INVESTING IN REAL ESTATE
A real-estate investment is a building or property other than a family home that generates income through rent or resale. The price of the investment and the earnings are driven by supply and demand.
Real estate also requires ongoing contributions of time and money. Investors must shop around for the best financing or refinancing terms, buy liability and property insurance, set up entities for tax and management purposes, install security systems and maintain buildings to code, screen and evict tenants, and possibly hire professional personnel to assume management responsibilities.
As with other securities, often the best time to buy real estate is when the seller doesn’t want it – in other words, when the market is depressed or a bank is unloading property in foreclosure. Investors can scout deals themselves, but most rely on the services of a topnotch realtor or broker. As a building’s income-and-expense statement may not always be accurate, an investor should be able to evaluate it cautiously, using knowledge of the current market to determine if the cash flow is realistic.
• Property. An investor can choose from four different types of property: residential (single- and multi-family homes, condominiums, townhouses, and apartment buildings), industrial (manufacturing plants, storage units, warehouses, industrial parks, and research-and-development parks), commercial (hotels, offices, and retail- or wholesale-sales space), and undeveloped land. When choosing one of these investment vehicles, the investor should be knowledgeable about the local real-estate market, general economic forecasts, and tax realities.
• Real-estate investment trusts (REITs). REITs are business entities that invest in income-producing real estate.
• Real estate mutual funds. These are funds that invest in different REITs, thus providing the investor with real estate diversification.
How to analyze a real estate investment.
Determining a property’s market value is best done by obtaining a professional appraisal or by comparing the asking price with the recent selling prices, called comparables, of similar properties. If the comparables are much higher, the investment is either a great deal or a lemon—a building whose location or condition is a problem. If comps are much lower, the property is either overpriced or has marketing advantages and cachet that place it in a league of its own. Secure investments tend to hover in the middle range of the pricing chart.
cash-on-cash return =
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positive net cash flow
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total cash requirement
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“Your banker might loan you money to buy a piece of rental real estate, but he won’t lend you money to buy stock.”
Pros and cons of investing in real estate.
For a relatively small amount of money, the real estate investor may well gain substantial returns.
The person who buys rental property is gaining a source of ongoing passive income as well as a hedge against inflation, since rents can be raised. Rental losses, including phantom losses from depreciation, may be deductible as long as certain conditions are met. Earnings from the appreciation of property are tax deferred, and capital gains can be rolled over into a “like kind” investment.
Real estate is not liquid, and there are many built-in risks. These include loss of income from tenant turnover and a low occupancy rate, the costs of property maintenance and management, increases in annual property taxes, heavy losses inflicted by natural disasters, and payment of taxes on capital gains if profit is not rolled over within six months.
Most real estate investors hire professional property managers to minimize their day-to-day involvement with the enterprise. The best plan is to start small and carefully review possible real estate purchases, working with a realtor in the community, looking at many properties, and analyzing each for its cash flow potential.
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