Real Estate Investing 101
August 28, 2007 by Lane Bailey
Real Estate investing is one of the best tools to build long term wealth and financial security. About 70% of millionaires in the US built their fortunes in Real Estate, so it is obviously an excellent tool. There are several ways to incorporate Real Estate into one’s overall financial picture.
The first method I’ll cover to invest in Real Estate is a shorter term option called “flipping”. Basically, flipping a property is buying a property at a below market price and then selling it at a market price. The property may be purchased below market value because it needs repair, or because the sellers have a need to sell the property quickly. The advantage of flipping a property is that it creates a shorter term profit compared to holding a property.
The disadvantage of flipping a property is that one needs to sell it to recapture their expenses. A mortgage or Home Equity Line of Credit (HELoC) may also be used to bring cash back out of the property, but may reduce the overall profit from the sale. When flipping a property, one needs to be very aware of not only the purchase price, but also the full cost of acquisition, renovations, selling the property, and cost of carrying the property.
Keep in mind that loan costs for this type of venture are generally more that of a primary residence. Taxes and insurance will also be higher. An investment scenario might look like this:
$165,000- purchase price
$ 1,650- acquisition costs (about 1% of purchase price)
$ 10,000- renovation budget
$ 11,700- carrying costs (budgeted as $1950/mo for 6 months)
$ 18,000- selling costs (6% for real estate commissions, and 2% for other costs)
$225,000- projected sale price after renovation
$ 18,650- projected profit
One thing to keep in mind is that the Return on Investment (RoI) is actually higher than it first appears. Initially, it would appear to be a 10% profit (about $186k invested to return about $18,650). Over a six month span, that isn’t bad. However, the return is actually much higher. Generally, the loan requirements for this type of property will only require 20% down (or less, but at a higher loan cost). So, that means the actual cash investment is closer to $55,000 ($33k down + $10k rehab + $12k carrying costs). This makes the RoI almost 34%. Not bad, but remember this isn’t like owning a stock, there is a lot of work that goes into making this happen. One also needs to be in a position to “carry the property if it doesn’t sell as fast as planned. The bottom line is that if one is realistic in their expectations, a lot of money can be made pretty consistently.
Buy and Hold
Another tool in the bag of the Real Estate Investor is the “buy and hold option. Buying and holding a property is a longer term strategy. In this case, one is using the increase in values over time, generally in conjunction with rental income, to increase their personal wealth. The renter is the key to this being a hugely profitable strategy. An example of this would be:
$200,000- purchase price ($40k cash, $160k mortgage)
$485,000- selling price (after 30 years at a conservative 3%/yr.)
$1,500/mo.- carrying cost (this will go up slightly as taxes and insurance increase)
$1,600/mo.- rent (first year)
* A note about the rent: I would rent to the “right tenant at a discount to keep them longer term. Also, the rent, which will increase around the same as property values over time will go from $1600 in the first year to $3900 in the 30th year. Keep in mind that while the carrying cost will go up, they won’t go up nearly at the same rate as the rent.
While there are a few things to plan for, such as repairs, upgrades and time without renters, if one held the property for 30 years, they would have a property worth almost $500,000 with no mortgage. I would feel confident in saying that the cash flow from the rents (especially as they increase) will cover any expenses in the long term. Compare this to a 6% return on the down payment from a mutual fund, and the $40k down payment would possibly yield $230k.
Either of these strategies can be used with both commercial and residential properties, as well as undeveloped land. The property may also be shifted from one class to another. Land can be flipped by building a home (residential) or shopping center or warehouse (commercial). A warehouse type of building may be renovated into loft apartments (B&H, and residential) or sold as loft condos (flipped). A home on a busy street may be renovated to offices and be re-zoned commercial and either rented or sold. Obviously there are a lot of variations that can be employed.
But what about for a different budget?
Also, the price and financial commitment can be varied as well. Condos ready to be flipped often come on the market at prices well under $100k, and occasionally as low as $50k. A $15k investment may be able to yield a $25k or $30k return. Also, one can partner with others looking to do the same type of investment and form a partnership. This arrangement adds complexity, but also spreads the risk.
Lastly, remember to talk with your accountant and/or tax preparer about the tax ramifications of these types of investments. One may be able to employ deductions and credits to lower their tax liabilities from their investments. If you have any questions, or would like to get started in real estate investing, please feel free to contact me.
Written by Lane Bailey
Lane Can be contacted through http://www.LaneBailey.com
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