Investing in real estate can be a difficult market for many real estate agents to break into. When your client is buying or selling a house or apartment, the goal is to make the best deal possible at the time. When a property is being purchased for investment purposes, the game changes to a longer plan and guiding investors in the right direction can take additional skill and savvy.
Many investors specifically seek out real estate as an investment opportunity to generate monthly income in their retirement years. This kind of acquisition is different from investors who seek to “flip” houses, or to buy additional property as a rental for short term and later move into it.
There are two ways to invest in property long term with the hope of receiving a monthly income to supplement retirement. First, the buy and hold option is ideal if a property can be found that can be expected to hold its value almost indefinitely and which can be counted on to be in demand for years to come.
Second, the trade-in option allows investors to conduct deals that simultaneously sell one property while buying another, without triggering a tax event that could lessen the value of the upgrade in property. Both are addressed in the tips below, along with plenty of valuable information you can use to guide your first time investor through the process of seeking an investment property.
Tip 1: Show how a portfolio of non-owner occupied properties can generate monthly income
Investment property shouldn’t just accrue value, it should generate income between the time of purchase and the time of sale. For most investors, the security of their golden years is a major factor, so the long term approach is key.
- Calculate the net profitability of your rental income property.
- Ensure that the monthly earning potential of the property leaves plenty of room for the cost of ownership, any repairs, and management if required.
- Do the math to show a conservative estimate of not just the income that can be put towards retirement now, but the potential future retirement income that can be counted on in addition to other funds.
- Find out if there is a way for your client to shelter their rental property income – they cannot put rental income into an IRA, but there are possibilities when it comes to creating a small company and “managing” the property for an income that can be contributed.
Starting an S corp is one way to accomplish showing an earned income. If there is already earned income aside from rental income, there is no need for this step; the extra income can be sheltered by taking advantage of loopholes that allow a maximum amount to be socked away pre-tax on an annual basis. The needs of the individual investor will vary.
Tip # 2: Location, Location, Location
Buying the cheapest property in the cheapest part of town may be tempting. Don’t let your client do this – areas that may become distressed hold the possibility of never turning back around and the investment will be worthless.
- The best location is one expected to stay steady when it comes to growth; possibly located near a university or military base, or in an area of rapid commercial growth.
- Look for bus stops, light rail stations, and freeway on ramps.
- Check the local school districts, and find out if private options exist.
By tracking trends in surrounding areas, being aware of companies bringing new business and thus new needs for employee housing to the area, and estimating the annual rate of growth over time, a decent guess can be made at the best location to invest in. The type of property is also important, and different demographics have different needs; student and military housing will be markedly different than housing designed for stationary families with children and the need for schools, etc. Seniors will expect easy access to real estate markets and medical care.
Tip # 3: Familiarize yourself with the real estate market.
Never buy (or help a client to buy) without doing research first. Knowing the price to income ratio and the job market stability in the towns you are canvassing is key.
- Use census data to discover median incomes and home values in the following Palm Beach County, Florida Towns: Boca Raton, Boynton Beach, Delray Beach, Green Acres, Highland Beach, Juno Beach, Jupiter, Lake Clarke, Lake Clarke Shores, Lake Worth, Lantana, Loxahatchee, Loxahatchee Groves, North Palm Beach, Ocean Ridge, Palm Beach, Palm Beach Gardens, Palm Springs, Royal Palm Beach, Tequesta, Wellington and West Palm Beach.
- Things to look for include: household income, population growth, unemployment rate, job growth, housing inventory, rental rates, and median home price.
- Properly analyze cash flow for the long term, and balance it against projected costs.
Rental rates in the US can fluctuate wildly, depending on the single family home real estate market, the availability of single and multi-unit housing compared to the transient rental market, and the number of people who may flood the market in upcoming years as old generations exit the scene. Newer generations have new needs, and the emerging tech markets attract a different demographic of renter.
Tip # 3: Check for hidden liens on the property.
Liens that don’t show up until the title is run by the closing attorney can kill a deal. Use the following resources to check and double check for potential problems.
