December 22nd, 2014 5:58 PM by Gregg Mower
Most of us have played a game or two of Monopoly in our life time. Do you remember how you won? Yes, it was the person with the most property and money. This is not far off from real life other than there are no winners in life just degrees of happiness. The Real Estate game starts to get much more complicated after you buy your primary home. Although, your primary home is also an investment and should not be taken lightly as an investment. However, the next house or piece of property you buy is going to be an investment property. This is dictated by the IRS tax codes unless the next house is truly a second home generating no income. The tax codes with regards to Real Estate will be for another blog for some other day. Today we are going to explore the different types of investment property and tactics you can use to invest in property.
Basic Rental Property:
So let’s start with the purchase of a basic single family rental property. If you chose to go down this road you are choosing to be a landlord like it or not. You can employ the services of a property management company to manage your property, but when it comes to getting something fixed on it, you will have to be involved as it will require your money to get the problem fixed. You also might be very handy and can do the work yourself, but you have to be willing to do that work at odd times of the day to keep your tenants happy. You may get lucky to have a tenant that can do the work and deduct it from your rent, at any rate you have to know the game. With a rental property you will have to be prepared to be hands on your investment. This is great from some folks, but before you decide to jump into buying rental property you should know the numbers.
The numbers I refer to are rate-of-return numbers or return on investment (ROI). In a rental property the way to look at the numbers are pretty straight forward. First, you take the price of the house and the amount of income you can make by renting the house out. Then you have to look at the expenses of that you will be paying such as, the mortgage, property taxes, maintenance, utilities, management, etc.. Once you have that information you can start with the basic number of monthly cash flow which is the monthly rental income minus expenses. If this number is positive we call this positive cash flow and if it is negative, well, it is negative cash flow. Another important number one should take into consideration is appreciation. This number can’t be quantified fully, or sometimes at all, at the time you purchase your property, but if you buy in the right location the chances of appreciation will be greater. You will only know the full extent of the appreciation when you sell the rental property.
Another tactic to purchasing investment property is buying with the intention of fixing the property and selling it for more without putting a tenant in the property. This is called flipping. Flipping is highly speculative and before one tries to make money flipping homes they should know the numbers inside and out. The numbers you need to know for making money in flipping homes are; one, what are similar houses in fixed up condition are selling for in the same neighborhood. Two, what will the cost be to fix up the potential flip. Three, and probably most important, what is the initial price of the home you want to flip. Once you have this determined then you have to decide if it is worth the investment for you. You will have to determine if you got the property for X amount and you put Y amount into the property will it sell for more than X+Y+Expenses of selling? If the answer is yes, there will be money left over after the purchase price, plus the costs of repairs, and the expenses to sell it when it is done, then you have to see if that profit is worth the time, money, and effort. This acceptable profit number will vary from person to person. You also have to take into consideration the time it will take to flip, from the time you purchase, fix it up, and then the time it will take to sell on the market. The time on a quick flip would be about 90 days, but I would say be prepared for 6 months financially.
Investing in commercial property can be very lucrative but you need a considerable investment to get started in this type of property. With any investment property you have to have the means to purchase the property either with cash or the use of a loan. Commercial property, generally being more expensive than residential property, will require a larger down payment. Commercial property comes in many forms from Office space, to retail space, to restaurant space. If you are not going to be an owner operator and are just looking at commercial property from an investment point of view the numbers here will be crucially import to you. In Commercial Real Estate we look at the Capitalization Rate (Cap Rate) which is the annual net income after expenses divided by the purchase price of the property. The higher the “CAP Rate” the better the investment, generally. So when you are looking a commercial property you should not only like the area it is in but you need to get the operating statement from the owner prior to purchasing the property to see what the income and expenses are prior to purchasing. You will have to determine what Cap Rate you like, generally a good rate is a 6 or higher.
Yet another way of investing in Real Estate without the typical ownership hassles is to be the lender. Yes, if you lend money to someone to purchase real estate and secure your loan with a Note and Trust Deed you have ownership rights without having the ownership headaches. As a lender you will receive a set rate of return over a period of time. You will not have the opportunity to make the appreciation on the investment, but you will receive a yield higher than you could receive in most investments. The way this works is pretty straight forward, you tell a Broker, which is in the business of lending, that you wish to lender your funds to folks that want to invest in Real Estate. The Broker will provide you with the legal paperwork and once you have signed you will be given opportunities to invest. The Broker will have the amount you want to lend, what you want to lend on, and he/she will find a borrower that fits your needs and give you the opportunity to view the property and the borrower’s qualifications. As an investor you have the right to see and verify anything you wish. The biggest consideration will be the amount of equity that is in the property after you lend the money. This is called loan to value or LTV. The lower the LTV the lower the risks. A borrower will be less likely to default on their loan if there is a large equity position in the property, and if they do default and there is a large equity position in the property, you as the lender will gain that equity after a foreclosure. Returns on these types of loans are generally between 7% up to 16% depending on the risks, with the higher the risk the higher the rate.
There are many ways to invest in Real Estate and these are just a few. We have negotiated all kinds of Real Estate investment over the years and these are just the most popular ways of getting involved. Investing in anything should be done with careful consideration and a good education. You should know your risk tolerance before you go into investing in anything, as with any investment the risk of losing money is there as well. This is why we at MAE Capital Real Estate and Loan do our best to run the numbers for you before you even look at a potential investment. This is your money and your future and we don’t take that lightly at MAE Capital Real Estate and Loan, for that we make sure you understand what you are investing in before we can, in good conscience, recommend any investment. As always please leave any comments you might have.