Investing in real estate has become more popular as investors seek to diversify their portfolios. Real estate is a good long-term investment option because it provides an excellent rate of returns and offers tax advantages.
The real estate market is very profitable when you have the knowledge to make wise investments. Real estate investing can be tricky and there are many details you need to understand before making your first investment.
This article helps you learn what to expect and know before investing in real estate.
Before starting the real estate investment process, you need to immerse yourself in the market and get a firm grasp of how real estate works. By educating yourself now, you’ll save yourself tons of headaches later.
In a recent Forbes article, DC Fawcett, Founder of the Virtual Real Estate Investing Club cautioned against skipping the education step.
“The most common mistake I see new investors make is to jump into investing without taking the time to get educated about what the best strategy is for them,” Foster noted.
Understand Property Value
In order to ensure you are buying or selling a property at the right value is important. To determine effective property valuation, these are the six factors which every property owner should look into since it influences a home’s value:
- Historical sale price of the property – how many times has the property been sold and what were the sale prices? Historical sale prices are dependent on the other factors on this list.
- Neighborhood – school system quality, the value of other properties in the area and crime rates can impact the neighborhood’s value.
- Market – property prices are shaped by supply and demand and can fluctuate based on subtle changes in the area’s economy.
- Size and appeal – Larger properties tend to sell for higher prices. Traditional, neutral layouts tend to have a higher value than an obscure layout appealing only to niche buyers.
- Age and condition – new homes tend to have a higher value than older homes. However, an older well-maintained could have a high value. However, a well-maintained, older home may sell for just as much as a newer home. The home’s foundation, structural integrity, electrical, plumbing, and fixtures are all considered in determining value.
- Nearby features – where the property is located in relation to nearby features such as highway access, schools or shopping centers can impact value
Understand Profit vs. Cash Flow
To be successful in real estate investing, you need to look at your real estate investments like a business. When it comes to cash flow and profit; the two are different financial parameters, but when you’re running a business, you need to keep track of both.
- Cash flow – money flowing in and out of your business from operations, financing and investing activities. It’s money that is necessary to meet current and near-term obligations. Cash flow is your total cash income minus the total cash expense.
- Profit – also called net income, is the remaining amount from sales revenue after all the business’s expenses are subtracted. Gross profit is sales minus the cost of generating revenue (i.e, expenses such as rent, salaries, and utilities. Profit is one of the core measurements of a business’s viability and watched very closely by both investors and lenders. is closely watched by investors and lenders.
An investment for cash flow income focuses on buying a property such as an apartment building to collect a stream of cash from rent. While cash flow is important for selecting real estate investments, investors must also weigh the amount of profit they could potentially earn by fixing up the investment property and selling it (also known as flipping) versus renting the property out.
Understand Investor Mortgage and “Leverage”
When purchasing a property, you can use debt by taking a mortgage out against a property. Lenders consider investment and rental properties to be riskier than a mortgage for your home because it’s not your primary residence.
To qualify for an investor mortgage, you most likely will have to put more money down than you would for a home mortgage. Conventional investor mortgages generally require at least 15% down for a one-unit property and 25% down on a two-to-four-unit property. An investor loan term is usually shorter than a typical 30-year residential mortgage and your interest rate will be higher because of real estate of the higher risk.
Leverage is the use of borrowed capital or debt to increase the potential return of an investment. In real estate, the typical way to leverage your investment is with your own money or through a mortgage. Leverage works to your advantage when real estate values rise, but if values go down, it can result in losses. The easiest way to access leverage is to use your own money.
Leverage is what attracts many real estate investors because it enables the acquisition, they would not be able to afford otherwise. In a falling market, using leverage to purchase real estate can be dangerous since the interest expense and regular payments can drive the real estate investor into bankruptcy.
Understand and Use Comparative Market Analysis Data
In real estate, a comparative market analysis is a process of determining the value of the investment property by analyzing similar, recently sold investment properties in the same market or location. To get the best comparison, you need to find the most identical properties, also known as real estate comps, in size, square footage, age, location, and features.
The real estate market is always changing. An investment property bought today would not be the same price as it was when first sold years ago. A comparative market analysis is the only way to determine how much the income property is worth, helping you to avoid overpaying.
Researching investment properties is essential before you make a purchase. When looking at different properties, ensure you understand the property value of each. As noted previously in the article, the property value is determined by location, neighborhood, condition, market, and age.
Here are some steps to take when considering a potential investment property:
- Get to know the neighborhood – Since your property value is determined partially by the surrounding area, find out as much as you can about the neighborhood. Drive-by at different times of day to get a feel for the area. In addition, get out of your car and meet with people who work and live in the area.
- Check for future development – talk to local government officials to determine if any plans for new developments. This will tell you if people are moving in or out of the neighborhood.
- Obtain property comparisons – ask a local real estate agent to find out the sale price for similar properties. To determine how competitive the market is in a specific area, find out the listing price versus the final sale price. To give you a better idea of whether the property fits your budget, include additional costs such as utilities, especially if you plan to include in the rental price.
- Visit the properties – Ask your real estate agent to take you to several properties within your price range to see what is available and the value of the neighborhood.
Decide if You’re Buying to Fix and Resell or Buying to Rent Out
How do you determine whether you should purchase a property with the intention of fixing it up and reselling it or whether to buy the property and rent it out? The answer depends on what your goals are for investing in the property.
The difference between flipping a property or renting the property out to tenants is really the difference between passive income and active income.
- Passive Income – money you receive every month from your investment such as rental income.
- Active Income – money earned through the day to day work. When you stop working, the income stops.
Buying the Property to Sell
Buying a property with the intention to flip it gives you a quicker return on your investment and you won’t have any long-term property management costs. However, flipping will also give you inconsistent income and extra costs including taxes and capital gains.
When determining if you should buy a property, fix it up and then resell it at a profit, you should consider:
- Cost to update the property- does it simply need a fresh coat of paint or an entire kitchen remodel?
- How much you can sell the property for?
- Profit after fixing the property and reselling
Buying Property to Rent Out
By buying a property and renting it out, you will have an ongoing monthly income and the property’s value should increase over time. In addition, renting property has tax advantages while flipping does not. Rental property owners can write off the appreciation of the property as well as certain expenses such as repairs and maintenance. You may also consider renting out your property to Airbnb or a similar home-sharing platform in which you can rent for shorter amounts of time for a daily price.
When determining whether to buy a property to rent out, consider:
- Costs to fix the property
- May have some vacant periods when you are looking for tenants
- Costs associated with furnishing short-term rentals, such as furniture, décor and toiletry necessities
- Need to hire someone as a property manager or manage yourself
Immediate Income vs. Long-term
When deciding the right real estate investment strategy, you need to determine whether your goal is immediate income or future value. As Mor Zuker, from Team Denver – Kirkwood Homes told Forbes: “Many properties are located in transforming neighborhoods that are currently showcasing lower returns but offer higher future returns for your money. Pay attention to the area.”
Only you can determine which strategy is better for your future as an investor. With immediate income, you will only earn money when the property is sold.
- Immediate income – your return will be faster and higher but there is more risk involved. A short-term investment strategy is good for properties in stable or insignificant increases in projected value.
- Long-term income – If you expect a large appreciation from the property and you could benefit from tax advantages, a long-term strategy may be best.