The Truth about Real Estate Investing
ďSome people handle the truth carelessly;
others never touch it at all.Ē Ė anonymous
So, you are thinking of investing in real estate or you own a house and would like to buy some rental property. Does the word "caveat emptor" sound familiar? Let the buyer beware! Real estate investing, including owning your own home, is a great way to enjoy a piece of the American Dream, but it comes with a price.
Rarely have I seen a realistic portrayal of both the good and the bad sides of real estate investing. Many late night infomercials and countless books would have you believe that "no money down" and creative financing techniques can take you from rags to riches with little more than the classified advertisements, a phone and a quick appointment to consummate the deal.
On the other hand, friends, family and even the Wall Street gurus will tell you that real estate investing is just not a good idea. Itís not a liquid investment. The tax advantages were taken away in 1986. Renters are all low-life, societal rejects who are intent on destroying your property and living in your rental house for free.
As is usually the case, the truth lies somewhere in between. Few people will argue that owning your own home is a bad idea. After all, it is a forced method of investing in a financial instrument that you can see and feel, and the taxes and insurance are even deductible.
What about all the other ways to invest in real estate?
Contrary to what most people think, there are many different ways to invest in real estate:
- If you are a passive investor who desires a low-risk investment with almost no hassles that consistently returns about 15 percent per year, Real Estate Investment Trusts (REITs) might be your ticket.
- If you donít mind doing a little research, making some phone calls and possibly going to an auction, then tax lien certificates might interest you.
- If you are ready to get your hands dirty, but loathe the prospect of dealing with renters, then you might like buying undervalued real estate that you can fix up for a tidy profit.
- Finally, if you have enough courage to deal with renters, consider letting someone else pay down a mortgage and leave you with a handsome nest egg.
As you can see, Iíve only presented a few options for investing in real estate. It is my opinion that real estate should be an important part of an investorís portfolio. Why? First, land is a precious commodity that is more or less finite during our lifetime. The population of the world is growing and we will need more land to support the voracious demands of the human species. Second, natural resources such as lumber and building supplies are dwindling. With fewer supplies, prices are rising and existing homes are becoming more valuable. Finally, real estate is one of the few investments where you can use a little of your money and a lot of someone elseís money (i.e., a mortgage company) to control a large investment.
Now, letís get back to the truth about real estate investing. As a real estate investor, I have read many books on the subject. I have attended seminars and classes, and I have purchased more than one of the infomercial programs. There is a lot of good information to be learned from this material; however, most real estate courses come at a hefty price. In the end, nothing works better than learning it on your own.
What are the benefits of real estate investing?
First, you make money through net cash flow, principal or equity, appreciation, and tax advantages. If you choose to be a landlord, your net cash flow is the difference between what you charge for rent and the monthly mortgage payment, including principal, interest, taxes and insurance. Unless you get the property at well below market value, it is a good rule of thumb to make at least $100 per month to offset the occasional repairs, fix-up costs, and move-in/move-out costs.
Equity is the amount of the original purchase price that you are actually paying off each month. The shorter the mortgage term and the lower the interest rate, the more equity you will accumulate.
Appreciation is by far the best part of real estate investing. Time is your friend. By investing in "bread and butter" houses (a term I picked up from Robert Allen ) in good locations, the value of your house will rise each year. The better the location is, given a good economy, the higher the appreciation. In my area of Johnson County, Kansas (a suburb of Kansas City, Missouri), houses have appreciated over 7 percent per year for many years. Although that may not sound spectacular to those of you in markets such as Los Angeles, Phoenix, Las Vegas or Miami, it has been very consistent with almost no downturns.
Finally, tax advantages include the following deductible items: depreciation of the property and other equipment, taxes and insurance, repairs and supplies, mileage, and office supplies used for the property.
That sounds pretty good so far. Are there any disadvantages?
You bet! First, if you buy a house using creative financing or if you buy a repossessed home, you are in for some fun times. Get ready for cleaning, painting, replacing carpeting, removing trash, mowing, raking, repairing plumbing, installing fixtures, replacing furnaces or air conditioners, and whatever else is needed to get the property sold or rented.
I recall a Veteranís Administration (VA) repossessed home that my wife and I bought in January 1996. While fixing it up, we heard several loud creaking sounds that eventually were followed by water spewing from broken copper pipes. Had we not been working when the water pipes thawed, the house would have been flooded. Luckily, the VA paid the plumbing bill because the pipes were apparently frozen when we bought the house.
Next, advertising for and securing a decent renter can be expensive and time consuming. The screening process for renters is often an arduous process of phone calls, screening, and crossing your fingers. If you are not nervous about renting your property, I suggest watching the movie Pacific Heights. Regardless of what your lease says, renters have inherent rights and, in the unfortunate event of eviction, you often lose.
Repairs are the Achilles heel of the rental game. After purchasing my first rental property, a continuously clogged sewer line led to installing a new line. Thank you very much Ė there went all of my annual net cash flow (approximately $1,200) in one fell swoop.
Finally, if you think that selling a property is as easy as a classified advertisement and a sign in the yard, you are wrong. Once a property has been labeled a rental house, its inherent value is slightly lower than owner-occupied houses. Even in a good market most buyers use a real estate agent. Why not? Itís free after all. The seller has to pay the realtor fees, right? In actuality, the fees come from the real estate transaction and it may appear to be free, but really both the buyer and seller are paying the fees.
If I havenít scared you away, then letís get started with the 10 Steps to Getting in the Game.
Additional Chapters you will find in the book!
Chapter 2. 10 Steps to Getting in the Game
Chapter 3. The Search Begins: Looking for and Evaluating Real Estate
Chapter 4. Estimating the Value of Real Property
Chapter 5. Creative Financing: Putting the Deal Together
Chapter 6. Presenting the Deal: The Art of Win-Win
Chapter 7. How to Profit from Foreclosures
Chapter 8. Rental Property Management
Chapter 9. Secrets of Selling Property
Chapter 10. Managing Environmental Risk
Chapter 11. Bankruptcy Issues
Chapter 12. Tax Implications of Selling Property