- Palm Beach County official court records. These can alert you to any information that may be in doubt, and bring to light potential lawsuits or court cases that involve the property.
- Palm Beach County property appraiser’s office. Has the real estate property been appraised in the past? Records can show you if there are past liens that may have not been satisfied.
- Florida Department of Revenue is another valuable resource when you are looking for lien information or any outstanding claims against the property.
Finding out too late that there is a substantial lien against the property your home buyer is interested can lead to delays. Worse, deals can be rushed through with pressure to resolve the lien by the buyer being presented as the best solution. This creates an unfavorable tipping point in some cases and can lead to a buy that doesn’t end up being as sensible as it first was perceived.
Tip # 4: Know the rules for “trading up”.
If a 1031 deferred tax exchange is desired, make sure your client is aware of the actual amount of the sale price which must be reinvested.
- You must reinvest your net sale price, which is your gross sale price less selling expenses such as brokers commission, title insurance charges, escrow fees, exchange fees and attorney closing fees.
- You must also reinvest all of your net cash proceeds in order to defer all of your taxes.
- You do not subtract any operating expenses (property taxes, HOA fees, etc.) nor do you subtract any loan payoff amounts or lender charges.
- Tax deferred exchanges can be better than “buy and hold” so consider the “designed obsolescence” of rental properties and be alert for ways to trade up. Cash flow and pricing under market value aren’t the only considerations when the goal is long term investing.
Be aware that 1031 transfers have strict rules concerning the qualifying properties (it can be different in some respects, but must considered a “like” property – in other words, used for the same purpose) and the new property purchase must close before the original property sale closes. For example, a property intended to be rented for profit can be a residential one or a commercial one, so don’t get caught up in thinking that if you own a four-plex you have to trade up into another four-plex, or even another strictly residential property.
Tip #5: Don’t forget to consider REOS (Bank Owned Foreclosed Properties).
Pros in favor of REO purchases include:
- Easily accessible properties
- Potentially great discounts from normal market price
Cons are more numerous, but don’t outweigh the massive savings:
- There is lots of competition, requiring cash offers with no contingency to get the deal closed over your competition
- Utilities are usually off & you won’t be inspecting the house with them on, due to the all cash offer
- There will be a LOT of paperwork
More information on buying REOs can be found here. The biggest factor in buying REOs is the rushed nature of many sales – in areas with limited numbers of REOs, there will be fierce competition to land these properties and cash deals will trump bank financed ones almost every time.
Tip 6: If your client is looking at an REO, don’t forget this crucial fact!
The desired property must be in such a condition as to pass a certificate of occupancy, as most mortgage lenders will require this document. This becomes critical when purchasing distressed homes through REO, as the purchaser may be asked to fix the property up to CO standards, prior to closing on the mortgage loan.
- This does put extra risk on the buyer, unless…
- The problem disappears if a cash offer is made, but…
- The risk does stand since the inspection may not be complete and hidden problems can crop up later.
Because the need to move fast on REO is so vital, important steps like proper inspections and walk-throughs are often cut short, or demands that the property be accepted “as-is” can rush buyers into purchasing properties with hidden issues that can cost immense amounts of cash to fix.
Tip #7: Consider REITs as an alternative for direct investing.
Buyers who are slow to decide, especially if the perfect buy isn’t presenting itself, can benefit from Real Estate Investment Trusts.
- Smaller amounts can be invested.
- All shareholders receive dividends.
- Diversification to minimize risk is possible instead of an all eggs in one basket approach.
Cons do exist; for example, early withdrawal penalties apply, but a REIT may be the best option for some clients who would rather not deal with a rental property income and are willing to accept the slightly small but less hassle option of a REIT.
For the individual buyer who lives abroad, travels a lot, doesn’t feel like having the hassle of tenants, repairs, and so on, and also prefers not to incur the expense of a property management company, a REIT can be a dream come true. While the returns may be lower, compared to the requirements to turn a profit on rental properties via direct purchase and subsequent handling this can seem like a much preferable option.
