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Five Easy Steps of Investment Real Estate.
No rocket science, just the basics.
By Kyle Dreier ~ Principal, Price Morgan
(April 14, 2006) Investment Real Estate can mean a number of things. Individuals who invest in real estate
do so in a variety of ways. Some investors my choose to buy fixer-uppers, other's may
choose commercial developments. Regardless of the type of investment property it is
important to understand the ins and outs of investing in real estate. All this being said,
these five steps are not rocket science but do outline a subjective way to approach your investment real estate goals.
1. Define "Investment Real Estate."
Investment real estate is a rather broad term. The bottom line, however, is clear —
you invest in real estate with the expectation of a return on investment i.e. an ROI.
The ROI must be worth the time, effort and risk associated with the investment. At
the end of the day investors want to end up with more money than they started with.
Obviously this is a pretty simple concept.
How will one achieve a positive ROI? It could be one or many ways. There is speculation
about appreciation. Those who invest in real estate with the sole objective to see the
property appreciate are speculators. There is also the concept of cash flow properties. With a property
that cash flows the investor is getting more revenue than the expenses associated with
owning the property. If a property is break-even cash flowing or positive cash flowing
then the investor can look at the capital tied up in the property and compare it to
the profit realized to determine if it is a good ROI or not.
2. Determine your financial capability.
Doesn't it always come down to how much money one has? This is where the rubber
meets the road for investors. What people often overlook is the ability to use
money they have but didn't know they could use it for real estate.
One source is if you already own real estate and maybe it doesn't have the ROI you wish for.
You may be concerned about selling the property because of capital gains taxes.
The IRS's Section 1031 allows property owners to sell their real estate and roll
the gains from the sale into a like-kind property, thus deferring the capital
gains taxes. The gains can be deferred again and again through this process.
Another interesting point about your ability to purchase real estate is the use
of retirement funds. Again, the IRS allows for individuals to use IRA funds for
the purchase of real estate through a vehicle commonly known as a Self Directed
IRA. There are a few parameters to follow for this great opportunity, but you'll be surprised how
easy it is. It simply requires a custodial account from which all expenses are drawn.
There are also tax benefits and incentives associated with owning real estate
investment property. If your property isn't cash flowing then you have losses
to go against your income, hence you pay less income tax. Depreciation is also
a deduction against income saving you thousands of dollars per year in taxes
depending on the value of your property and your income bracket.
Your financial ability is also determined by your ability to borrow or leverage.
In simple terms, if you can qualify to pay debt service on a $500,000 property and
only have $50,000 cash in the property then your money is working exponentially and
your ROI will be higher than if you had paid cash for the entire purchase price.
3. Consider potential ROI and exit strategies.
As you get closer to the decision making step the points you have to consider
become more important and more difficult to evaluate. No one knows exactly how
well or how poorly a real estate investment will perform. Time and time again
you'll hear the phrase "historically speaking" since the past is the only absolute
going forward.
When conducting your own due diligence for a property you are considering
you have to apply Stephen Covey's second habit from The 7 Habits of Highly
Effective People - begin with the end in mind. What is your goal or your
desire with your investment in real estate? What ROI are you hoping for?
When it comes time to sell how will you accomplish that?
Historically speaking, real estate is a great investment over time. The
shorter the time you plan to hold the real estate the more risk you are
exposing yourself to. The seasoned investor purchases real estate on a
scheduled or paced basis. If you purchase real estate every six months
then you are dollar cost averaging your purchases and mitigating the
risks and fluctuations in price.
4. Review common concerns and questions.
Will the real estate cash flow?
The best answer is "it depends." It depends on how much equity or capital
you have in a particular property. Obviously you'll have expenses outside
of debt service such as HOA dues, property taxes, maintenance but the
biggest expense will be debt service. On the revenue side you have to
consider what kind of rental program the property has as well as how
that program is managed. In many cases you can manage it yourself. Then
the question is what your ROI is on your time.
What is the cost of ownership?
If you have the long term vision and plan to hold your investment real estate
then you have to consider the cost to do so. What is the carrying cost of your
property? Let's assume you have negative cash flow, but you're comfortable with
that because of how that works with your income tax situation or because of the
growth and appreciation in that market. Now, with all those things in mind, what
is your bottom line cost of ownership? This is where you decide if your ownership
is a costly hobby or a profitable investment.
What are my return on investment options?
Your return on investment can come in many shapes and sizes. In a perfect world
you would experience positive cash flow on very little capital investment in a
market where prices of real estate are on the rise. This is like having your
cake and eat it, too. This is rare. In most cases you'll be looking at a combination
of any two of these - a small capital requirement, positive cash flow, aggressive appreciation.
5. Choose real estate.
Walt Disney probably said it best. The way to get started is to quit
talking and begin doing. We live in the day and age of information.
This is an incredible time where we can find anything and everything
just by doing a little research from our own computer. The danger in
this is that too much information creates confusion and paralysis by
analysis. This is not to toss all reason and viable data out the window
but it is to say that at the end of the day there are no absolutes.
Will a property cash flow? There is no guarantee. Will a property
appreciate? There is no guarantee.
To make an informed and educated decision you have to look at the
fundamentals. Look at the fundamentals of investment real estate, the
type of property, the location, the market trend, the area data. At
Price Morgan we evaluate properties on these merits. We are real estate
investors ourselves and believe in each and every opportunity we present to our clients.
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