With all the gyrations in the stock market in recent years, investors have looked beyond stocks and considered other types of investments as they adjust their portfolios. Hard assets, those that you can feel, touch and see have always been an option.
Hard assets, those that you can feel, touch and see have always been an option. Certainly, there is no shortage of commercials touting the advantages of precious metals such as gold and silver but while precious metals can protect against inflation- of which we haven’t seen any for a long time- and can appreciate over time, they don’t do what real estate does. Real estate not only appreciates over time, generating long-term wealth but also provides a monthly cash flow.
There really is no other type of investment that you can see and touch that provides monthly income as well as adding to an investor’s bottom line. If you’re thinking of adding real estate to your portfolio, here is how to analyze a potential purchase as well as important things you need to consider before making the leap.
Analysis On Investment Properties
At first, glance, investing in real estate is much like any other investment. Yet with real estate one needs to decide about the initial disposition of the property being purchased. So-called “flips” occur when a property is considered priced below market and soon sold for a profit. With a flip, it’s important to work with a real estate professional as well as a general contractor. The real estate agent will tell you what the property would be worth once repaired and updated based upon recent sales of similar properties I the area. The contractor would then inspect the property and provide a punch list of required updates and repairs and how much they will cost. From there, it’s nothing more than a simple calculation. Will I be able to sell the property for a profit once all expenses have been deducted?
Be careful with this initial analysis. As with the old saying, “Measure twice, cut once,” you must estimate your expenses on the high side with some room to spare. When remodeling a home, make sure you add at least an additional 10% of the cost quoted to you by the contractor for unexpected repairs that will surely pop up during the job. There are hard costs and soft costs. Hard costs include items such as hammers and nails while soft costs include fees and permits. You’ll need insurance on the property while it’s being repaired as well. And don’t forget, the biggest expense might very well be the costs involved when selling the property, most noticeably the real estate agent’s commission.
For quick flips, you’ll need to price it as low as possible, take the profits from the sale and close on your next transaction. If you want the highest price possible and can wait for the right offer, your agent will provide that number as well.
On the other hand, if you’re not flipping but intend to keep the property for the long haul, you need to consider not just the present cost and the final value but the cash flow each month. Your investment must show a positive cash flow each month, otherwise, it’s not as much of an investment as it is a monthly expense.
Again, your real estate agent can provide you with an estimate of market rent. From there, work with your lender to find the right mortgage program to finance the purchase. You can get a lower payment with the longest term, typically a 30 year fixed rate loan. Shorter terms have higher monthly payments but the long term interest expense is much lower. Your loan officer can put together a series of loan options from which to choose. One quick note, with interest rates as low as they are now, avoid an adjustable rate loan or a hybrid. There’s no reason to take on the additional risk of a variable loan for a long term hold.
Once you get your principal and interest payment determined, consider a monthly amount for property taxes and insurance as well. Now subtract the housing payment from the rent you expect to receive. If you’re looking at a good positive number, you’ve probably found your first property.
How much is a good return?
That’s going to be relative but a monthly cushion of at least $250 each month seems to please most investors. Don’t accept an amount much lower, as property taxes and insurance premiums can go up from year to year, eating into your monthly profit.
Other Considerations For Investment Properties
What type of property makes the best real estate investment?
Different types of real estate make for good investments if the financial analysis is positive. If you want to invest where renting is the norm, you may want to find a condo near a college or university. For long term stability, look for a single family home in an established neighborhood. Good schools and easy access to transportation and amenities are also things that will add value.
If you decide to invest in single family homes, you need to know there will be more maintenance and repair costs involved compared to a managed condo where the homeowners’ association takes care of most maintenance issues. Whichever type of property you decide to purchase, it’s important to understand you’re now a landlord. Remember when you first rented your own place and the sink disposal went on the blink? You didn’t go to the hardware store and buy a new disposal, you called the landlord and had the landlord take care of the disposal.
Repairs and maintenance issues are an ongoing affair so be clear at the outset that you will get called about an issue, even the most inopportune moment. For landlords who don’t wish to get involved with the day-to-day operations of a rental property, there are property managers for hire that will take over those duties for you. Your real estate agent can help provide some referrals. In fact, many real estate offices have an in-house property management company you can use. And finally, be prepared for vacancies. Leases are renewed and tenants either extend the lease or move out. With no monthly income, there is no cash flow. Your lease needs to have a clause that requires the tenants to provide at least a 30 days’ notice before moving out. With proper notice, you can have another tenant lined up before a 12-month lease expires.
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