I’m a huge proponent of real estate investment. I’ve come to realize that it’s not the panacea and get-rich-quick strategy that infomercial gurus would have you believe, and it’s definitely not easy money, but real estate investment can be a very lucrative long-term investment that can significantly enhance your wealth.
My latest realization is that around 45% of the gross rents of a residential property go to cover operating expenses, such as utilities, management, maintenance, taxes, insurance, uncollected rents, and legal and administrative fees. This leaves just 55% of the gross rents to cover mortgage payments. The most significant mistake that most new investors make is underestimating these expenses. Many investors simply compare the rents collected (or that they think they’ll collect) with the PITI (principal, interest, taxes, and insurance) and consider the rest profit. This is naive. I did this when I bought my first property, a 4plex, and I can tell you that it has been much more expensive than that.
I can also tell you that, in most areas, it is almost impossible to find a property for nothing down that will truly provide a net cashflow in the first year. However, that doesn’t make a nothing-down investment a bad one. On the contrary, buying an investment property without putting any cash down can be a great long-term investment, provided that you do it for the right reasons.
Other than buying for less than the fair market value (always a good idea), there are four ways to make (or lose) money through real estate investment:
This is what’s left after you pay for the operating expenses and the mortgage. It probably won’t be much at first, and you’ll probably actually experience a loss for the first few years. However, if you buy smart and manage smarter, you can convert this into a positive number by raising the rents over the years, while your mortgage payments will stay the same, provided you have a fixed-rate mortgage. After 30 years, or however long it takes you to pay off the mortgage, this number can be many thousands of dollars per month per property.
Real estate generally goes up in value over time. Over the very long term, it’s usually not quite as dramatic as what we’ve seen over the last few years, but your properties can easily double or triple in value over the course of 30 years. The important thing to remember here is that you don’t need to time the market if you hold long-term, generally 7-10 years or more. There’s an old saying in real estate that the best time to buy is 20 years ago. The second best time is now.
3. Loan amortization
Every month, a portion of your mortgage payment goes to reduce the outstanding balance on the loan. Initially, it’s a very small portion, but over time, that amount will grow larger and your liability against the property will drop rapidly, until you own the property free and clear. The best part of this is that your tenants will end up paying for almost all of this over the course of the mortgage term.
4. Tax incentives
Though not as lucrative as they once were, real estate still represents a great way to decrease your tax liability. There are many issues in this category, so I won’t go into them. Consult a reputable accountant, which you should be doing anyway if you’re going to invest in real estate.
The bottom line of real estate is this: real estate offers an opportunity to buy an cash-producing asset with someone else’s money and have that money paid back by someone else, and in the end, you own the property. After the first few years of feeding the alligator, your property should turn around and begin feeding you, and it will continue to do so forever, with the amount it feeds you only increasing each year.
Here’s my advice on getting started investing in real estate: get started. Don’t wait. Do your homework, seek wise counsel, and just do it.