Real Estate Investment Amateurs Just Look At The Numbers, The Savvy See More
As the story is told in Infomercial-land, just about anyone can make serious profits in the real estate business. That, of course, simply isn’t true. Financial success in investment real estate requires skill and knowledge. A superficial understanding of the business just isn’t going to bring in the types of returns on investments that are hoped for. This is especially true when evaluating the potentials of properties – real estate investment amateurs often make the mistake of focusing primarily on the numbers and how they shake down, while the savvy investor also considers many additional factors.
Numbers are important, make no mistake about that. But, numbers tend to fall into clear cut categories of black and white… or red. And, as we all know, there’s plenty of gray in real life and, presumably, your investment properties will include people living their real lives and will be surrounded by others doing the same. Successful real investors realize there is more to investment decisions than merely running the numbers.
In addition to looking at the numbers, it is important to determine whether or not the property under consideration fits into your overall investment plan. Hopefully your investment strategy is more sophisticated than just amassing properties, if not, you may to address this issue with an investment consultant before buying any further investment real estate. Seek professional help if necessary, but get yourself a plan. Having an investment plan is essential to the type of organization that separates amateur level money from professional profits.
Part of determining whether or not a particular property fits your investment plan is looking at such factors as – yes, the old adage is about to appear – location. However, today’s real estate investor has a bit of a different strategy on real estate’s most ancient adage, and that strategy is emerging markets. Developing the skill to take advantage of the potentials of emerging markets is a significant distinction between the real estate dabbler and the successful investor.
Emerging markets have the potential to offer a strong return on investment, as these are not the already discovered desirable locations. These markets are on the cusp of a shift in rate of growth. Some are even almost bad areas about to go good. When investment properties are bought by future thinking investors, investors that are selective in their tenants and careful in their property upkeep, they contribute to the overall value of a particular market segment and can be a valuable part of the growth process. Experience, research, and familiarity with local growth trends and patterns can position an investor to be able to step into a given market at the right moment and maximize profit potentials.
Other factors to consider when thinking about location and tenant quality are what is in the local area – colleges, employment opportunities, etc. – and how that is going to affect the demand for rental units and the vacancy rate potentials, as well as how those factors will influence the type of people seeking those units. The set up of the building, its age, and its structural integrity are going to affect the amount that will have to be spent on maintenance and remodeling, and should also factor into the decision making process.
These are things that can be difficult to assign a specific number value to and can influence numbers in ways that are hard to predict, but they are essential considerations to savvy investment real estate decision-making. Numbers should serve as a foundation to the decision on whether or not to buy a particular investment property, but should not be the only consideration. After all, a building can have a strong foundation, and still have a leaky roof that unexpectedly caves in and sucks the profit right out.
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Cash Flow — Or Else!
I was flipping through the radio stations while driving yesterday and landed on a hip hop station that was playing a song called “Cash Flow”. My first thought was “Cool, a song about real estate investing!” Upon further review the song was NOT about real estate investing. After listening to it for a few minutes it became clear to me the song was actually about drug dealing. The hook to the song made me think that this hypothetical drug dealer and the investment real estate owner actually have a few things in common.
What do you do if you don’t get paid on time? Well, let’s see the approach this “drug dealer” takes by listening to the lyrics of the hook.
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I’ll tell ya one thang dont play about mine
i be bangin on your front door wit da nine
ima come see ya (see ya)
ima come see ya (see ya)
i need all my dough not a dolla short
and if u dont have it then u gotta go
ima come see ya(see ya) hey hey we put our hands
in da sky let em know that we bout that
cash flow..i need it on time im
talkin bank roll my money my money my money
cash flow…i need it
on time im talkin bank roll my money my money my money…
As a law abiding citizen you shouldn’t be “bangin on your front door wit da nine” (nine = 9mm gun reference), at least I hope not. So how can you, the investment property owner , ensure that you receive your “cash flow”, “bank roll”, “rent check” or whatever you want to call it on time?
The best way is to avoid being in this situation in the first place is by properly screening your potential tenants. They should know from the get-go that you will be charging late fees if they don’t pay on time, they should also know that you will start the eviction process as soon as the lease and local ordinances allow it. As a last resort….you can always flash your “nine”.
