Often investors are attracted to the real estate market because it seems like a sure thing. In the last quarter-century, average home prices in the US have climbed almost every year.
But most people have enough difficulty carrying just one mortgage. Is it really possible for the average Joe or Josephine to finance a real estate investment?
There are many strategies for investing in real estate. Some, such as buying land and building new houses, apartments and commercial buildings, are the domain of developers. But you don’t have to have deep pockets to buy a second home as an investment.
As with so many things, success at investing in real estate depends on doing your homework. Bookstore shelves are full of how-to guides for the neophyte. There are also seminars and home-study courses available. Whatever your method of educating and preparing yourself to invest, you need to learn how to locate a property, inspect it to make sure it isn’t a money pit, run the numbers to see whether rental income will cover your carrying costs, secure financing, negotiate a deal and close the transaction.
Buying a house and renting it out while it grows in value sounds easy, right? This strategy can be an effective way to invest in real estate: you buy the property, sit back and watch it appreciate while someone else’s rent checks pay the mortgage, taxes and maintenance. But be prepared for the headaches of being a landlord. You’ll have to cope with plumbing emergencies and the like, as well as general upkeep, or pay someone else to do it. You’ll also have to deal with tenants who are tardy with the rent, make noise, upset neighbors and abuse the property. And you must ensure that the investment will be a paying proposition. A rule of thumb is that you’ll need to charge 10 to 15 percent of the value of the property in rent each year to cover management costs. Remember that landlords can usually deduct management costs, taxes and mortgage interest from their tax bill. Consult your tax advisor to find out the details of tax treatment.
Buying and flipping
It’s every handyman’s dream: you purchase a neglected house in a good neighborhood, put a few thousand dollars into renovations, and sell it a few months later at a profit. This can be a successful strategy for those who are good at estimating renovation costs as well as handy with a hammer and nails. To come out ahead, you’ll also need business smarts, or you’ll have to hire some -- you may need the help of a lawyer, accountant and escrow company, among others. To make your investment worthwhile, experts suggest that you aim to add two dollars to the home’s value for every dollar you spend on improvements.
While real estate has proven to be a reliable investment, there are risks attached to both of these strategies. If you are buying and holding a rental property, a slump in the local rental market could force you to reduce the rent to a level that isn’t profitable, or leave you tenant-less for a period of time. If you are renovating and flipping, local layoffs or a sudden hike in interest rates could make your fixer-upper hard to resell and force you into the role of landlord in order to offset your carrying costs for the property.
With either of these strategies, you’ve got to arrange financing at the lowest possible interest rate to maximize your profit. That means timing your investment to coincide with low market rates, and shopping around to get the best mortgage deal available.
If you are planning to buy and hold a rental property, you can consider a long-term adjustable rate mortgage (ARM) or a traditional fixed rate loan. If you are going to renovate and flip a property, you are probably better off choosing a one-year or two-year ARM, to take advantage of the very low initial interest rates currently available for these products.
You also need to think about where the down payment for your investment property will come from. The most cost-effective source of financing could be the equity in your own home. You can take out a low-interest home equity loan to make a down payment on a rental property, and repay it out of rental income. But remember, that increases the debt secured by your primary residence.
If you are renovating and flipping, consider a home equity line of credit that you can draw on for renovation expenses as well as your down payment.