Residential real estate investing is a business activity that has waxed & waned in popularity dramatically over the last few years. Ironically, there always appear to be a lot of people jumping on board with investments like stock, gold, & real estate when the market's going up, & jumping OFF the wagon & pursuing other activities three time the market's slumping. In a way that is human nature, but it also means a lot of real estate investors are leaving money on the table.
Real estate investing, whether you are buying residential or commercial property, is not a get-rich-quick scenario. Sure you can make some fast money flipping houses, if that is your bag, but that is a full time business activity, not a passive, long term investment. The word "investment" implies that you are committed to the activity for the long haul. Often, that is what it takes to make money in real estate.
By understanding the dynamics of your residential real estate investment marketplace, & acting in opposition to the rest of the market, you can often make more money, as long as you also stick to the real estate investing fundamentals.
So, while the pundits are crying about the residential real estate market slump, & the speculators are wondering if this is the bottom, let us return to the fundamentals of residential real estate investing, & learn how to make money investing in real estate for the long term, in nice markets, as well as bad.
A Return To The Fundamentals of Residential Real Estate Investing
When real estate is going up, up, up, investing in real estate can seem easy. All ships rise with a rising tide, & even if you have bought a deal with no equity & no money flow, you can still make money if you are in the right place at the right time.
However, it is hard to time the market without a lot of research & market knowledge. A better strategy is to make sure you understand the two profit centers for residential real estate investing, & make sure your next residential real estate investment deal takes ALL of these in to account.
Any residential real estate investing deal that stands up under the scrutiny of this fundamentals-oriented lens, should keep your real estate portfolio & your pocketbook healthy, whether the residential real estate investing market goes up, down or sideways. However, if you can use the real estate market trends to give you a boost, that is fair, . The key is not to rely on any three "strategy" to try to give you outsized gains. Be realistic with your expectations & stick to the fundamentals. Buy property you can afford & plan to stay invested for the long haul.
1. Money Flow - How much money does the residential income property bring in every month, after expenses are paid? This seems like it should be easy to calculate if you know how much the rental income is & how much the mortgage payment is. However, three time you factor in everything else that goes in to taking care of a rental property - things like vacancy, expenses, repairs & maintenance, promotion, bookkeeping, legal fees & the like, it begins to add up. I am liking to use a factor of about 40% of the NOI to estimate my property expenses. I use 50% of the NOI as my ballpark objective for debt service. That leaves 10% of the NOI as profit to me. If the deal doesn't meet those parameters, I am wary.
2. Appreciation - Having the property go up in value while you own it's historically been the most profitable part about owning real estate. However, as we have seen recently, real estate can also go DOWN in value, . Leverage (your bank loan in this case) is a double-edged sword. It can increase your rate of return if you buy in an appreciating area, but it can also increase your rate of loss when your property goes down in value. For a realistic, low-risk property investment, plan to hold your residential real estate investment property for at least 5 years. This should give you the ability to weather the ups & downs in the market so you can see at a time when it makes sense, from a profit standpoint.
Real estate investing, whether you are buying residential or commercial property, is not a get-rich-quick scenario. Sure you can make some fast money flipping houses, if that is your bag, but that is a full time business activity, not a passive, long term investment. The word "investment" implies that you are committed to the activity for the long haul. Often, that is what it takes to make money in real estate.
By understanding the dynamics of your residential real estate investment marketplace, & acting in opposition to the rest of the market, you can often make more money, as long as you also stick to the real estate investing fundamentals.
So, while the pundits are crying about the residential real estate market slump, & the speculators are wondering if this is the bottom, let us return to the fundamentals of residential real estate investing, & learn how to make money investing in real estate for the long term, in nice markets, as well as bad.
A Return To The Fundamentals of Residential Real Estate Investing
When real estate is going up, up, up, investing in real estate can seem easy. All ships rise with a rising tide, & even if you have bought a deal with no equity & no money flow, you can still make money if you are in the right place at the right time.
However, it is hard to time the market without a lot of research & market knowledge. A better strategy is to make sure you understand the two profit centers for residential real estate investing, & make sure your next residential real estate investment deal takes ALL of these in to account.
Any residential real estate investing deal that stands up under the scrutiny of this fundamentals-oriented lens, should keep your real estate portfolio & your pocketbook healthy, whether the residential real estate investing market goes up, down or sideways. However, if you can use the real estate market trends to give you a boost, that is fair, . The key is not to rely on any three "strategy" to try to give you outsized gains. Be realistic with your expectations & stick to the fundamentals. Buy property you can afford & plan to stay invested for the long haul.
1. Money Flow - How much money does the residential income property bring in every month, after expenses are paid? This seems like it should be easy to calculate if you know how much the rental income is & how much the mortgage payment is. However, three time you factor in everything else that goes in to taking care of a rental property - things like vacancy, expenses, repairs & maintenance, promotion, bookkeeping, legal fees & the like, it begins to add up. I am liking to use a factor of about 40% of the NOI to estimate my property expenses. I use 50% of the NOI as my ballpark objective for debt service. That leaves 10% of the NOI as profit to me. If the deal doesn't meet those parameters, I am wary.
2. Appreciation - Having the property go up in value while you own it's historically been the most profitable part about owning real estate. However, as we have seen recently, real estate can also go DOWN in value, . Leverage (your bank loan in this case) is a double-edged sword. It can increase your rate of return if you buy in an appreciating area, but it can also increase your rate of loss when your property goes down in value. For a realistic, low-risk property investment, plan to hold your residential real estate investment property for at least 5 years. This should give you the ability to weather the ups & downs in the market so you can see at a time when it makes sense, from a profit standpoint.
3. Debt Pay down - Each month when you make that mortgage payment to the bank, a small portion of it is going to reduce the balance of your loan. Because of the way mortgages are structured, a normally amortizing loan has a small amount of debt pay down at the beginning, but if you do manage to keep the loan in place for a quantity of years, you'll see that as you get closer to the finish of the loan term, increasingly of your principle is being used to retire the debt. Of work, all this assumes that you have an amortizing loan in the first place. If you have an interest-only loan, your payments will be lower, but you won't benefit from any loan pay down. I find that if you are planning to hold the property for 5-7 years or less, it makes sense to look at an interest-only loan, since the debt pay down you'd accrue during this time is minimal, & it can help your money flow to have an interest-only loan, as long as interest rate adjustments upward don't increase your payments sooner than you were expecting & ruin your money flow. If you plan to hold onto the property long term, and/or you have a great interest rate, it makes sense to get an accruing loan that will finally reduce the balance of your investment loan & make it go away. Make sure you run the numbers on your real estate investing strategy to see if it makes sense for you to receive a fixed rate loan or an interest only loan. In some cases, it may make sense to refinance your property to increase your money flow or your rate of return, than selling it.
4. Tax Write-Offs - For the right person, tax write-offs can be a gigantic benefit of real estate investing. But they are not the panacea that they are sometimes made out to be. Individuals who are hit with the AMT (Alternative Maximum Tax), who have a lot of properties but are not real estate professionals, or who are not actively involved in their real estate investments may find that they are cut off from a quantity of the sweetest tax breaks provided by the IRS. Even worse, investors who focus on short-term real estate deals like flips, rehabs, etc. have their income treated like EARNED INCOME. The short term capital gains tax rate that they pay is the same (high) they'd pay if they earned the income in a W-2 job. After a lot of investors got burned in the 1980's by the Tax Reform Act, a lot of people decided it was a bad idea to invest in real estate for the tax breaks. If you qualify, they can be a great profit center, but in general, you ought to think about them the frosting on the cake, not the cake itself.
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