Complete Guide on Real Estate Investing

UTC by Osaemezu Ogwu · 14 min read
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Photo: Depositphotos
Photo: Depositphotos

This guide will show you all you need to know about real estate investing, its pros, and cons, as well as how to make the most profit as an investor.

Real estate investing is the purchase of a property and giving it out for rent in return for money monthly. In this case, an investor who purchases this property will have to pay the home loan, taxes, stamp duty, and other expenses. In return, they charge rent for their property a certain amount within a specified time interval.

Also, the amount charged is often enough to cover the expenses that have been made to acquire the house. At a later time, a major part of the rent becomes profit to the property owner. For this reason, the aim of real estate investment is to make more money in the long run than what was invested in a property.

Considering the Risk and Reward of Real Estate Investing

On the other hand, for an investor to be profitable from a business of this nature, they have to consider the risk and reward. The reward must be worth taking the risk to buy the property, pay taxes, interests, etc. There’s also the cost of maintaining the real estate, paying utility bills, and even opting for insurance.

Asides from the returns and risks, a beginner or professional investor in real estate business need to have good knowledge of how the investment works. The same can be said about being enlightened about economics, how to purchase properties, set the rent, avoid bankruptcy and acquire more properties.

What’s more, real estate investing may even be more labor-intensive compared to investments in stocks or bonds. In line with that, investors may get emotional since they may be expecting the property to yield profit soon so that they can pay off the home loan or mortgage.

It is, however, worth noting that there is a growing trend with more people diving into property investments. The reason is, the time it’ll take to reap returns is shorter compared to mutual funds that could take at least 8 years to mature.

Basic Rental Properties

Here’s a breakdown of the basic rental properties:

Landlord

A landlord is a person who buys a property and puts it up for rent. The landlord also pays taxes, mortgages, and covers costs for the building’s maintenance. Alternatively, the rent that is charged is used to make up for these expenses. And more rent may be charged to ensure that while these costs are covered, the remaining money can serve as profit.

Nonetheless, a common practice by landlords is to charge enough rent to cover costs until they have been fully paid for. After the mortgage has been paid, most part of the rent will now serve as profit.

Property Appreciation

Compared to when the building was purchased, it’s value would’ve incremented significantly years later. Hence, the property is worth more. An even though its value may have depreciated during the course of the year, it could potentially appreciate again. An instance is a decline in the housing market between 2008 and 2010. However, the value of homes has appreciated since then.

Knowledge of the Market

It is important for an investor to have a good knowledge of the rental property market or employ the services of a professional to assist them. Asides from relying on a professional’s expertise, it may be better to employ their services given that investing in rental property takes time. As such, investors who have little time of their hands can still ensure that the purchase of the building, its operation, and other processes are well handled.

Nonetheless, hiring the services of an expert may come with its own expenses. This is because the expert will have to be paid a salary on a monthly basis. Dishing out the extra cash for salary may impact on the returns of the property.

Location

Great consideration has to be given to the location of the property to determine if the building is a good buy. For instance, its closeness to a college will increase its potential of being rented yearly thanks to the high number of students in that location. Consequently, getting a building that is close to a school will ensure it does not stay empty for long even when a tenant moves out.

In addition, a property that is situated in a good location can attract tenants faster. For a residential house, it needs to be in a peaceful place and a neighborhood where social amenities have been put in place. On the contrary, a commercial property needs to be situated close to a warehouse, transport hub, etc. It is, however, worth pointing out that an investor may not find everything they want in a particular location, hence they need to prioritize what is more important.

Risks Associated with Rental Property

Having tenants would mean an investor can start collecting part of the money they’ve spent to purchase a house and keep it running. However, it is possible that there may be no tenants for a very long time. Certain factors can contribute to this, such as a bad neighborhood or high rent. When that happens, it would mean more expenses to cover mortgage payments without receiving any income.

