Investing in Real Estate
Real estate is defined by Investor Words as “A piece of land, including the air above it and the ground below it, and any buildings or structures on it, also called realty”. That of course is the permanent value on which all the rest of the market value is based. I know you have been invited to those “seminars” where they promise to teach you how to make millions without spending a dime of your own money in real estate. (Not going to happen my friend.) The real key to successful real estate investing is to do your home work and do not get overconfident. Here are the things to research before investing directly in real estate.
• Be aware of your cash flow limitations. The first investment in real estate for most players tends to be the single family house. In fact the data show that about 25% of the single family homes sold in 2004 were actually sold to investors instead of families. The income from those properties, calculated after taxes and expenses, should ideally be above $150 to $250 a month. If you are in an area where prices and property taxes are high, such as Los Angeles, Boston, or New York City, housing prices may be too high. There may be so much competition to find those rental houses (driving prices up) that the investor cannot find a property that they can get a high enough rental income from to cover all the expenses. Check the numbers, if the cost of the house is in the $600,000 range and the property taxes are high your expenses will force you to charge rents in the $3000 to $4000 range. That limits your pool of potential renters pretty severely. If you are good at the nuts and bolts of repair and remodeling you can consider an investment in a fixer upper property. But you still must be aware of property taxes. Ideally you could find a cosmetically challenged home in a low property tax area and do the home improvement work yourself. For that to work you have to know if the cost of materials and your time will go over budget so be sure you inspect completely. (Kosnett, J., 2006, Get Real About Real Estate, Kiplinger's Personal Finance)
• Be sure you understand what the property’s net operating income as a percentage of the price is. This is called capitalization and is an expression of how much every dollar you make in a year will cost you.
This is not a place to get independent and forge ahead on the basis of some intuition. Look at what the property is selling for and the net income it is projected to generate. Divide the net income for the past year by the purchase price. The property should give you a 10% or better cap rate. Take the information packet to a lawyer who specializes in real estate. If you do not know how to do commercial property inspections yourself you need to hire a professional property inspector. If you have any unanswered questions about the property, the actual income potential, or the economic base that supports the renters, don’t risk the investment. (Kosnett, J., )
• Beware of high pressure sales tactics. If some one is pushing hard for a decision then something about the deal is not right. My father once bought a piece of property that was also being sold to another party at the same time. Each of them wound up with a fifty percent ownership in the property which caused immeasurable problems. Harold Schnitzer of the Harsh Investment group once told me that there is never an “emergency” situation in business and that if someone is pressuring you, to back away from the deal. Be sure that if you intend to convert the property from its present use to a different use that you do your own zoning research. We once bought a residential property that was actually zoned commercial. What that means is that no matter how bad the condition of the house on the property, it cannot be removed and replaced with another residence. We can remodel it, add to it, rent it, live in it; but not replace it with a better house. We can also convert to a commercial enterprise. The problem is the property is off the main street on a street that gets very little traffic flow that would be useful for any commercial enterprise. When we ask questions at the time of purchase the realtor was a bit pushy about how many other people had made offers on the property, how good the price was, and how close it was to amenities like restaurants, stores, the cleaners and the main highway. The zoning question never was actually answered but that escaped our attention until after the sale was a done deal.
• Know the history of the current tenants and the reputation of the neighborhood. A beautiful old house with charm and style may sell for a great price but be located in a decaying area of the city. In a neighborhood where the prospective tenant will be facing security risks such as drug and gang activity or where they are afraid to send their children to school they will not stay. If you can’t attract and keep good tenants the property is a poor investment as well as an insurance risk.
• Develop your real estate business skills before committing your entire fortune to an investment. This area of investing requires different business skills than investing in
stocks and bonds. Most real estate investors like to stay pretty much “hands on” with their acquisitions, especially if the properties are the remodel and refurbish types of investments. In order for the formula to work, you must be able to negotiate air tight and favorable contracts with a variety of contractors, and of course your tenants. You must understand local laws and ordinances and know where to obtain permits and schedule inspections. Learn to forecast the market by watching the housing starts, the new and existing sale numbers and calculate the average days on the market of properties in your range. (For specialized instruction you can take the Certified Commercial Investment Member course.) (Kosnett, J,)
There are, of course, other ways to invest in real estate and you should examine them if you choose not to invest directly. There are real estate stocks and mutual funds that put a buffer between you and the day to day headaches of managing an investment property. Like any investment the facts need to be clear to you and you should internalize the prospectus before making any decisions.