Tip #8: Multi-Unit Investments have different rules.
Financing for multi-unit investment properties have different guidelines then purchasing a single family home or condo as an investment.
- Many mortgage programs and lenders require months of reserves in savings in order to qualify for the investment loan. These reserves are meant for repairs that may be needed in the future. Reserves can include everything from the roof to the water heater (and don’t forget depreciation!)
- Consider shopping around for insurance when considering multi-unit properties.
Don’t let the issues with multi-unit properties dissuade you, however! Overall, especially in competitive rental markets, a very high profit margin can be obtained with multi-unit properties and they are well worth the effort. A fully occupied rental unit can generate a very nice monthly income that won’t fluctuate as much if one or two occupants switch out occasionally.
Tip #9: Joining real estate clubs can help investors pool money.
REI clubs can be a valuable resource for investors, both from the information sharing point of view and the financial point of view.
- Meetups are a great place to hang out and share information.
- Dozens more REI clubs can be found – just research who you are getting into business with before you commit!
REI clubs can be a valuable place to network; to learn more about new real estate markets you want to explore; to seek out information on topics you may not be as well versed in, and to allow your investor client to strike out on their own a little and get exposed to different ideas.
Tip #10: Knowing what NOT to do is just as important as knowing what you should do.
Check out the valuable information on investing in real estate, in video format from Jeff Brown over at Brown and Brown for common weaknesses when it comes to real estate investing.
Real Estate Investing is a business that involves countless problems and solutions. It’s ever-changing, and requires an adaptable and pragmatic approach to problem solving and a growth mentality. It’s a business – although often considerably less difficult and more time-tested than starting a truly new company from scratch. I like to call it a “semi-passive” business.
When folks ask about the “common” problems that real estate investors run into, they usually get a list like this:
- Failing to screen tenants
- Underestimating expenses like repairs, maintenance, utilities, taxes, and insurance
- Forgetting about “capital expenditures” like roofing, HVAC, foundation issues, etc
- Making big tax mistakes that cost thousands or tens of thousands of dollars
- Poor property management
I could list every specific problem that real estate investors are likely to run into, but we’d go on all day. There have been entire books written about this subject. Instead of going into that much detail about the specific problems that investors will run into, I’m instead going to share some of the foundational weaknesses that indicate investors that are at risk of catastrophic failure.
While these foundational weaknesses aren’t necessarily a deal breaker for investors, those that are weak in all or most of these areas are at significantly higher risk than those with a strong investing foundation.
Weakness number 1: Personal Financials
You are setting yourself up for a real problem if you have weak personal finances. Indications of weak personal finances include things like bad (below 700) credit scores, less than $5,000 in readily investable and accessible cash, and a low savings rate (less than $1,000 per month).
Most people think they are financially responsible if they own their home, have some equity, and contribute regularly to their 401(k)s. Sure, you might be better off than most Americans in that scenario, but you can still be ill-equipped to begin investing in real estate with finances like that. For a real estate investor, low or no wealth outside a 401(k) and home equity doesn’t even let them meet the bare minimum requirements as far as I’m concerned.
See, in real estate, things like capital expenditures come up – these are large, infrequent expenses like replacing a roof ($10K-$15K+), foundation issues ($10K+), electrical and plumbing repairs and upgrades, appliances, and other similar expenses. If you don’t have a strong financial position that can pay for these things, in cash, you will likely refer to capital expenditures as “disasters.”
People who experience “disasters” in real estate are highly likely to become a “motivated seller.” I, as an investor, love motivated sellers. They sell their properties at huge discounts so that I can get great deals. Their “disasters” are really a result of their bad choices and failure to prepare for these inevitable expenses. In nearly every situation I’ve seen or even heard of, careful planning and conservative financial management could have avoided the “disaster” and allowed the business owner to maintain his/her property.
If you are barely breaking even after your mortgage, car payment, student loans, and the other regular monthly bills, then any mistakes on your first property are exponentially compounded and become disasters.
