Source: Liz Brumer-Smith, Fool.com
Investing in property can be a great way to build your net worth, diversify your investment portfolio, generate cash flow, or build your retirement fund.
However, you have to know the basics before you start investing in properties. They’ll help you determine whether property investment is right for you.
Many people want to invest in real estate. Few put forth the time or effort to learn what they need to invest successfully. Do you think investing in real estate might be the right investment vehicle for you? Here are a few property investment basics to help get you started.
Why invest in properties?
Real estate is a worthwhile long-term investment because it offers attractive benefits, including cash flow, appreciation, diversification, tax deductions, and competitive returns. It’s the combination of these advantages that creates such an appealing investment vehicle.
There are dozens of ways to invest in real estate, but for the most part, investors partake in this asset class for these five reasons.
1. Cash flow
Cash flow is the income from renting or leasing a property. Positive cash flow means there’s money left over after paying expenses. Negative cash flow means there are more expenses than income.
Most investors buy property because it offers positive cash flow. Cash flow can be acquired from a single-family rental property, apartment complex, industrial building, retail space, self-storage facility, and many more real estate investment vehicles.
Let’s say you buy a duplex that produces $2,000 a month in monthly rental income. After $700 in expenses and paying the mortgage, you have a positive cash flow of $300. That might not seem like much, but once you pay off the mortgage, it’ll go up. And if you buy another property, your total cash flow will go up again.
Eventually, with enough time and positive-cash-flow properties, you can create a monthly income that sustains your living expenses. It could even replace the income from your job or support you in retirement.
When building long-term wealth, cash flow is almost always a factor.
If you hold a property over some time, there’s a chance the property will increase in value, or “appreciate.”
Appreciation is a potential added benefit of real estate investing — there’s no guarantee it will happen. Market fluctuations or shifts in local economics can disrupt the local supply and demand. That changes the value of a property.
However, the longer you hold a property, the higher the chance it will appreciate over that time.
Managing risk is a large part of investing. You can manage risks by selecting certain investments over others or making multiple investments. Many people use real estate to diversify their investments beyond stocks, bonds, and mutual funds.
There’s still risk in real estate investing. But having properties across multiple asset classes, markets, or investment vehicles can lower your risk.
4. Tax benefits
While most new investors don’t get into real estate because of the tax advantages, they can be a significant benefit.
Learn the tax benefits available when investing in properties. And if you have questions, speak with an accountant who specializes in real estate investing. They’ll help you figure out how to get the most tax benefits from your investment.
5. Return on investment
It doesn’t matter if you invest in stocks, bonds, cryptocurrencies, or real estate — the goal is to grow your money. This is called a return. The higher the return, the faster you get your money back and start making a profit.
For example, if you put $25,000 in a real estate investment receiving an 8% return, you would get $2,000 in yearly income. Over 20 years, that initial $25,000 would garner you $40,000 without requiring additional money.
It’s worth noting that you may have to put in more money for things like maintenance and tenant screening. But those expenses are deductible.
There’s no guarantee your money will grow in real estate — or any investment vehicle, for that matter. But you can get a consistent return with real estate. Buying a rental property today could mean cash flow for decades to come. Appreciation, tax benefits, and a strong long-term return sweeten the deal.
Realistic expectations for beginner property investors
It’s more work than you think
All too often, beginner investors don’t know what it means to be a real estate investor. Property investments aren’t just stunning house flips, big checks, and passive cash-flowing properties.
There’s a lot of work involved in learning how to invest in real estate and finding, analyzing, and managing worthwhile investments. While it can be a very profitable business, it takes commitment.
It’s a long game
Building wealth doesn’t happen overnight. It’s a long-term game. Making enough cash flow to replace your income or adequately meet your retirement goals takes time. It’s not uncommon for new investors to try growing too quickly, leading to quick investment decisions that result in poor returns.
While you can achieve financial freedom through real estate, it’s important not to rush. Carefully review and evaluate each investment opportunity. Make sure each property is well managed and running efficiently to support further growth.
Many people make their first property investment in residential real estate. It costs less than investing in commercial properties and there’s less analysis, acquisition, and management required.
If you want to invest in commercial real estate, consider investing in a REIT or real estate ETF first. After learning and saving more, you can work toward acquiring your own piece of commercial real estate.
Find the right market
While investing locally may be the most comfortable option, it’s not always the best. Finding a market that supports your property investment is imperative to a successful real estate venture.
Areas have different demands; some may have a higher need for assisted living, mobile home parks, or student housing. Research the supply and demand of the type of property you want to invest in and find geographic areas that support the growth or development of that asset class.
Keep in mind the amount of money you have available to invest, as well. Specific markets, like the Pacific Northwest or New York City, have incredibly high real estate prices, and some investors get priced out of the market. You can spend $250,000 or more on a down payment for a property. That much money would buy you an investment property in cash elsewhere.
If you’ve identified a market with affordable investment opportunities, look into the local economy. Job and population growth, low vacancy rates, and a stable median income are good signs.
Know your numbers
If you want to venture into investment properties, learn how to analyze individual opportunities. You’ll need to know how to calculate the potential income, expenses, and return on investment. Make sure your numbers account for vacancy rates and routine maintenance and repairs.
If you have a loan on the investment property, make sure you have 3–5 months of mortgage payments saved. If there’s an economic downturn, a longer-than-expected vacancy, or other unexpected events, you may need it.
Rather than taking any positive cash flow as income now, it may be wise to use that to pay down your mortgage faster. This reduces the interest you pay over time and increases your cash flow sooner.
Master your niche
Become an expert of whatever avenue of property investing you decide to pursue — residential rentals, vacation rentals, commercial property, or another niche. When you master that area, you can analyze opportunities faster, acquire and manage properties more smoothly, and use your experience to build a larger portfolio.
Try not to get distracted by other investment avenues until you’ve seen sustained success with your current investments. It’s better to do one thing well than three things poorly.
Investing in properties can be very lucrative if done properly. But keep realistic expectations. Always weigh the risks and rewards before investing and keep learning about each niche. Build your expertise as you build your portfolio.