We can all agree real estate investing in 2012 is a different animal than it was before the market crash. Prior to the crash investors were focused primarily on speculation of appreciation upside. Do you remember how expensive mortgages were? Finding good cash flow properties was extremely difficult because rents where so far below the leverage and mortgage market, and of course property prices were way too high. Today’s real estate investors have evolved, and strategy has shifted to a renewed emphasis on safety.
So, how do you safely invest in real estate? How can you be self-assured when there is still so much fear and uncertainty out there? It is actually much simpler than you might think. In this article I will walk you through how to not only make money in real estate today, but also how to set yourself up for success for years to come. In addition, I’ll talk about some of the unique factors impacting the real estate market right now, how to take advantage of them, and why it’s an incredible time to be a real estate investor.
Why you should be investing in real estate
Before we get into the “How To” strategies for safely investing in real estate today, let’s talk about why it makes so much sense to invest in real estate now.
1. Pricing: Most people see the real estate market crash as a horrible thing, and these same people use the crash as exhibit A in their argument against investing in real estate. I on the other hand take the opposite view. I see the market crash as something that was necessary, and thanks to it, we now are enjoying one of the best windows for real estate investing in recent memory. Why? Because pricing has readjusted well below replacement values, and in the right markets buying property at these historic lows creates long term opportunity. Sure we aren’t going to see property values go up by 40% a year like before the crash, but the cash flow generated by these properties more than makes up for that.
2. High Occupancy Levels (Rental Demand): Prior to the crash, finding properties with cap rates over 7% was a challenge – property prices were just way too high, and rents just didn’t justify the carrying costs. Today, thanks to the market correction, finding cap rates over 10% is a walk in the park. With cap rates that high, and rental demand at all time highs, it is pretty easy to find quality renters and generate positive cash flow. Many of these renters are worn out from home ownership — they now prefer the freedom that comes along with being a tenant rather than a home owner. At the same time, though, they want to keep their same high standard of living. Because of this, you can find longer term tenants that treat your investment with respect.
3. Rents Make Sense: In today’s rental market, demand in certain markets is exceeding supply, especially in the supply of affordable A and B class properties with modern amenities. Because the acquisition prices on these properties have not adjusted to their replacement values yet, there are purchase bargains to be had with rents that justify double digit net returns. The general rule of thumb is you want to get 1% per month in collected rents compared to the purchase price. For example, if you buy a property for $100,000, the minimum rent collected should be $1,000. In today’s market, we are finding numerous properties that meet this criteria (many with even better numbers than that) in desirable rental markets.
4. Historically Low Mortgage Rates: Lastly, let’s talk about mortgage rates. Thanks to the market crash and lousy economy, interest rates have been kept ridiculously low. Right now the average rate on a 30 year fixed mortgage is around 3.5%. Crazy isn’t it? Non-owner occupied loans are a little higher, but rates are still very low. For example, on several of our developments we were able to get banks to offer Non-Recourse investment loans to our investors for interest rates around 4.75% – yes, I did say 4.75% on a non-recourse investment loan! Why is this important? To acquire a $100,000 property, instead of putting $100,000 cash in a property, you can invest $40,000 in cash and borrow the remaining $60,000 at these historic low rates. Taking advantage of this low cost money gives you increased liquidly — while still enjoying huge cash flow — allowing you to take advantage of other investment opportunities.
How to safely invest in real estate
Okay, now that you are completely sold on investing in real estate, let’s talk about how to safely go about it, while putting yourself in the best position to avoid losses. In order to do this, let’s discuss risks associated with real estate investing:
1. Paying too much: There are deals to be made in today’s market on investment property, especially if you can use leverage to your advantage. However, to minimize risk, don’t pay retail prices. As a real estate investor you should always try to purchase below replacement and market pricing. This will increase your cash on cash returns, and set you up for a better back end equity realization years from now when you sell.
2. Maintenance: Anytime you purchase an investment property, you must take into account potential maintenance costs — this is especially true with older homes. How much will it cost you to own and maintain the property? One of the greatest risks to your cash flow will be repairs and maintenance, because there are a lot of unknowns when it comes to property maintenance. To minimize risks, there are 4 big ticket items you want to be very aware of, Roofing, Plumbing, Electric, and HVAC. If any one of these items needs to get replaced, not only will it discourage a renter from renewing, but it can also wipe out an entire year’s worth of earned rental income.
Tip: If you can find newer properties — with new appliances and amenities — that still meet your cash flow and value requirements, believe me, not only will you thank me later but your wallet will as well.
3. Vacancy: What good is an investment property if you can’t rent it? To avoid long periods of vacancy, identify areas in job growth markets with positive economic outlooks. These high job growth markets — especially those with high new construction real estate demand, colleges, and quality transportation — are ideal. Also, buying new property originally built for owner-occupants (higher quality amenities), will increase the quality of renter you attract, as well as the rent you can demand. Remember, your most important renter is the first one, make sure they’re qualified, and then keep them happy.
4. Exit: Eventually you may want to sell your property. To avoid having to discount your property for an all cash buyer, make sure there are banks willing to finance the property. If the property is not financeable, ask yourself why. If banks won’t put their money behind that property, there better be an exceptionally compelling reason for you to do it. Typically you will want to avoid those areas and properties that are on the no funding list for banks. When you sell the property down the road, you want to ensure that an average family can purchase it — which means it will need to qualify for conventional financing. The broader your potential market, the better.
If you want to make money in real estate, without taking on huge risks, then be smart about It. At the same time, remember that you can’t win the game if you aren’t in it — if you want to make money, you have to do it. Regardless of what you think about the man, few can challenge the investment prowess of Warren Buffet. Buffet also happens to be the author of one of my favorite quotes. He said “Be fearful when others are greedy and greedy when others are fearful.” How many of your friends and co-workers are scared right now to buy real estate? There you go. Follow the tried and true formula for real estate investing success , know how much money you will make before you buy. If you do that, and focus in on highly desirable areas, and homes, then you should do well as a real estate investor in today’s market.
Take what the market is giving you and evolve. With interest rates at all time lows, leveraging your investment makes since. If you want extra safety, choose a 30 year fixed interest rate — use your head. All the stars are aligning in the real estate market for investors. Prices are low, renters are plentiful and interest rates are low. Remember, real estate investing doesn’t have to be risky; really it should be one of the safer investments you ever make — and it is, as long as you are smart about it.