Posts

Making Money In Real Estate

/in , /by

Learn how wealth is created through real estate. This article focuses on the basic ways that money is made through real estate. These haven’t changed in centuries, no matter how you spin it the basics have remained the same.

Appreciation
The most common source for real estate profit is the appreciation – the increase in the value – of the property in question. This is achieved in different ways for different types of real estate. And, most importantly, it is only realized through selling or refinancing. (For related information, be sure to check out Avoiding A Big Tax Bill On Real Estate Gains.)

Raw Land
The most obvious source of appreciation for undeveloped land is, of course, developing it. As cities expand, land outside the limits becomes more and more valuable because of the potential for it to be purchased by developers. Then developers build houses that raise that value even further.

Appreciation in land can also come from discoveries of valuable minerals or materials, provided that the buyer holds the rights. An extreme example of this would be striking oil, but appreciation can also come from gravel deposits, trees and so on.

Residential Property
When looking at residential properties, location is often the biggest factor in appreciation. As the neighborhood around a home evolves, adding transit routes, schools, shopping centers, playgrounds and so on, the value climbs. Of course, this trend can also work in reverse, with home values falling as a neighborhood decays.

Home improvements can also spur appreciation, and this is something a property owner can directly control. Putting in a new bathroom, upgrading to a heated garage and remodeling to an open concept kitchen are just some of the ways a property owner may try to increase the value of a home. Many of these techniques have been refined to high-return fixes by property flippers who specialize in adding value to a home in a short time.

Commercial Property
Commercial property gains value for the exact same reasons as the previous two types: location, development and improvements. The best commercial properties are in demand, and that drives the price up on them. (For related reading, see 7 Steps To A Hot Commercial Real Estate Deal.)

The Role of Inflation in Appreciation
Of course, there is one major factor we skipped in our summary – the economic impact of inflation. A 10% inflation of the dollar means that your dollar can only buy about 90% of the same good the following year, and that includes property. If a piece of land was worth $100,000 in 1970, and it sat dormant, undeveloped and unloved, it would still be worth many times more today. Because of runaway inflation throughout the ’70s and a steady pace since, it would likely take over $560,000 to purchase that land today – assuming $100,000 was fair market value at the time and all other factors remained constant.

So, inflation alone can cause appreciation in real estate, but it is a bit of a Pyrrhic victory. Even though you may get five times the money due to inflation, many other goods cost five times as much to buy now. (Learn more in 5 Tales Of Out-Of-Control Inflation.)

Income

Generally referred to as rent, income – or regular payments – from real estate can come in many forms.

Raw Land Income
Depending on your rights to the land, companies may pay royalties for any discoveries or regular payments for any structures they add. These include pump jacks, pipelines, gravel pits, access roads, cell towers and so on. Raw land can also be rented for production, typically agricultural production.

Residential Property Income
Although it’s possible to earn income from the installation of a cell tower or other structure, the vast majority of residential property income comes from basic rent. Your tenants pay a fixed amount per month – and this will go up with inflation and demand – and you take out your costs from it and claim the remaining portion as rental income. While it’s true you will get an insurance payout if your tenants burn down the place, the payout only covers the cost of replacing what is lost and is not income in a real sense.

Commercial Property Income
Commercial properties can produce income from the aforementioned sources – with basic rent being the most common – but it can also add one more in the form of option income. Many commercial tenants will pay fees for contractual options like the right of first refusal on the office next door. These are essentially options that tenants pay a premium to hold, whether they exercise them or not. Options income is sometimes used for raw land and even residential property, but they are not common.

What About REITs or MICs?
Real estate investment trusts (REIT) and Mortgage Investment Corporations (MIC) are typically considered to be great ways of earning income from real estate. This is true, but only in the sense that real estate is the underlying security. With a REIT, the owner of multiple commercial properties sells shares to investors – usually to fund the purchase of more properties – and then passes on the rental income in the form of distribution. The REIT is the landlord for the tenants (who pay rent), but the owners of the REIT get the income once the expenses of running the buildings and the REIT are taken out.

MICs are even further removed, as they invest in private mortgages rather than the underlying properties. MICs are different from MBSs in that they hold entire mortgages and pass on the interest from payments to investors, rather than securitizing the interest streams independent of the original mortgage. Still, they are not so much real estate investments as they are debt investments, and thus outside of our area of interest. (Learn more in How To Assess A REIT.)

Similar to securities with real estate underlying the investment, most alternativesare merely a layer on top of these two basic steams of income.

For example, there are informal residential real estate options where you pay a fee to have the right to buy a house at a given time, say after a month, for an agreed upon price. Then, you find investors who will pay more than your option price for the property. In this case, the premium you get is essentially a finder’s fee for matching a person looking for an investment with a person looking to sell – no different than a real estate agent. Although this is income, it doesn’t come from buying (i.e. holding the deed to) a piece of real estate.