To that effect, each of these can be curbed by choosing a good area that will attract people to live in. Such an area should also have a low vacancy rate to increase their chances of being taken.

After finding a good property that will likely attract people to live in, a mortgage calculator can be used to check the total expenses that will be made for the property. The interest also has to be calculated. It may also be useful to find a mortgage type with the most interest rate. It’ll help to reduce expenses significantly. That aside, another risk that may occur is the destruction of the property by tenants. Certain areas may be destroyed, thereby bringing about the need to spend more to fix them.

Pros and Cons of Real Estate Investing

Like any other business, there are pros and cons to rental investment.

Pros of Rental Investing

Some advantages of real estate investing in properties include:

Level of risks and volatility is lower compared to stocks

The price of homes does not rise and fall as fast as the prices of stocks do. As such, investors can expect a steady increase in the value of the properties they own. In the same vein, the home’s value takes time to depreciate which posses lesser risk. The downside is, the profit may be lower compared to stocks.

Can serve as a continuous source of income

Rental properties can generate a continuous flow of income for investors. Rents can be received on a monthly or yearly basis. Much more, the rent can be incremented with time. This means investors with several rental properties can have a steady cash flow.

Good profit can be expected in the long run

While rent is collected for these properties, the value of the homes themselves will appreciate with time. Therefore, the homeowner will be left with a property that is worth more than its purchase price after a few years.

Tax breaks

Investors in this niche can have tax breaks, hence, deductions such as mortgage interest, property tax, etc. can be made from taxes

Cons of Real Estate Investing

Some cons of real estate investment include:

Lower potential for a massive return

Reportedly, the percentage increment in the value of the S&P 500 between 1991 and 2019 was over 600%. In contrast, the value of homes appreciated by160%. This shows that an investor would’ve made at least thrice the profit if they had invested in stocks.

Startup capital may be high

Asides from covering expenses for the building itself, there are other costs to consider and these may add up to the capital needed to set up a rental property business. Payments have to be made for building maintenance, running the company, handling taxes, and so much more.

Low liquidity

An investor cannot just wake up one morning and decide to sell their property for cash. They’ll have to go through the process of getting the right documents ready for a potential buyer. They’ll also have to source for buyers while negotiating with them. Consequently, it could take weeks or months before the property is finally sold for cash.

Challenges in dealing with tenants

Landowners, landlords, property managers, etc. often face difficulties managing their tenants. Some rowdy tenants may tend to break things or make the place unconducive for other tenants. What’s more, some tenants may not pay their rent on time, and may even owe for months.

Challenges in handling building problems

With time, certain issues may spring up in the building. There may be roof leakage, lack of water, power outage, etc. These issues will have to be resolved by the investor.

Ways to Make Money from Real Estate Investing

Here are some of the best ways to earn through real estate investment:

Real Estate Appreciation

Appreciation in a property’s value takes place when there are changes in the real estate market. An instance is a case where the land in the areas surrounding the property becomes more scarce or busier. In the case of the latter, a mall may have been built in the area thereby attracting people from different locations.

Another way the value of the property can be increased is when changes have been made to its aesthetics. This improvement can make the building more appealing to potential buyers, thereby increasing its selling price. Nonetheless, real estate appreciation cannot always be predicted accurately. Hence, it is just as risky compared to an investment for steady income.

Cash Flow Income

Here, a property such as an apartment building can be purchased and rented to tenants. The rent is collected from tenants on a monthly basis and could mean a consistent stream of income for the investor. Asides from apartments, rental houses, storage units, etc. can also be used to generate steady income.

Real Estate Related Income

An individual can also become a real estate broker who helps clients to buy or sell their properties. As a reward for their effort, they get a commission for offering their services. There are also real estate companies who manage the daily operations on properties for individuals or other companies. They can get a certain percentage from the rent that is paid.

