There are lots of different “types” of real estate investments. You can invest in land for long term hold, commercial property and so on. However, since I am primarily a residential REALTOR, this post is about different types of residential real estate investing.
The first time I learned about real estate investing I was 4. My dad had built 4 houses for a developer on Vale Road in Oakton. The market was terrible and when he was done, the builder owed him about $70,000. But he could not pay because he could not sell the houses. Eventually, he came to my dad and made an agreement to give my dad a house in exchange for the debt, and my dad could take a loan out on the property to pay off his suppliers, etc. My father was not happy about being forced into homeownership. However, it’s probably the best thing that ever happened to him. Today, both of my parents (since divorced) own homes that they own free and clear of any mortgage because since that time, they have both been homeowners, and the value of the properties they have owned, over time, have always increased.
So I believe that real estate ownership DOES built wealth over time. Here are some examples of how YOU can build your wealth in the world of real estate.
There’s no better investment, in my opinion, than the real estate you purchase to live in. Sure you are going to let emotions and non-financial things guide this purchase but the truth is, you have to live somewhere. So even if you pay a premium for something that may not equate to market value, you’re still reaping the dividends. Buy what makes you happy – life is short. Then, maintain it and care for it and love it. Most importantly, do not use it as an ATM. Do not refinance every 2 years to pay off revolving debt, buy a car or go on vacations. Choose your financing wisely, take advantage of tax benefits and focus on paying down your mortgage until you own it free and clear. A good equity position goes a long way in increasing your net worth.
Residential Rental Properties
Some people intentionally buy their first home to keep as an investment, and once more established, they keep that residence as a rental (as recommended in David Bach’s Automatic Millionaire series). This may or may not be a good decision. At the time you’re deciding, consider the net value of the home vs. the rental income and consider how it will impact your next primary home purchase (i.e. your ability to have a sizable down payment, and to be able to afford the mortgage on the home you want). If it passes that test, evaluate that house just like you would any other residential rental property investment.
When evaluating a purchase of residential investment properties, first decide how long you wish to own the properties. A “long term” investor (in my book) is 10 years or more. Consider the acquisition cost (including any repairs), the expected costs to hold (taxes, insurance, maintenance, financing, and management costs), and expected rental income. Then assume moderate growths in all of these areas, including a moderate rate of appreciation for the home. At the end of 10 years, are you making money? How much? Will it have been worth it?
Fix & Flip
If you want to buy property to fix up and sell, you need to have high risk tolerance because just when you think the market has recovered, and it’s got no place to go but up, it’s sure to change. So make sure you have a back up plan or lots of room for error.
Know your acquisition costs, your hold costs, your repair costs and your cost to sell. Then pad these numbers in case you’re wrong, because unless you’ve done this a few times, you probably are.
The residential real estate market is hard to predict in 6-12 month increments because it can turn in the blink of an eye. So, my F&F friends – work fast. Be ready to start the “fix” on closing day and get that thing back on the market quickly – 30 to 60 days should be the goal, because you want that place sold within 90-120 days.
The key is making this work is to know when the market is turning and react fast. If you see a slow down, don’t “wait and see” if it picks up next month – drop your price, cut your losses and get out. If you can’t… if your budget was blown and you’re not going to reap the benefits, know your back up plan. Can you rent it and still be comfy cozy? Then do it.
This type of investment is also high risk in my opinion. It circles back to my original story about how my dad became a home owner. Much like the “fix and flip” investors I just mentioned, these investors most know their acquisition costs, their construction budget, their hold costs, and their costs to sell. But the building process will take longer than repairing a property, which means they need even more market knowledge and wiggle room in their assessments.
I guess that developer that had the four properties in Oakton made a judgement error. But, kudos to him for realizing that the properties did have value and he could still pay off debt with them. He did sell the other three properties, in time. And he did not go bankrupt. Most importantly, because of him my parents have personal wealth today and a home that costs very little for them to live in.
Remember: There Are Tax Consequences
The goal with real estate investing is to build wealth and produce income. Wealth and income are taxable. Don’t forget that. So, a tax advisor needs to be involved in helping you to evaluate any purchases and sales like these.
I can not mention real estate investing without talking about legal liabilities. Owners are responsible. For everything. All real estate owners need to have good insurance, and lots of it. You’ll need to protect yourself from being sued, as well as against Acts of God. Make sure you understand your risks by talking to an attorney, and consider limiting your risks through various avenues. Get that legal advise before you even write an offer, so that you take title the best way (in your name? your business name? as tenants by the entirety? in an LLC? in a trust?) and so that any financing you’re using to acquire the property is also in the right entity name. Then, talk to your insurance advisor and make sure you have plenty of coverage for all the what ifs.
Are you ready to get started? You can reach me at 703-669-3142 or [email protected].
If you’re considering owning rental housing, you might also enjoy this post: Property Management 101