The Seven Keys of Profitable Real Estate Investment
Having been in the mortgage and real estate business for over 20 years you come to realize opportunities and trends within the Sioux Falls housing market. As Sioux Falls continues to grow, there is currently a significant shortage of houses for rent.
On a recent visit to a top rental website, there were only four 3+ bedroom houses available to rent. Although that can be a challenge for people moving to the Sioux Falls area, it presents an opportunity if you are willing to become a landlord.
Long-term ownership and purchasing the right properties are the keys to successfully investing in real estate. Unlike what you see on the late-night TV infomercials is not a get rich quick opportunity; investing in real estate is hard work. However, if you have the right strategy and make good decisions, owning properties can help you earn a fairly substantial amount of wealth over a lifetime.
With all of our clients, we use a seven-step process to make sure that we help them evaluate the risks and rewards before they invest in real estate. We also use this seven step process with existing investors to make sure that they’re implementing the right strategies.
Step #1 Do we have a positive or negative leverage? Are we better off with or without a mortgage?
Step #2 Determine the level of liquidity – how quickly can we liquidate the investment and get access to our cash? Generally, real estate is not liquid. That is why we should never be 100% invested in real estate. This means that if our budget for real estate investment is $300,000, we should keep part of that cash in the bank, sitting on the sidelines. This way we won’t get into trouble if the property sits vacant a few months. Also, a cash cushion allows us to quickly take advantage of other investment opportunities when they arrive.
Step #3 Determine marketability – what are the costs to carry the property and you should always consider the costs of sale in your decision.
Step #4 is to evaluate investment management issues – with real estate, we have asset & property management. Asset management is what you and I should be doing with our investor clients once a quarter or once a year… reviewing the numbers and making sure the investment still makes sense. Should we refinance the mortgage? Should we change the rent? Should we sell the property? This is an area where a lot of investors can use help. That’s where I come in. I can help you to better serve your investor clients by running the numbers with them like we saw earlier.
Step # 5 is to calculate and compare the rate of return on various opportunities. Should we choose investment A or investment B? Should we use a 30 year mortgage or a 15 year mortgage?
Step #6 is to consider the tax impact. We work very closely with our investor clients’ CPA to make sure that everything is working properly from a tax perspective. For example, a lot of investors don’t understand the difference between passive income / passive losses and active income / active losses. We educate our clients and work closely with their tax advisors in this regard.
Step #7 is to understand & calculate investment risk. Investment Risk can include any of the following eight danger zones:
-House price risk: what if the house goes down in value?
-Carrying costs: if you’re fixing and flipping, have you factored in the costs of carrying the mortgage, and paying the property taxes, utilities and other expenses on the home?
-Eviction costs: what if the tenant defaults on the rent and you have to hire a lawyer or go through a costly eviction process?
-Maintenance costs: what if you encounter some unforeseen maintenance expenses?
-Vacancy risk: what if you can’t find a tenant?
-Opportunity cost: what rate of return could you have earned in a different investment with less headaches?
-Lack of Liquidity: what if you need access to your capital and you can’t sell the house?
-High costs of sale (8% +): do you realize that you’d have to sell the house for at least 8% more than what you paid for it just to break even and cover the real estate commissions and transfer taxes?
As you can see, there are many risks involved with making a decision to invest in real estate. Just like any other investment, it is important to consider all aspects so that you can make a well-informed decision.
David Kelly is a certified mortgage planning specialist in Sioux Falls.