Real estate investing involves purchase, ownership, management, rental and/or sale with the purpose of realising a profit.
Improving properties is a sub-specialty called real estate development and is very often part of a real estate investment strategy.
Real estate is an asset class with relative limited liquidity requirements compared to other investments, such as stocks. It is capital-intensive and depends highly on cash flow, although capital can be gained by leveraging the mortgage. If these factors are well managed, real estate becomes a less risky investment.
The primary reason for succeeding when investing in real estate is first of all to see and act on the opportunities in the market. Afterwards to stay in positive cash flow and thereby avoid being forced to resell the property at a loss.
Why investing in real estate is an excellent choice if you want to both preserve and grow your capital
Identify and act on ways to generate positive cash flow
One of the biggest advantages of an income-generating real estate asset is that the lease generally secures the property. This provides consistent stream of income, which is significantly higher than the typical dividends that stocks yields.
Use leverage to multiply the value of your asset
Another important characteristic of real estate investing is the possibility to place debt on the asset. The debt can be and most often is several times bigger than the original equity, which enables you to buy more assets with less capital and significantly multiply your asset value to increase the equity as the loans are gradually paid down.
Leverage on low-cost debt to multiply your cash flow
Placing “positive leverage” on an asset allows investors to effectively increase positive cash flow from operations by borrowing money at a lower cost than the property pays out.
For example, if a property generating a 7 percent return on investment were to add debt at 3 percent, investors would be paid both a percentage on the equity and the capital borrowed which is leveraging the debt.
Hedge on inflation
For each euro (i.e. currency) generated, there is a corresponding liability. Historically, real estate investments, compared with any asset class, such as stock indexes and bonds, have shown the highest correlation to inflation.
Since money is continuously printed to stimulate economic growth, it is important to take advantage of income-generating real estate as a hedge against inflation.
When inflation occurs, the price of real estate, particularly multi-tenant assets with a high ratio of labor and replacement costs, will also rise.
Capitalise on physical assets
Income-generating real estate is one of the few investment classes with an physical and intrinsic, purposeful value. The property’s land has value, as does the structure itself, and the income it generates has value to future investors. Income generating real estate investments do not have red and green days, as does the stock market.
Maximise tax benefits
There are tax advantages benefitting real estate owners in a number of ways, including mortgage interest deductions and depreciation accelerations that can shield a portion of the positive cash flow generated and paid out to investors.
Asset value appreciation
Over time, more and more inflation has made it into the economy, drastically reducing purchasing power. However, income generating real estate investments have historically provided excellent appreciation in value that meet and exceed other investment types. Properties historically increase in value as the net operating income of the property improves through rent increases and more effective management of the asset.
No one can guarantee the future of rental of income properties’ values, but this asset class seems positioned to continue to benefit from many other socio-economic issues that can be elaborated on another time.
10 guidelines that will help you avoiding the fundamental mistakes when investing in real estate:
1. Create a viable plan
Not having made a viable plan is a common mistake new real estate investors make. They buy a property as they think it is a good deal and afterwards they try to figure out what to do.
The right order and sequence is that first you create a real estate investment plan based on a variety of expert advice based on the current state of market and realistic figures and then you find the property that fits into this plan.
The challenge is that most people look at real estate as a short-term transaction or a “get-rich-quick-scheme” instead of as a long-term investment strategy.
2. Invest long-term
Real estate is a long-term investment and continuous hard work and investment management is required.
Real estate investing and developing based on a long-term horizon will help you making the right decisions but does not prevent you from an early exit in case you identify an opportunity to realize a good profit by exiting your investment earlier than expected.
There is a practice within real estate investing known as “flipping” which can be a reason for failure as the nature of the investment is often associated with short-term profit and less effort.
However, “flipping” can also cause a successful real estate investment. In many cases nothing happens with a specific real estate asset. It seems stuck where it is and can be empty for years because no one sees the potential and no one dares to think and execute the creative ideas giving the property its best purpose of use.
Not until an experienced and inspired real estate investor creates the appropriate future development plan and presents it to a capable investor that buys into the idea and thus the property.
In that case “flipping” helps pushing the market in a positive direction and what ever happens without creative ideas, the will to move forward, see the possibilities and not only the challenges which are there to be dealt with in a rational manner.
3. Surround yourself with the right team
You need to be surrounded by the right team of professionals, such as real estate agents, architects, lawyers and lenders. In addition, an experienced mentor with background in real estate investing can help you to avoid many of the typical mistakes made by enthusiastic beginners.
Real estate development requires a team of specialists, such as a plumber, an electrician, a roofer, a painter, a flooring installer, a garden maintenance service, a cleaning service and an all-around handyman.
In short you need to have the right team of trusted professionals in place to move safely and smoothly forward with your real estate investment.
4. Pay the lowest possible purchase price
The profit very much depends on the initial price you pay for the property.
A good initial deal will most likely make a profitable exit possible. However, creative and professional development and solid management of the property also plays a large role when calculating the final profit.
5. Educate yourself
Educate yourself before you take risk and put your family’s financial situation on the line.
Find an experienced real estate investor, ask as many questions as possible and learn the fundamentals before you make your first investment.
6. Do thorough due diligence
Investors often have to move very quickly on their deals. It is crucial to act quickly to be able to get the position you want but also to analyse and understand what you are buying into. A thorough due diligence will give you the required knowledge about the deal, the costs and the market conditions.
It is necessary to have the right idea about what you want to do with the property but you also need to substantiate your idea based on solid information and realistic figures to stay cash flow positive.
7. Make a conservative budget to stay cash flow positive
If your real estate investment strategy is to buy and rent out, you need sufficient cash flow to cover the management.
You have to pay the mortgage, taxes, rental agent fees, insurances, cost of advertising and community fees. If you have not thoroughly budgeted these costs an asset can quickly become a liability.
8. Establish a steady pipeline of prospective deals
In order to run a professional real estate investment business you need a steady pipeline of prospective deals as sufficient volume will balance the marginal deals and let the good ones rise to the top.
9. Clarify your exit strategy before you invest
Many people buy a property and get stuck with it because they only have one exit strategy. If the plan is to refurnish the house, put it on the market and resell it, then plan B could be to offer a lease-purchase to a buyer. Plan C to hold the property and rent it out. Plan D to sell to another investor below market price.
Best case you make a profit but as a minimum you cut the monthly losses as you avoid carrying the costs.
10. Base your decision on cautious estimates
Be realistic and in many cases double the amount of time and money you think is required. If you can make money on a conservative base scenario it is a good deal.