I’d encourage you to reconsider buy and hold real estate carefully if you don’t have a solid, stable, and reliable income that you can rely on, don’t save significantly ($1,000+ in CASH savings per month), and don’t have at least $15,000+ in the bank AFTER your down payment. Figure that stuff out first, then buy real estate.
It’s the guys that lever up by taking out a hefty HELOC, or that borrow against their 401(k)s that are particularly susceptible to losing everything. Why are they leveraging against their retirement and home equity? It’s because they have systemically failed to manage their personal finances the way an investor should. They’ve systemically been unable to save anything beyond the forced savings plans that are home equity and hard to access retirement savings.
Manage your finances like an investor. Build cash, have strong, regular, predictable monthly savings, and have large capital reserves BEFORE buying properties. This will prepare you more than anything else for the unknown.
Weakness number 2: Lack of Knowledge and Lackadaisical Approach to Investing
Remember how I mentioned that the list of problems new real estate investors can run into could run multiple pages? That’s where strengthening yourself in this area can save you.
You have to commit to learning about real estate continuously, year-round, for life to succeed in this business. Listen to podcasts like the BiggerPockets podcast, read a few dozen books on the subject, and peruse countless articles.
If you can do all that, you are off to a good start. If you aren’t willing to do that, expect some problems, and expect them to be more serious and to get steadily worse the longer you hold onto your properties.
There are always more things to learn and always ways to improve. You must be prepared for every problem that comes up and to compound that preparedness with each passing year and each new investment property.
It’s possible that one day you can train up others to run your business for you. But, if you go in with the expectation of rapidly systematizing your real estate business, especially if you are trying to do this on the side, you are in for some nasty surprises.
Weakness number 3: Failure to commit to a LOCAL Area
Real Estate is local. Stop trying to think that you can passively invest at a distance and handily beat the market. Trying to pick the company that is going to produce outsized returns in the podunk midwest is no different than trying to pick a mutual fund manager that you hope will outperform the market. That strategy is and always has been historically difficult to master, and I’d argue it is even harder than just building a real estate business in your hometown!
If you want to earn outsized returns in this business, you are going to have to commit to an area. A SPECIFIC area. A neighborhood. You must plan to travel there. A lot. You must plan to make contacts and nurture those relationships with people in that area. A lot of people. You must plan to study that market and understand the trends, the blocks, the people, the culture, and most importantly, be able to spot a good deal.
The bottom line is that if you purchase property, you should plan to have that location remain a part of your life, forever. A part of your life that you will have to physically visit and get to know intimately. Are you willing to make that commitment? If not, you are at a huge disadvantage right off the bat. I like having you as my competition.
I can eat out of area investors up for lunch here in the two neighborhoods I monitor closely in Denver. There is no way you can get anything close to what I get in terms of returns in my hometown. I live here! I can see where the trends are moving, what needs to be done on the properties. I can look my contractors in the eye and verify their work is up to my standards.
Can you commit to investing in your target market? For life?
If not, that’s fine, but why not just park your money in the stock market? You probably won’t be able to earn outsized returns in real estate without a local commitment, so why not do no work to get a similar historic return!?
Weakness #4: Personal Problems and a Lack of Time
Maybe you are committed to your area, have spent a lot of time learning about real estate investing, have a strong network, and have an excellent investor financial position.
But perhaps you just started a new job. Or had your first kid. Or Momma is sick. Or your wife is having health problems. Or you are about to move to a new city.
Now is a bad time for you to begin investing in real estate. You don’t have the time to commit to building your business.
In order to be successful investing in real estate, you need to spend a significant amount of upfront time and effort (and money) stabilizing your new investment. You need to be there to see what the contractors are doing, to meet your tenants if you are managing the property yourself, or to meet with property managers if you are outsourcing it. You need to do research, drive around town, and otherwise involve yourself.
If you don’t have the time to devote to this new business, you are highly at risk of missing opportunities, experiencing absurdly high costs for projects that take just minutes to do yourself, and you are going to miss out on learning opportunities that compound drastically over time.
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