Real Estate Investment Basics

Investment property has provided many investors with positive cash flow, tax benefits and the satisfaction of making an impact in others lives.  However like any investment, real estate has intricate nuances and market trends that when ignored can cause an investor tremendous heartache.

Unbelievably, many first-time investors and even seasoned investors are willing to part with their hard-earned cash without taking the time to study their investment.  They rely on traditional trends and gut feelings.  

Before you risk your investment, take the time to learn all you can about your market. By aligning yourself with the right professional, you can avoid these common mistakes and you'll ensure an excellent return on your investment.

 Failure to determine your time need. Cash flow, capital appreciation, tax benefits, loss of management, equity pay-down and pride of ownership are just some of the things that need to be addressed before you make that investment. A service-minded real estate professional can be a tremendous asset by taking the time to evaluate your needs and making sure you've got all your bases covered.

Use the current tax laws to your advantage . The new tax law changes the rules to avoid capital gain on the sale of the property.  In the past you had to rollover your equity into a new home or take a one-time exclusion if you are over 55 years of age.   Now the requirement is that you need only live in the home two out of the last five years.  This means that you can convert a current residence to a rental, hold it for two or three years and sell it tax free.  This can be a strategic advantage in your plans to acquire property

Failing to check out the seller or seller agent's math. Claims of extremely high rates of return run rampant in real estate investment.  Don't get caught up in the excitement—check everything: rent amount, payment history, taxes, expenses, deposits, future modifications—everything! Make sure you have the right agent.  It's like having a good insurance policy against overlooking all the seemingly insignificant but very important details. 

Don’t forget you're buying a business. Owning investment property carries great potential for creating wealth and some potentially difficult decisions.  Evictions, re-investment into the property and time management all need careful consideration.  Remember this is not a "hands-off' business.

Avoid negative cash flow. Property that eats cash every month can drain your working capital.  This creates stress, frustration and can become quite painful.  Predicting constant appreciation is extremely difficult if not impossible for the unseasoned investor.  A strain on your cash flow may cause you to sell the investment before the benefits of ownership are ever realized. 

Low interest rates and increasing rents have made it easier for cash flow investments.   Multiple units, from two to four, normally provided a greater cash flow because their value is based upon the income that the property generates.  Their value is not based on some intrinsic or emotional value that you would find in a single family detached home where you are competing against people who plan on living in the property.

Failure to do a thorough inspection. Look under every rock!  Hire a professional inspector.  Ask the tenants about pest problems, structural damage or recurring problems.  Don't overlook anything!  A value-driven real estate professional will help you find the right inspector and can help you avoid costly mistakes.  When investing your hard-earned money, be sure and use sound business judgment!

Failing to have adequate insurance. Investment property brings accountability.  Tenants, cars, parking lots, property responsibility—the list is quite extensive that increases your exposure to liability. Adequate insurance coverage is an absolute must!  Be sure to consult with an insurance professional and protect your hard-earned assets.

Inspect, approve and confirm all documents. The list of documents that need to be proofed can be overwhelming to the first time investor: Building permits, zoning laws, rental and lease applications, health licenses, laundry leases, underlying loan documents, by-laws, title policies, mineral leases, inspection reports, purchase contracts and insurance. Don’t attempt to do it alone.  The right professional can remove most of the stress and bring the transaction to a conclusion smoothly.

Get a Bill of Sale for all property involved. Many types of personal property (appliances, furniture, fixtures, etc.) can be involved in an investment sale.  Be very detailed—know who owns what!  You don’t want to close escrow and find that what you bought was not what you bargained for.

Charge a fair rent amount. Vacancies, turnovers and lease terminators are your biggest expense.  Charge a fair rent amount, treat your tenants with respect and respond as quickly as possible to their needs.  It's a lot less costly in the long run to take care of the little problems before they become big problems.  Vacant property is your Achilles heel.   You may squeeze an extra $25-50 out of the rent, but if you lose a month’s rent in the transition, you will lose all the benefit.

Select qualified, good tenants from the start. Take the time to check references.  Previous landlords, employers, financial references, credit, judgments are all vitally important.  If there are any questions, investigate fully.  Drive by their previous residence.  A little work upfront can save tremendous problems later on down the line.

Make sure you get estoppel letters. Get letters from tenants confirming the status of tenancy.  Make sure their version of the rental or lease agreement corresponds with the seller's interpretation. (Estoppel letters are documents used in commercial mortgage transactions where the lender is secured by property that is leased to tenants. The estoppel letter gives the lender more rights and more flexibility for disposing of the property in the event that the borrower defaults.)

Don't spend positive cash flow. Most successful investors have free and clear properties.  Be sure to re-invest your cash flow back into the property payment and speed up the amortization schedule.  This decreases your debt load and increases your equity—which builds your net worth.

An ounce of preparation. Investment property can be one of the most rewarding aspects of your financial portfolio.  Be certain to have all your "ducks in a row" before you invest.  Do your homework!  Consult with a professional real estate agent and relieve yourself of the hidden troubles that can plague first time investors.

Just because you bought a house for your home doesn’t mean it will make a good rental. Just because you own the home you are in now does not mean that it is the best rental property for you to keep.   You bought this as a home to live in.  Would you have bought it as a rental?  There is a different thought process and motivation.   Ask yourself if you would buy the home you are in for the price you could sell it for in the open market.   Look at the equity you have in the property and calculate the return on investment you would receive for your equity.  Just because it is convenient doesn’t mean that it is the right thing to do.  Do the math and analyze the benefits.

Real estate investing allows investors several ways to make and/or save money. Here's how you can build wealth through your real estate investing:

Positive cash flow. This is simply what it sounds like—the rent covers the mortgage, taxes, insurance, fees, etc. and once all that's paid; you have money left over at the end of the month. A wise investor will also have enough money in reserves to cover all these expenses for a few months in case the property goes vacant.

Equity growth via amortization. As the mortgage shrinks from the mortgage payments, your equity grows (and so does your net worth). This is one of the most powerful means of wealth growth—using OPM (other people's money) to build your net worth. The tenant is providing the investor with hundreds or thousands of dollars per month to pay off debt, which turns into equity for the landlord.

Capital improvement. This is the fixer-upper that most people think about when investing in real estate. Purchase a property for $50,000, put in another $25,000, and now the house is worth $125,000 ($50,000 more than the initial investment).

Bargain purchases. The most effective way to build net worth and equity is to buy a house for a bargain price. These properties would be the pre-foreclosure, foreclosure, tax sales, etc., where the investor buys the property well below market price. In essence, you make your money when you buy the house at such a low rate.

Lowering tax bills. One of the greatest benefits about real estate investing is all the tax breaks allowed for these type investments. Uncle Sam allows many tax deductions, tax credits and other government-sponsored programs connected with real estate investing that cut the investor's tax bill, thus, increasing the bottom line and equity growth.

Smart asset management. Many real estate investors lose money simply by not managing the asset wisely. For instance, painting properties before the wood is actually peeking through will keep the asset in good shape, seal the wood, and protect it from more expensive damage. Managing the asset is just as important as buying smart and cash flow. The real estate investment is a commodity, not a money machine, and must be managed and protected to maintain future wealth growing potential.

Asset value growth. As your property increases in value, so does your wealth. This is the old fashioned principle of buy and wait. Buy at today's prices and with time, your asset will grow in value because of local appreciation. In addition, your equity will grow along with the amortization principle.

Rent appreciation. As the cost of living increases, so, too, should your rent cash flow.