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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6 Renovation Tips for New Landlords

If you’re new to investing in real estate, you’ll probably be really excited when you close escrow on your first purchase.

6 Renovation Tips for New Landlords-Professor-BaronThat’s great because real estate investing can be a very good way to improve your long-term wealth picture. However, if you are an average real estate investor — as 99 percent of us are — that excitement will turn quickly to the realization that a lot of hard work is coming to your plate, especially when it comes to renovating your new investment property.

Here are some items you should be aware of so you can better prepare for your future as a real estate mogul.

Budget money and time wisely

As your closing come close, you are probably putting together a starry-eyed list of all the improvements you’re going to make on a shoestring of a budget. Of course the repairs will also be completed in 30 days so you can rent the property out and start earning some income. Not going to happen! Once you get going and realize improvements cost much more than you thought and take longer to complete, you’ll be doing some major revisions to your estimates. Be cautious when estimating a low-priced and quick-turnaround renovation, as that rarely ends up being the case.

Expect to invest your sweat equity

To better educate yourself and minimize budget overruns, plan on spending a lot of time at the property from the day you close escrow until about one month after it is occupied by renters. Why? Because it’s a lot of hard work — getting bids, waiting for deliveries, reviewing work, doing work, shopping for supplies (and more supplies), advertising your property, reviewing rental applications. You’ll be doing it all at your new property. It may start out fun but will not end that way; however, you are in this for long-term wealth building, and that’s why you are willing to invest your time and energy in hopes of a better retirement.

Don’t take the first bid

You must get several bids to ensure that you’re getting a fair price for any contracting work. The more expensive the job, the more bids you should get. This is going to be exhausting and time consuming. However, doing your legwork can lead to better and/or less expensive bids in the long run.

Focus on paint and flooring

If the paint and flooring in your property don’t look nice — and they usually don’t — fix them! It’s going to cost some money, but hopefully you’ll get a little more rent when you make these improvements.

Paint:
Use a bright and neutral color, and paint all the walls the same color and sheen. When you have to do touch-ups down the road, it’s nice to just have one color in the property, and you can always have a can of that color on hand.

Flooring:
Your flooring options include carpet, tile, wood laminate and vinyl. Tile is best for kitchens and bathrooms due to water and moisture issues. Wood laminate is best for elsewhere due to its durability and easy cleaning. Carpet is not good for rentals as it stains easily, and every new tenant wants new carpet. Shop around: You can find some good laminate deals, and it’s relatively easy and inexpensive to install.

Check for plumbing and electrical issues

Properties that are more than 20 years old usually should have the water valves and electrical outlets replaced. So round up a few plumbers and electricians and get some bids. Do this while the property is empty. Water valves, supply line hoses, washing machine and dishwasher hoses and drains pose the biggest leak and flood risk. Change them all out. Electrical outlets and covers are not as big a risk, but usually look really bad with many coats of different color paint on them. An electrician can change out a whole house of outlets and on/off switches in half a day or less.

Don’t go for the lowest-priced supplies

When you get bids and are reviewing costs at a home improvement store, don’t just pick the least expensive supplies. Those items will never stick when you are actually making the decisions on what to contract for and purchase for your rental. You’ll end up buying the more expensive stuff, creating a budget headache that could have been avoided.

These basic tips should be supplemented with your investigation and seeking guidance from experienced real estate investors in your area. They’ll have other good advice, too. Just don’t think being a real estate investor is an easy walk in the park. It’s more like a marathon in the hot sun with a lot of hard work. But this hard work and determination will make your eventual success even more rewarding!

Have questions? Just leave me a comment below and I’m happy to help you!

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Is Now a Good Time to Buy Real Estate?

People always ask, “Is it a good time to buy real estate?” The answer is always, “Yes, but it depends.” In order to make that determination for you, we first must understand the three most important words in real estate:

Long-Term Ownership

is-now-a-good-time-to-buy-real-estateWe buy property, whether a personal residence or for investment, in hopes that we are financially better off down the road than we are today. The chance of that occurring is very low if one does not own real estate for at least five or more years. The reason is that transaction costs, repairs, monthly ownership costs higher than comparable rent, and ownership hassles dictate that it is better to invest your money elsewhere and stay as a renter if you are not sure you will own long term.

Therefore, since you are going to be a long-term holder (the longer the better) you really should not be that concerned with short-term current market price fluctuations because ten years from now the home’s value will be more than it is today.

What you should be concerned about is finding a house that you “love”— one that fits all the right reasons you want to own that particular property for a long time!

That could almost be the end of this article…but there are a few more issues to consider to make sure it is a good time for you to buy property. If you fail any of the below tests, you should think through the issue(s) and whether or not it really is a good time for you personally to buy.

