|
If you believe what it says, late night TV is full of great ways to invest in real estate. Most investors -- they seem to suggest -- are looking at big paybacks with no money down. That's unlikely, like going to the store to buy a watermelon and offering to pay for it with a paperclip (a highly-unlikely feat which my daughter successfully managed to do this summer at camp).
It takes forethought and preparation to be successful in real estate. You also need to realize that buying real estate is investing and with investing there is risk: If you don't know what you're doing, you can make a costly mistake.
Choosing Your Investment
Beginning investors should start with small projects, just like Walter from Hawaii. He's been involved in real estate for more than 12 years and invested in various two- to seven-unit properties. Properties -- both commercial and residential -- in good locations have made money for him. The properties he purchased in marginal locations, with high leverage down payments and extensive tenant turnover have not worked out for him.
Walter started with a duplex, which he later refinanced to buy a four-plex. He painted and put a new roof on the four-plex, then sold it for a seven-plex. He also bought a four-plex with one-bedroom units. He renovated the units and installed new siding, but in the end, he was lucky to receive a return on his investment.
Living in Oregon, he was far away from his investments in Hawaii and could not pay enough attention to the renovations. One moral of the story is that fixer-upper investments -- like real estate investments generally -- work best if you live nearby and, if possible, do the work yourself.
Other factors hampered the success of his investment, such a market more suited to two-bedroom units rather than one-bedroom units. As to Walter, he learned more with each investment and he also learned to be conservative.
Whether you're looking to purchase a house, duplex, 50-unit apartment project, or commercial property, you need to carefully review the property's economics. Are the rents used in your projections realistic? Are the expenses correct? Can you live with the cost of investment mortgage financing? What happens when you have a vacancy? Is there enough cashflow to cover it?
Are you putting money aside in a reserve account? How much money do you have to spend on repairs? Some investors believe that they should never repair a property. Unit inspections in occupied units will uncover problems that can be solved while the tenants are still living there and while there is cash flow, rather than waiting for a vacancy.
The West Coast and the Sun Belt are currently better bets than investing on the East Coast. Larger cities tend to be better investments than small towns because there is a larger potential pool of tenants and buyers. Communities located on freeways also tend to be more attractive as investments because they have good access to metro areas. Vacation destinations or towns that are economically diversified will be more stable as well.
Another client had 13 houses in the 1980's and lost them all. So he went back to being a painter and started all over again one house at a time. His goal is to have 20 houses for retirement. He adds bedrooms, renovates, upgrades, and paints them, and then he either sells them so he can buy two more or holds them.
Planning an Exit Strategy
Remember that the economy, interest rates, layoffs, job opportunities, and construction trends impact every investor. Watch the trends and speak with local brokers, appraisers, investors, and real estate attorneys.
An investor always needs an exit strategy, preferably more than one, when he or she buys property. You need to have a vision showing when you will sell, if you will take the money and pay taxes or complete an IRS 1031 tax deferred exchange. Is your plan to have enough money for retirement? Are you going to pay off the property or refinance it and use the proceeds to buy another investment?
And what if values decline?
If you live in a depressed marketplace you need to decide if the weak economy will last a long time or if the area will pull out of it. This information is critical to your exit strategy. If you cannot find a buyer when you're ready to sell, then what? Structure your mortgage without prepayment penalties, or make sure that your loan can be assumed. Check what the loan assumption costs will be and if financing terms will change with an assumption. Remember banks structure loans to benefit their bottom line and financing can be very hard to assume or refinance. It pays to research financing options before you make a final decision, and interest rates should not be your only focus.
You have to think ahead and be prepared for a range of possible events. For example, you invest with your best friend and her husband, but she gets divorced and needs the funds out of the investment to pay off her husband, what would you do? Another variable is your health or your family's health: Will you may have to liquidate the real estate to pay bills?
Your exit strategy will help you make a better decision as you invest into the future. Plan your goals ahead. No one is forcing you to buy. Pick your time, and pick a property you can live with into eternity. Worst case, if the market does not move the direction you expect and the value does not go up, at least your tenants are paying off the loan.
|
