Want to Make Money in Real Estate? Understand Returns

Most people purchase real estate in hopes of earning wealth from their purchase, just as they would with any other investment asset.

However, real estate is unique in that it has four distinct components of investment return.

Essentially, here are the four ways you can make money as a result of real estate ownership:

  • appreciation in value
  • cash flows
  • income tax benefits
  • mortgage principal pay down

make-money-in-real-estateIt’s important to note that just because there are several components of returns, that does not mean you will earn money on real estate investments.

Many people lose money due to insufficient research and analysis, as well as through unmitigated risk issues. Do your homework before investing in real estate.

Appreciation in value

Most people buy investment properties with the thought that “it will appreciate in value and I’ll get rich.”

If the past six years have taught us anything, it is that real estate doesn’t always go up on value.

However, over long periods of time, say 15 to 25 years, real estate seems to perform well and has earned much wealth for many long-term holders.

Be aware, though, that appreciation does not pay the bills. It is better to invest based on cash flows, the next noted component of returns.

Cash flow positive

Most real estate investors do not understand how to pencil out their real estate deal. What this means is putting conservative estimates of rents and expenses down on paper and making sure that the rents, less all the expenses, leave the owner some cash in the bank. We call these “cash flow positive” properties.

Buying properties with true positive cash flow is the best way to ensure that your investment will add to your wealth. Far too many buyers purchase negative cash flow real estate and take additional monies out of their bank accounts each month, for years, to cover the deficit. That is no way to invest your hard-earned capital.

Income tax benefits

There are potential income tax benefits from owning rental properties. “Benefits” means that as a result of your ownership, you pay less in taxes than you would have if you did not own the property. Unfortunately, few investors really understand how this works.

If you are self-employed and pay little in taxes or you have income greater than $150,000, you probably have little tax benefit from your real estate ownership. Before you start banking on the tax benefits you’re going to get from a real estate investment, consult with a tax pro who can tell you whether or not you will actually save a dime.

Mortgage principal pay down

If you have an amortizing mortgage – which most are these days — you may realize some return. Each monthly mortgage payment pays the accrued interest, plus a little bit of the outstanding principal of the mortgage. That principal is pure investment return and it can really super-size your returns.

However, principal pay down does not provide cash flow, so it can’t help pay the bills if you need money for a plumber, electrician or handyman.

While all the investment returns may help your long-term wealth, the cash flow component is the most important. Cash feels nice in your hands, it pays the bills and, most importantly, it accumulates in your bank account and earns interest.

If your investment doesn’t generate cash, you won’t be able to pay the mortgage, you’ll likely lose the property and you’ll never realize the returns you’d hoped for.

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Rent It Out or Sell It? Options for a Home You No Longer Love

You might be one of the countless homeowners who’ve fallen out of love with your current home.

Maybe it’s the general area, the neighbors or the house itself.

3D red glass houseOr maybe the “dream” of homeownership has become a nightmare for some reason.

Regardless of your situation, push has come to shove, and it’s time to make a decision on where to go from here.

Your choices are to keep the house as a rental property for investment purposes or sell it and maybe buy elsewhere. Answering the questions below should help you decide which route is best for you.

Do I have the money to purchase another property if I hold this one?

When you purchase a home you need to have enough cash for a down payment and closing costs, plus funds for moving expenses and associated costs. A 20percent down payment is ideal because you’ll avoid paying private mortgage insurance (PMI). 

Therefore, take a look at your savings.

Do you see enough cash to be able to put down a hefty chunk of change on a new property? If you don’t, it’s probably best to sell your current property, and hopefully that will generate the cash needed to put down a large down payment on your new home.

Do I want to be a landlord?

Yes, all the TV shows make it look like owning property is fun and doesn’t take up too much of your time, energy and effort. Unfortunately reality TV isn’t reality rental property investing.

You do have the good fortune that your current home is probably already in good shape, so at least there won’t be a lot of money out of pocket to make it rental-ready. But you will still have to educate yourself, obtain leasing documents, advertise and show the property and screen prospective tenants.

It really can take a fair amount of time, so is that within your interest? Alternatively you could have a property management company handle it, but that would wipe out a lot of your potential wealth generation from the property.

Would this property even be a good investment?

Good real estate investments are cash-flow positive and provide a fair rate of return on the equity you hold in the property.

Will the rents less all the expenses and mortgage be positive? If the answer is no — and this is often the case — that particular property probably isn’t a good investment.

Talk to your financial adviser or accountant and ask for help penciling out your real estate deal based on the cash flows and current equity in the property. Once you figure out your current investment returns — free cash flow divided by your equity — you can compare those returns to other investments.

