Home real estate investing is a business activity that has waxed and waned in popularity dramatically over the last few years. Ironically, generally there always seem to be a lot of people jumping on board with investments like stock, precious metal, and real estate when the market’s going up, and jumping OFF the wagon and pursuing other activities once the market’s slumping. In a way that’s human nature, it also means a lot of real estate investors are leaving money on the table.
By comprehending the dynamics of your residential real estate investment marketplace, and acting in opposition to the rest of the marketplace, you can often make more money, as long as you furthermore stick to the real estate investing fundamentals.
Real estate investing, whether you’re buying residential or commercial property, is not a get-rich-quick scenario. Sure you can make some fast cash flipping houses, if that’s your bag, but that is a full time business activity, not a passive, long term investment. The term “investment” implies that you are committed to the experience for the long haul. Often , that’s just what it will take to make money in real estate.
So , while the pundits are crying about the residential real estate market slump, and the speculators are wondering if this is the bottom, let us return to the fundamentals of residential real estate investment, and learn how to make money investing in real-estate for the long term, in good markets, as well as bad.
A Return To The Fundamentals associated with Residential Real Estate Investing
When real estate is certainly going up, up, up, investing in real-estate can seem easy. All ships increase with a rising tide, and even if you’ve bought a deal with no equity with no cash flow, you can still make money for anyone who is in the right place at the right time.
However , it’s hard to time the market without a lot of research and marketplace knowledge. A better strategy is to make sure you understand the four profit centers regarding residential real estate investing, and make sure your next residential real estate investment deal takes ALL of these into account.
Cash Flow – How much money does the residential income property bring in every month, after expenses are paid?
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This seems like it should be easy to calculate if you know how much the rental income is and how much the mortgage payment is. However , once you factor in everything else that goes into taking care of accommodations property – things like vacancy, expenses, repairs and maintenance, advertising, bookkeeping, legal fees and the like, it begins to really add up. I like to use an aspect of about 40% of the NOI in order to estimate my property expenses. I personally use 50% of the NOI as the ballpark goal for debt service. That leaves 10% of the NOI as profit to me. If the deal doesn’t meet those parameters, I am wary.
Appreciation – Having the property increase in value while you own it has historically been the most profitable component about owning real estate. However , because we’ve seen recently, real estate can also go DOWN in value, too. Power (your bank loan in this case) is really a double-edged sword. It can increase your price of return if you buy in an appreciating area, but it can also increase your price of loss when your property goes down in value. For a realistic, low-risk property investment, plan to hold your residential real estate investment property for a minimum of 5 years. This should give you the ability to weather the ups and downs in the market so you can see at a time when it makes sense, from the profit standpoint.
Debt Pay down — Each month when you make that home loan payment to the bank, a tiny part of it is going to reduce the balance of your mortgage. Because of the way mortgages are organized, a normally amortizing loan includes a very small amount of debt pay down at the beginning, but if you do manage to keep the loan in place for a number of years, you’ll see that will as you get closer to the end of the loan term, more and more of your rule is being used to retire the debt. Of course , all this assumes that you have an amortizing loan in the first place. If you have an interest-only loan, your payments will be lower, but you won’t benefit from any loan reduce. I find that if you are planning to hold the home for 5-7 years or much less, it makes sense to look at an interest-only mortgage, since the debt pay down you’d accumulate during this time is minimal, and it will help your cash flow to have an interest-only mortgage, as long as interest rate adjustments upward no longer increase your payments sooner than you were expecting and ruin your cash flow. If you plan to hold onto the property long term, and you have a great interest rate, it makes sense to obtain an accruing loan that will eventually reduce the balance of your investment mortgage and make it go away. Make sure you run the numbers on your real estate investing technique to see if it makes sense for you to get a fixed price loan or an interest only loan. In some cases, it may make sense to refinance your property to increase your cash flow or your rate of return, rather than selling it.
Tax Write-Offs — For the right person, tax write-offs can be a big benefit of real estate investing. But they’re not the panacea that they’re sometimes made out to be. Individuals who are strike with the AMT (Alternative Minimum Tax), who have a lot of properties but aren’t real estate professionals, or who are not actively involved in their real estate purchases may find that they are cut off from a few of the sweetest tax breaks provided by the IRS. Even worse, investors who concentrate on short-term real estate deals like flips, rehabs, etc . have their income handled like EARNED INCOME. The short-term capital gains tax rate they pay is just the same (high) they’d pay if they earned the income in a W-2 job. After a lot of investors got burned in the 1980’s by the Tax Reform Act, many people decided it was a bad idea to invest in property just for the tax breaks. In case you qualify, they can be a great profit center, but in general, you should consider them the frosting on the cake, not the particular cake itself.
Any residential real estate investing deal that stands up under the scrutiny of this fundamentals-oriented lens, should maintain your real estate portfolio and your pocketbook healthy, whether the residential real estate investing market rises, down or sideways. However , when you can use the real estate market trends to give you a boost, that’s fair, too. The key is not to rely on any one “strategy” to try to give you outsized gains. Be realistic with your expectations and stick to the fundamentals. Purchase property you can afford and plan to stay invested for the long haul.