Residential real property investing has seen a dramatic rise in popularity over the past few years. Ironically, when the market is up, there seem to be many people jumping on investments such as stock, real estate, and gold. However, once the market has fallen, they tend to jump OFF the wagon and pursue other activities. It's human nature to do this, but it also means that many real estate investors are putting money at risk.
Understanding the dynamics of residential real estate investments can help you make more money. However, it is important to stick to the fundamentals of real estate investing.
Real estate investing is not about getting rich quick. Flipping houses can be a quick way to make some extra cash, but it is not a long-term, how to sell your home passive investment. The term "investment" means that you are fully committed to the activity over the long-term. This is often what it takes to make a living in real estate.
While pundits are blaming the slump in residential realty markets and speculators wondering if it is the bottom, let's get back to the basics of residential realty investing and how to make money in both good and bad markets.
Return to the Fundamentals of Residential Real Estate Investment
Real estate investment can be easy when it is rising in value. If you are in the right spot at the right time, even if there is no equity or cash flow, all ships rise with the rising tide.
It's difficult to predict the market without extensive market research. It is better to understand all four profit centers of residential real estate investing and ensure that your next residential real property investment deal includes ALL of them.
- Cash Flow How much income does the residential income property generate each month after expenses have been paid? If you know the amount of the mortgage payment and the rental income, this should be simple to calculate. It becomes a lot more complicated when you consider all the other costs involved in maintaining a rental property, such as vacancy, expenses and repairs, maintenance, advertising, bookkeeping and legal fees. To estimate property expenses, I use a factor of 40% of the NOI. As a guideline for debt service, I use 50% of my NOI. I take 10% of the NOI profit. If the deal does not meet these parameters, I am cautious.
- Appreciation This is the best part of owning real estate. As we have seen, real estate can also drop in value. Leverage, which is your bank loan in this instance, can be a double-edged sword. Leverage can help you increase your return if your property is in an area that is growing in value. However, it can also decrease your risk of losing your property. You should plan to keep your residential real property investment property for at most 5 years in order to make a sound, low-risk investment. This will allow you to weather market fluctuations and make a profit.
- Debt Payment - Every month, when you make your mortgage payment to the bank a small amount of it will reduce the loan balance. A normally amortizing mortgage loan will have a small amount of debt to pay down in the beginning. However, as the loan term approaches, you will see that more of your principal is being used to repay the debt. All this assumes you have an amortizing loan. Your payments will be lower if you have an interest only loan. However, you will not receive any loan repayments. If you plan to keep the property for less than five years, an interest-only mortgage is a good option. The interest rate adjustment upwards won't affect your cash flow and increase your monthly payments. An accruing loan will reduce your investment loan balance and allow you to keep the property for a long time if you are looking to retain the property. To determine if it is worth your time to obtain an interest-only loan or a fixed rate loan, you should do a thorough analysis of your real estate investment strategy. Refinance may be a better option than selling your property.
- Tax Write Offs - If you're the right person, tax write offs can be a huge benefit to real estate investing. They are not the panacea they are often made out to be. Individuals who have multiple properties, but not real estate professionals, and who do not actively participate in real estate investments might be affected by the AMT (Alternative Minimum Tax). Investors who are primarily interested in short-term deals such as flips, rehabs, and the like may be even worse. Their income is treated as EARNED INCOME. They pay the same short-term capital gains tax rate (high) as they would if they had earned the income from a W-2 job. Many people realized that it was not a good idea to invest in real property just because of the tax benefits. They can be a great profit centre if you are eligible, but they should not be considered the main ingredient of the cake.
Any residential real estate investing deal that stands up under the scrutiny of this fundamentals-oriented lens, should keep your real estate portfolio and your pocketbook healthy, whether the residential real estate investing market goes up, down or sideways. If you are able to use real estate market trends as a way to boost your profits, that's also fair. It is important not to depend on one strategy to make you huge gains. Be realistic about your expectations and stay true to the basics. Purchase property that you can afford, and plan to remain invested over the long-term.