Maybe it’s better to invest elsewhere

If you could sell and generate a large chuck of change, like $100,000 or $300,000, you could invest that money elsewhere. Considering the risk factors for real estate, a well-diversified large capitalization stock mutual fund, with long-term returns of 7-9 percent per year probably is a better deal than owning real estate.

Note: As an added bonus on financial assets, no mutual fund has ever had a clogged toilet that flooded the house.

Those are some items to consider just to get into the landlord game. If none of those look appetizing related to your current home, sell it! Then you can decide whether to take a step back and rent for a while or try to find a new home and not repeat the home buying mistakes of your past. Good luck!

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Homeowner’s Insurance: Do You Have the Right Type and Amount of Coverage?

With all the hurricanes, forest fires, even an earthquake on the East Coast in the recent past, now is a good time to start paying a little more attention to the homeowner’s insurance coverage you carry on your property.

Most people select their homeowner’s insurance policy when they buy property and just pay the bill each year, giving little thought to keeping the proper coverage in place. Rarely do they understand, or even look at, their coverage in following years. And as long as they don’t have a loss, they don’t even notice. The problem is once you have a loss, it’s too late!

do-you-have-the-right-type-and-amount-of-coverageConsidering that your residence is probably your largest and riskiest investment, it really makes sense to better understand how insurance works to ensure you have the right type and enough coverage in place for your specific situation.

The objective of insurance coverage is to try to assist policy holders in avoiding major financial issues and disruptions to their lives if they have a loss. Insurance companies know that losses are generally predictable in total relative to a population of properties, but they are not foreseeable as to which specific property will incur the loss. You have insurance so that when that specific loss happens to you, the coverage will help ease the financial burden.

That loss could be a variety of different issues: a tree falls through your roof, a broken water line could cause a flood, or your playful golden retriever mistakenly bites a neighbor’s child.

Reviewing your homeowners policy, or renter’s insurance, is something you should do each year  to make sure you are adequately and properly covered.

How Much and What is Covered by Your Policy?

A standard policy has a single page noted as “Coverage Limits” with the maximum amount an insurer will pay out on each category of risk you have in being a property owner. Here are the more important ones:

Dwelling/Structure – This covers the main building structure, walls, roof, doors, windows, kitchen, etc. My house of 1,250 square feet is valued at $560,000 but I only have $205/per square footage worth of coverage, or $256,250 maximum loss payout. That is because the rest of the value in my property relates to land (about $264,000), which typically doesn’t need insurance. Rule of thumb: If you have a big fancy house, you need more coverage.

It’s important to talk to your insurance professional each year and make sure that the current coverage maximum dollar limit for your dwelling is enough to pay to rebuild your house in case it is destroyed. Other dwelling coverages to discuss are “Extended Replacement” and “Building Ordinance” coverage — so as to make sure you are fully protected.

Personal Property – Your insurance also covers your personal items (i.e., clothing, computers, couches, flatware, etc.). Make sure you have enough coverage as personal property costs more than you think. Special expensive items like jewelry, and artwork should be discussed with your agent for the proper separate insurance.

Liability and Lawsuit Protection – Homeowners insurance also typically covers you if you get sued. Some examples would be if your child hits a baseball that hurts another child, or a slip and fall accident occurs on your property. Typical liability coverage is $300,000 and you need to discuss your net worth with your insurance agent to see if that is sufficient. If your net worth is high, it is smart to consider an “Umbrella” policy to increase liability coverage to $1 million+. Talk to your insurance agent to determine the premium cost increase.

Want a lower premium? Raise your deductible! When a loss occurs, you are required to pay for the first few hundred or thousand dollars of a claim out of pocket. This is called your deductible amount and you can select the amount. The reason to have a higher deductible is to get a lower premium.

Realize. however, that you will pay more out of pocket when a loss occurs. It’s wise to discuss this with your insurance professional.

What Isn’t Covered and What to Consider Adding

You also need to understand that a typical homeowners policy does NOT cover many perils like earthquakes, floods, business activities and other specialty occurrences. Other policies may cover these and your insurance professional can help.

HO-6 Policy for Condos: For townhouse and condominium owners, it’s wise to have an HO-6 policy in place. HO-6 refers to the form used for a condominium/townhouse insurance policy. An HO-6 policy typically covers the interior of the unit, personal property and personal liability from the “studs in.” Many people are under the impression that the condo association’s master policy protects interior unit coverage, but most times it does not.

