Some say it’s hard not to make money from residential real-estate investments, but plenty have tried and failed to make the fortune they believed was there for the taking.
Thorough research and knowledge certainly help, as does strong industry contacts.
For most people, what makes real estate investments so attractive is that, unlike most investments, there are multiple ways to realize a profit – and these methods can often be applied in combination.
Picking the right strategy is undoubtedly the key issue if you’re hoping to maximize your returns.
So, let’s look at some of real estate’s wealth-building opportunities.
As the owner of residential properties you receive rental income on a monthly basis and your cash flow is the amount of income this generates after your costs have been met.
Though certain costs, like utility charges and management fees, can be anticipated, it’s important to understand that your income will fluctuate. This is because you will have to fund unexpected repairs or replacements – for example of domestic appliances, the building structure, electrics or plumbing.
You may also have to allow for vacant periods in between tenants, especially if you need to carry out major refurbishments while the property is empty, during which you receive no rental payments.
Rental returns are a matter of judgment and strategy and much will depend on whether you take a short-term view by pitching rents relatively high, which runs the risk of a high turnover of tenants, or at more moderate rates, which is likely to offer more stable returns. Many owners find that longer-term rentals return a healthy net profit of around 15% per annum.
Property value appreciation
History tells us that property in America generally increases in value over time – throughout the 20th century the average yearly appreciation was a steady 3%. So just owning a residential real estate portfolio, even without considering rental income, would still, in all likelihood, continuously build up your investment.
It’s worth noting that appreciation is a well-recognized long-term trend, not a guarantee, which means short-term market fluctuations could produce higher or lower returns.
An alternative way to gain from property appreciation is to acquire viable real estate below market value and then invest in improvements. This results in a ‘forced’ appreciation because the restored properties then immediately attract a higher market value.
This approach requires careful research to identify suitable target properties which can be brought up to rental standard without delay, and for a moderate outlay, thus leaving ‘headroom’ to produce decent profit margins.
When real estate is purchased via mortgage arrangements, property rentals cover the mortgage repayment costs. While mortgage repayments can be fixed, the amount owed on the original loan effectively falls month by month.
As a result, you gradually build up equity in the mortgaged properties. When the mortgage loan is paid off, you will then own valuable real estate funded entirely by tenant rental payments.
This scenario assumes your rental income does little more than meet the mortgage and property maintenance costs. Nevertheless, your mortgaged real estate will continue to appreciate in value over the term of the loan, further adding to your wealth.
Real-estate investors can take advantage of significantly lower tax liabilities allowed under U.S. fiscal legislation designed to encourage property ownership. Using deferred tax arrangements like the 1031-exchange regulations and many other initiatives, investors can use their privileged status to build up their real-estate assets.
Playing the combinations
Using a duplex rental property to illustrate the possibilities, consider this scenario:
After making a $50,000 deposit, the $200,000 balance is mortgaged over a 30-year term. Monthly rental returns total $3,000 per month, while averaged total costs (monthly mortgage, maintenance etc) amount to $2,500 per month.
This realizes a net cash flow figure of $500 per month, which gradually rises as rental rates increase throughout the mortgage term. While this cash flow is taxable, it’s actually wiped out by an allowance for property depreciation.
Thirty years’ appreciation at 3% boosts real estate value to $600,000 when the loan is settled. Now owned outright, the duplex will bring in thousands of dollars each month.
Maximized returns can be achieved by negotiating hard to get your property for a low price. Likewise, buying in areas where prices are reliably forecast to trend sharply upwards may produce annual appreciation nearer 5-8%.
Similarly, buying a cheap property at around $150,000 then spending $30,000 on improvements may allow you to put a rental property on the market that attracts a valuation of $275,000 and brings in even higher returns from the outset.
Tweaking your strategy further, trading up properties at any point will also deliver increased returns from that point onwards.
As mentioned earlier, detailed knowledge and experience of the real-estate market can help you maximize your returns. This is why many investors focus on one type of property, tenancy or geographical area in order to maximize their gains while minimizing their exposure to risk.
Melanie Luff is an Online Journalist for PropertySales.com, the market-leading directory of commercial property for sale from Dynamis. Melanie writes for all titles in the Dynamis Stable including BusinessesForSale.com and FranchiseSales.com.