1. You are planning to be a long term holder, 5+ years of course

2. For owner occupants – payments are affordable and you have a steady job

3. It isn’t significantly more expensive to own over renting – this very important.

4. For investors – It makes cash flow sense, 4-5 percent-plus cash on cash. The higher the better but watch out for returns that appear too good to be true.

5. It is the RIGHT property for you for all the right reasons; you “love” it!

6. It is fairly priced relative to the recent comparable market sales in the immediate area for similar properties

7. You plan to own it for a long long long time!

8. Vacancy isn’t too high in the area. This is very important whether an owner occupant or investor. Empty unstable neighborhoods or communities have a higher risk of vandalism and risk downward price spirals.

9. It is in decent shape and doesn’t need much fixing-up. Skip the junkers, the ones with foundation issues, or anything labeled as “needs a little TLC” in the listing, as that means it is a wreck. Leave the fixers for the contractors. And doing it yourself doesn’t usually save you much money.

10. It is not near a big vacant parcel, non-residential zoned parcel, empty or retail/industrial/religious site where you are not 100 percent sure what is going to be built or in use there. A new use of that land could impact your “quiet enjoyment” of your residential unit.

11. You complete the proper due diligence steps to reduce your risk as much as possible. Mind your contract terms and contingencies, pencil out your deal, get a couple of bids on financing and dissect your GFE, review the HOA condition, review the property condition, make sure you have the right type and amount of property insurance in place, make sure you adequately review the title abstract and title policy and everything else you need to do to lower your risk.

12. And you plan to own it a long long time!

Those Three Important Words? I laughed when someone once said “location, location, location” were the three most important words in real estate. Not only is that actually only one word but we pay a handsome premium for “location” and is that premium worth it? It may or may not be, but “long-term ownership” are by far and away the three most important words in real estate.

To summarize: Subject to the above issues, it is always a great time to buy real estate but:

  • Not for everyone,
  • Not at any price, and
  • Not just any property.

Find a house you love or rental property that makes sense, that you will own for a long time, is in decent shape, lock in a long-term mortgage and sleep well.

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Investing in Real Estate – What is a “Good Deal?”

Let’s look at a tried and true way to measure rental property investment returns and what we as buyers should be looking for in our purchases. Total investment returns in real estate are really comprised of two pieces: operating positive cash flows and long-term appreciation. In today’s world, even though it probably will come, we cannot count upon and should not consider long term appreciation. That leaves positive operating cash flows as our primary source of investment return. Let’s call this: “earning money the old fashioned way.”

So how do we calculate our returns and how do they compare to other investments where we could place our hard earned cash equity dollars? It is quite straightforward to calculate our investment returns, unfortunately few people do this leaving many a buyer to make poor real estate choices.

Most Important – “Cash on Cash return” is the most important measurement. So while the price is important, one’s actual cash equity investment is the vital issue. So for every dollar invested what is our percentage yield return on our equity cash investment. CDs offer 1.5%, Bonds 4.5%, stocks 7.5% and real estate is generally high risk, so we want fairly high returns to compensate for the risk.

If one is buying a $200,000 investment property they probably put down 25% or $50,000 plus another 5% or $10,000 for closing costs, loan fees and rehab costs. So the mortgage is $150,000 and a buyer’s cash equity is $60,000 from the start. Again: The property price of $200,000 is important too, but how much cash equity one invests is much much more important.

investing-in-real-estateSee Chart – Using a conservative estimate, depending on the local market, that property might generate $1,800 per month in rent and have 33.3% operating expenses ($600) leaving net operating income of $1,200. Then subtracting the monthly mortgage payment of $900 leaves $300 of monthly cash flow or $3,600 per year.

Divide that $3,600 by the $60,000 of cash equity and this property has a first year cash on cash return of 6.0%. And it should increase a little each year as rental income increases, as do general expenses, but the mortgage stays constant.

That 6.0% is a pretty fair return for real estate and of course there hopefully will be some long term appreciation, tax benefits and a little more yield from the mortgage balance pay down via amortization of the loan.

Be Smarter – It is stunning how many real estate buyers fail to do this simple calculation and buy properties with minimal or negative cash on cash returns – to their own financial detriment. Let’s be a little bit smarter and make sure we take a good look and a conservative approach to real estate investing for our own long term benefit.

Go for the Cash Flow! – As a final note, buyers will find prize properties, like at the beach or fancy condos, generally have very low or negative returns. Skip those! It is the moderately priced units that have decent cash on cash returns. Hence… “prize” properties are NO prize…moderately priced cash flowing properties are the real prizes! Then you will have to figure out where to invest all that positive cashflow….

To help you do better analysis, you can download my simple and straightforward spreadsheet for free when you join my email list. Sign up below!

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