All Real Estate is Local – Truth or Myth
Between basketball games at the gym I got to talking to a local agent today.He asked me what I thought was going to happen with local real estate values and I asked his opinion also. He then went on to play the “All Real Estate is Local” card while trying to justify his point. While I do agree most trends that affect real estate values are on a local level, he blatantly disregards (like most people) the national trends that affect real estate values.
There are multiple national trends that affect real estate, but I’m only going to touch upon two for this post; inflation and the psychology of the masses.
Real estate cycles are partially shaped by these national trends and they can directly influence if your next real estate investment is successful or an opportunity cost. Don’t get me wrong, you can go against the grain and invest successfully when these trends are not favorable, but great care must be taken.
More often than not inflation occurs on a national level and if you are a real estate investor, most often inflation is your friend. If prices of building material (lumber, steel and other raw materials) go up, then the cost to build a home or building will rise also. This obviously helps your investment to hold its value or more likely appreciate.In addition to appreciation, during times of inflation we can usually raise rents.
You might be thinking “so far so good”, but one of the key measurements most inflation loving investors forget is wage inflation. If wages aren’t inflating accordingly you have a bad situation on your hands, and that my friends is part of the reason most real estate markets aren’t finished correcting at the time of this writing.Their values simply aren’t inline with local wages and historical price to rent ratios.
The second trend I want to talk about today is the psychology of the masses. There are many reasons our country recently experienced probably the greatest national real estate boom in our history, but one of them was the phychology of the masses. From the year 2000 to 2005, no matter where you went people were talking about real estate. Everybody thought they were Donald Trump and money was pouring into real estate as if it was impossible for values to go down. Fast forward to today and we obviously know how that story turned out. Try talking about real estate today and most people treat you as if you have the black plague. The psychology has shifted. The proverbial pendulum swung too far in favor of real estate during those heady times and I believe it will swing too far the other way (at least in some markets) as time goes on (some markets will “over-correct”).
In summary, don’t believe the hype, while there are many trends that affect real estate on a local level, remember there are national trends that affect values too.
P.S. If you are reading this John, I will see you on the court on Monday, be prepared to be schooled again (just kidding).
Investment Real Estate – A Great Tax Shelter
I’ve found that most people really don’t understand that tax sheltering benefits of real estate investments.Your investment property can actually shelter its own income and sometimes income from other investments.>How can that be?
When it comes time to do your taxes, you have to figure how much rental income you have received and how much tax deductible operating expenses you have paid out (examples are insurance and repairs).You are left with what is known as your Net Operating Income (NOI) on which you are expected to pay taxes.One of the great things about being a real estate investor is that Uncle Sam has written the tax codes in your favor, he allows multiple deductions on your investment, so you can save money; he does that because he wants to spur on the economy.
One of these deductions is for mortgage interest.Mortgage interest on your investment property is considered an operating expense and the IRS allows you to deduct it.
Another deduction is cost recovery (official name), but is widely known by real estate investors as depreciation.Most people associate the term depreciation with decling property values, but in this case the term is associated with the tax code.Given enough time you can probably bet your real estate investment will increase in value, but you can also bet that it is in fact “wearing out”, the IRS allows you to take a deduction for this presumed decline in value.(This concept combined with a 1031 exchange is a very powerful wealth building technique)
The deprecation deduction is the most exciting part of the tax code.Out of all the deductions involved in your investment this is the only one that doesn’t require you to have written a check thus it does not affect your cash flow ( it is not an operating expense).This powerful deduction can shield most, if not all of your investment’s year to year income from being taxed.Sometimes this deduction can be so large it can cover all of your investment’s income and then in turn provide tax shelter for other real estate investments as well.(We are seeing this with our GO Zone investors)
Here is a simple formula to help you figure this out.
Rental Income less Operating Expenses = Net Operating Income
then
Net Operating Income less Mortgage Interest less Depreciation = Taxable Income
Let’s look at example of how a real estate investor can realize the tax sheltering benefits of real estate investing.
Let’s say you invested in a fourplex that had a rental income of $128,000 and operating expenses of $46,000
Rental Income = $128,000 less Operating Expenses of $46,000 = Net Operating Income of $82,000
Your mortgage intrest for the year was $64,000 and your deprecation deduction was $16,000.
Net Operating Income $82,000 less Mortgage Interest of $64,000 less Depreciation of $16,000 = $2,000 in Taxable Income
Wow! Only $2,000 in taxable income! As you can see, other investment vehicles just can’t compare with the power of properly chosen real estate investments.