individual is different than purchasing from a bank and purchasing a for-sale-by-owner is much different than purchasing from someone using a real estate agent/broker.
Location is key
To maximize the return on your investment, finding housing unit(s) desired by tenants is the number one goal. You need a property that is in demand and finding one in a desirable location is the sure way to meet that requirement. As you probably know from you own home search, an important criterion for tenants, especially ones that are willing to pay high rents, is location. Living in a desirable area with plenty of amenities is on everyone’s must have list and will factor heavily on the amount of rent commanded for a certain area.
Things such as unemployment, crime levels, job growth, income levels, demographics, proximity to schools and their rankings are important indicators when evaluating a location. The information is easily obtained on-line as there are numerous websites available to assist investors.
Run the numbers
Your investment must provide a positive return for it to make sense. The numbers must add up and the only way you will gauge success is the bottom line.
Once you’ve found a property with potential, determine if it is priced correctly. Your real estate agent is best suited to assist in making this determination as they will know where the market is and how to determine a value for the property you are looking at. If possible, your Realtor® will complete a comparative market analysis, also referred to as a comp, to get an accurate value of the property.
The purchase price compared to long term costs and expected rental income are important things to evaluate. If major renovation or repairs are needed on a lower priced home, the property may be more costly in the long run.
Previous years’ tax documents (both returns and property tax statements), maintenance receipts, HOA assessments, etc. will help determine expenses. You always want a positive cash flow with a net income that is worth your time, money, and risk.
There are two important factors to consider when looking at the profitability of a potential project. First, you’ll want to consider the potential price appreciation (price growth of the property value over time). Secondly, you’ll want to review the rental rates (monthly cash flow). These two are often evaluated together with Net Operating Income (Annual Figures)/Property Value or Sales Price. This ratio is known as the Capitalization rate or “Cap Rate”. You may see that Cap Rates trend in a specific area for a specific type of property. For example, you may see rental property near the coast have a smaller percentage of annualized income in relationship to the value. However, you may find that these properties appreciate at a greater rate than a similar property in a very different geographic region. For example, a lower priced residence in an inland suburban area may be slower to appreciate in price, but have lower monthly costs, generate modest rents and produce a positive monthly cash flow. There is no wrong or right answer on which investment scenario is better. It all depends on what your individual goals are.
How much monthly rent will it generate?
The amount of money your property can generate monthly is a huge factor in determining the profitability of an investment. Remember, the income expected from a property is the reason you are investing. When determining the rental rate, consider the amount of money you can lease the property for as is, and what you could expect if you added value by making some improvements. Purchasing property to add value can be a good option. If spent well, it has the potential to increase the income generated in a property but also could increase the overall value of the property. IMPORTANT NOTE: Just because you spend money on improvements, doesn’t mean you will see an increase in value or rents. It depends on condition of property, the overall market and what improvements you make.
There are several factors to look at when assessing rental rates and the outlook of the rental market. Things such as the demand for housing, the number of vacancies in the area, average rental rates, unemployment, and job growth are all things to consider when evaluating the potential of a property.
There are useful and popular sites out there such as Zillow, Apartments.com, and Realtor.com, to name a few that could help assist you in determining the rent prices. Nothing makes up for experience, so your real estate agent is likely your best resource as they know what rents are going for in their local markets. If you are ready to secure your financial future, now is the time to consider real estate in your investment portfolio. With a little research, time, and effort you can be on your way to financial success.