In guiding clients through the world of real estate investing I work to ensure that they have a comprehensive picture of potential profits and risks. Ensuring client success in real estate investing
begins with following the following steps: |
Working with the strategy with investment portfolio.
As you work with your financial planner in your investment portfolio, the addition of real estate can often help to balance your current strategy. The basis of financial planning is to develop a well-diversified investment strategy that will help you to achieve your specific goals and objectives. The problem is that, if you truly do not understand what "diversification" means and what tools are available to you, you are setting yourself up for failure. The average investor has been misled into thinking that diversification is about owning different types of domestic stocks (large, medium, and small companies) and focusing on different management styles (growth vs. value). This is not diversification. Diversification involves owning different "asset classes." Asset classes are defined as various categories of investments that are affected differently as economic conditions change. They do not go up or down for the same reasons and are distinctly different from one another. I would define the major asset classes to include: cash, domestic bonds, domestic stocks, international bonds, international stocks, real estate and commodities. In order to achieve true diversification, these asset classes must be utilized. I work with your accountant or financial planner to see how your overall investment risk can be lowered and returned optimized through real estate investing. |
Determining purpose of real estate investment.
Real estate investing, as in other types of investments, can produce income either via an income stream or capital gain. For real estate investment purposes an income stream would be along the lines of rental property in which income is paid in increments along the lifespan of the investment. Capital gains are incurred with the sale of the property in the form of the proceeds from the property appreciation. The primary purpose of your investment will dictate the feasibility of the amount of initial investment as well which types of property will suit these needs. |
Determining best fit for property type.
In investing in real estate there are various property type options including: single family residence, multifamily residence, and various commercial properties. For the beginning investor, the first step is usually in the rental of single or multi-family properties. From a financial perspective, outright ownership is the most simplistic. A person can easily gain an understanding of the numbers, which would include debt services, expenses, income generated, appreciation potential, etc. The potential risks involved can also be more easily identified. The downside is that more time is required. The maintenance and management of the property will fall on the owner’s shoulders. If a person decides to hire a third party to take care of these issues, he/she should be sure to include the costs in his/her expenses. |
Funding Determination.
Funding for investment property often has more stringent requirements than primary residence homes. This is because the income stream resulting from the property is what in most cases guarantees the repayment of the loan. Addition requirements are taken by the bank as the liquidity of investment property is often slower than that of primary residence. Working with a bank to determine what amount of loan you qualify for is important not only in the search for the property, but also in determine the your effective cash flow. |
Property Search.
Identifying the properties which are best for your investment changes from a personal need/want list, to a financial one. In addition to considering your needs and limitations in the transaction. It becomes critical that you also know the demographics for the surrounding area. This may help in foreseeing possible pitfalls and proactively working to solve them. Additionally vacancy and absorption rates give an idea as the supply and demand for your property, another critical issue in determining cash streams. |
Financial Analysis.
One of the most critical steps in the investment property process is the financial analysis. Calculating financial indicators such as the capitalization rate, Return on Investment, and your return after your debt service will support the feasibility of a purchase. Additionally, determining several scenarios for worst to best cases ensure that you will be at minimum to meet your expenses. Below is a scenario which examines the feasibility of real estate investing: |
RETURN ON INVESTMENT SCENARIO
Purchase Price | $55,000.00
Mortgage Payments @ 7.5% Interest | $384.57
Appraised Value | $51,984.00 |
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Mortgage Balance
(100% Financed) |
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| Sale at Year End Gains **** |
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* Assumes yearly appraised value increase of 3%
** Beginning Rent of $650/ month w/ 4% increase every 2 years (Equivalent of $26 every 2 years)
*** Assumes maintenance expenses of $10,000 over the 10 year period
**** Assumption includes approximate closing costs resulting from sale and sales price equal to
appraisal approximations |
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