Policy Binder – Your insurance company will mail you a policy binder that has all the coverage items, maximum limits, terms and conditions outlining your coverage with the insurance company. While this document is lengthy, it is your money at risk if you have a loss and are not covered.

To lower your risk and potential financial disruptions in life, make sure you have the right type and amount of insurance in place. Any loss will most likely be devastating, but by properly preparing yourself with sufficient insurance the loss should be a lot less painful!

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Is Homeownership a Good Choice for Young People?

holding-a-houseIf there’s anything we’ve learned in the past few years about real estate, it’s that property doesn’t always go up in value. And because it doesn’t, you shouldn’t just buy property and assume that you’re going to earn equity and wealth from that ownership.

Instead, buying a home should be a personal decision based on your life and financial situation.

So if you are young, should you buy real estate? The answer, as with many things, is that it depends. But for the vast majority of young people, the answer is probably no. Here’s why.

Real estate is long-term

We buy real estate in order to hopefully earn wealth and improve our lot in life. The most likely way that you will earn real estate wealth is by owning property for long periods of time, preferably a decade or greater. This long-term ownership does not coincide with the habits and traits of most young people. So if you’re not very sure you will own a property for a long time, let a landlord deal with the inherent risks, pains and issues of real estate ownership.

Here are some reasons why, as a younger person, you might not own property long term.

Not settled in a career

At a young age, you rarely know whether you’ll be living in the same area for a long time. People are very mobile these days, including switching jobs, getting job transfers, changing careers, going back to school, etc. If you buy a property and have to sell it due to a career move in a few years, you’re most likely going to lose money on your real estate ownership.

Can’t afford a place you love

Additionally, you might not have the financial resources to afford a place that you really love, and you’ll end up buying in anticipation that you’ll earn equity and trade up in a few years. Now you probably will trade up in a few years, but you probably won’t earn any equity. In fact you’ll likely lose money — primarily due to steep transaction costs. The better way to go is to save your money for several years and buy a place you really love when you have the savings and income to be a homeowner.

Not settled in life

You finish school, get a job and work a few years. Then you realize you’ve got to move somewhere else, “see the world,” if you will! That house you bought would hinder your ability to relocate, and if you did move, you’d probably lose money.

So if you are young, wild and free — and not sure of your 5- to 10-year plan — you’ll probably do better as a renter.

When might it make sense to buy young? If you’re sure you’ll own the property a long time, then it’s probably a good idea to buy. Just make sure you can comfortably afford the payments along with all your other bills. Also if you want to be in the landlord business and plan to convert the property from a personal residence to a rental, then buying at a younger age would be a smart move for you.

Just ask yourself before you decide whether to buy real estate, “Am I sure my ownership will be for the long haul?”

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Tips for Preparing to Buy a Home

first-time-homebuyersYou’ve been saving your pennies for a down payment and watching the housing market news. You see the low interest rates, are confident you’ll own a property for at least five years and know that you’ll be able to find a home that you’ll love within your budget.

You’re finally ready to buy a home!

Here are a few tips to help you get started.

Get with a lender

First up is going to a bank, direct lender, credit union or mortgage broker to get qualified for a loan. They will run the numbers to set your price range for financing. This will help you in working with a real estate sales professional to determine which areas and types of properties fit within your budget. The lender will also pull a credit report to see if you need to be aware of any credit issues. If necessary, this will give you time to start improving your credit picture to make you the most creditworthy you can be when it comes time to lock your loan rate and terms.

Find a competent real estate agent

You also should look for a real estate agent whom you feel can best represent you. Talk to friends and acquaintances for referrals, and interview at least three agents. Find out how many properties they’ve sold in the past few years, what training they have and whether they work as an agent full time and know the areas where you would like to purchase. Get some references from each one and actually take the time to call those references and see what they thought of the real estate professional’s service level and experience.

Educate, educate, educate

This will most likely be your most complicated, expensive and riskiest purchase of your life. You should talk to friends, family members and possibly a lawyer; read books, articles or take a class. In other words, do everything you can to better understand the real estate buying process and how to make the best home purchase decision.

Shop, shop, shop

Consider all the neighborhoods that fit in your price range. Drive them during the day, at night and on the weekend to get a feel for the areas. Look at the neighbors’ properties, any retail spaces nearby and check online neighborhood ratings, crime reports and school ratings. Learn all you can about where you are going to be a real estate owner.

With a price range from your lender, a good real estate sales professional on your side and a solid education on buying a home and the areas where you want to buy, you’re now better prepared to make 2013 the year of the home purchase.

Good luck!

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