For instance, a company can oversee processes in a hotel such as a maid hiring, lawn mowing, front desk operations, etc. And in return, they may charge 10% of the sales made in the hotel.

Ancillary Real Estate Investment Income

Small businesses can be formed in larger real estate investments. Among this is the ancillary real estate investment income. The latter includes vending machines that are used in offices. Owners of these machines can also earn money from leaving them in office premises.

Tips for Beginners in Real Estate Investing

One more way to make a profit through real estate investment is to know the tips that will guide you. Accordingly, new and old investors can rely on the following:

Take a Mortgage

Even when you cannot afford to own a property, a mortgage allows you to. Hence, you can take a mortgage loan. You’ll become a proud owner of a piece of property using little of your own capital. Nonetheless, there is still a level of risk here. For instance, a decline in the housing market would not stop payments to cover interest rates and mortgage payments you have to make. The latter could potentially lead to bankruptcy since these payments would be made for a devaluing property.

Accordingly, resorting to holding these investments through limited partnerships and other legal entities can protect your assets. Here, the property will not be tied to your name. Hence, if the problem arises and it eventually leads to a lawsuit, the legal entities will bear the burden. You’ll only be losing the capital that was invested and not other assets you own. That notwithstanding, it is better to ask your lawyer which is the better route to go to avoid making costly mistakes.

Hidden Costs of Real Estate Investing

There are several hidden costs associated with real estate investing. These costs are not limited to the following:

Commission to the Property Dealer

Despite an investor’s level of knowledge and expertise in the field, they may still have to resort to a property dealer that will give them sound advice on the property to purchase. There’s a commission tied to hiring an expert of this nature.

Here, a commission has to be paid to the dealer to enable them to search for a potential property to buy. Another fee in the form of a certain percentage the property is worth is paid once the deal has been sealed. This means that whether an individual buys the property or not, they would’ve already spent to hire an expert.

On the other hand, investors can get a good idea of how much they’ll likely pay for this service even before they hire a broker. There’s a formula that will help in deducing this fee and it is given by Commission Charges (in %) X Property Price = Payable Property Commission.

Cost of Closing the Deal

After selling the property, there’s also money to be paid to those involved in its sale. These individuals may have handled the legal papers for the property and other basic aspects. The closing cost can be determined using the formula Closing Cost = 2% – 5% x Purchase Price.

Renovation of the Property

A purchased property may not meet the standard of the investor, and as such, renovations may be carried out to improve its outlook. Further, the chances that an investor will be satisfied with the aesthetics of the property after its purchase is low. Accordingly, changes might be carried out in certain areas to ensure that the building looks modern and has a higher value.

Therefore, more money will be spent to cover the demolition and purchase of new items needed to restore old parts. While renovation could potentially increase the value of the property, it would mean spending more money even before the investor reaps the first profit from their investment. Nonetheless, unnecessary expenses can be eliminated by setting a budget for the renovation even before the process begins.

Maintenance

Property may need to be fixed in certain areas to make it livable especially if it is a house. In line with that, each time these parts break down, they’ll need to be fixed or replaced. Therefore, even after the house has been rented, it is still generating more costs, meaning an investor has to spend more.

Over and above that, maintenance cost might be difficult to manage especially if an investor owns more than one house, it would mean moving between houses to get things in place to prevent their further deterioration.

Insurance

Another hidden cost that will bring more expenses is insurance. While this will protect the house against unforeseen circumstances such as a fire outbreak, it might add up to how much is spent each year since it has to be renewed yearly. Insurance does not also come cheap since it costs hundreds to thousands of dollars. And payment has to be made to keep on insuring your building even when it’s not generating any profit.

Conclusion

Real estate investing is less risky than some investments such as stocks, however, it’s profit is lower compared to the latter. Despite this, investors can still make the most profit by being informed about what it entails, and what’s required to run a property profitably. This and many more have been covered in this guide and you too can make an informed decision on whether an investment of this nature is right for you.

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