Similarly, no money down or OPM deals are simply the financing aspect of the deal – it doesn’t change how the buyer is planning to make money in the long run.

The Summary
If someone is trying to sell you a new way to make money from real estate other than buying low and selling high or collecting rent, they’re probably trying to sell you on the process of real estate investing rather than a new mechanism for making profits. Whether the process is worth it or not is up to you, but know that it doesn’t change how money will be made (or lost).

Investing in Real Estate Made Easy

/in , , /by

Buying real estate is not just finding a place to call home. Investing in real estate has become a common investment over the last 50 years.

Although the real estate market has plenty of opportunities for making big gains, buying and owning real estate is a lot more complicated than investing in stocks and bonds. This article, explores real estate as an investment.

Rental Properties
This is an investment where a person buys a property and rents it out to a tenant. The owner is the landlord and he/ she is responsible for paying the mortgage, taxes and costs of maintaining the property.

Hopefully, the landlord charges enough rent to cover all of the aforementioned costs. A landlord may also charge more in order to produce a monthly profit, but the most common strategy is to be patient and only charge enough rent to cover expenses until the mortgage has been paid, at which time the majority of the rent becomes profit.

Furthermore, the property may also have appreciated in value over the course of the mortgage, leaving the landlord with a more valuable asset. According to the U.S. Census Bureau, real estate has consistently increased in value from 1940 to 2006, then proceeded to dip and rebound from 2008 to 2010 and has been increasing overall.

There are, of course, blemishes on the face of what seems like an ideal investment. You can end up with a bad tenant who damages the property or, worse still, end up having no tenant at all. This leaves you with a negative monthly cash flow, meaning that you might have to scramble to cover your mortgage payments. There is also the matter of finding the right property. You will want to pick an area where vacancy rates are low and choose a place that people will want to rent.

One of the he biggest difference between rental properties and other investments is the amount of time and work you have to devote to maintaining your investment.

When you buy a stock, it simply sits in your brokerage account and, hopefully, increases in value. If you invest in a rental property, there are many responsibilities that come along with being a landlord. When the furnace stops working in the middle of the night, it’s you who gets the phone call. If you don’t mind handyman work, this may not bother you; otherwise, a professional property manager would be glad to take the problem off your hands, for a price, of course.

Real Estate Investment Groups
Real estate investment groups are sort of like small mutual funds for rental properties. If you want to own a rental property, but don’t want the hassle of being a landlord, a real estate investment group may be the solution for you.

A company will buy or build a set of apartment blocks or condos and then allow investors to buy them through the company, thus joining the group. A single investor can own one or multiple units of self-contained living space, but the company operating the investment group collectively manages all the units, taking care of maintenance, advertising vacant units and interviewing tenants. In exchange for this management, the company takes a percentage of the monthly rent.

There are several versions of investment groups, but in the standard version, the lease is in the investor’s name and all of the units pool a portion of the rent to guard against occasional vacancies, meaning that you will receive enough to pay the mortgage even if your unit is empty. The quality of an investment group depends entirely on the company offering it. In theory, it is a safe way to get into real estate investment, but groups are vulnerable to the same fees that haunt the mutual fund industry. Once again, research is the key.

Real Estate Trading
This is the wild side of real estate investment. Like the day traders who are leagues away from a buy-and-hold investor, the real estate traders are an entirely different breed from the buy-and-rent landlords. Real estate traders buy properties with the intention of holding them for a short period of time, often no more than three to four months, whereupon they hope to sell them for a profit. This technique is also called flipping properties and is based on buying properties that are either significantly undervalued or are in a very hot market.

Property flippers will not put any money into a house for improvements; the investment has to have the intrinsic value to turn a profit without alteration or they won’t consider it. Flipping in this manner is a short-term cash investment.

If a property flipper gets caught in a situation where he or she can’t unload a property, it can be devastating because these investors generally don’t keep enough ready cash to pay the mortgage on a property for the long term. This can lead to continued losses for a real estate trader who is unable to offload the property in a bad market.

A second class of property flipper also exists. These investors make their money by buying reasonably priced properties and adding value by renovating them. This can be a longer-term investment depending on the extent of the improvements. The limiting feature of this investment is that it is time intensive and often only allows investors to take on one property at a time.

REITs
Real estate has been around since our cave-dwelling ancestors started chasing strangers out of their space, so it’s not surprising that Wall Street has found a way to turn real estate into a publicly-traded instrument.

A real estate investment trust (REIT) is created when a corporation (or trust) uses investors’ money to purchase and operate income properties. REITs are bought and sold on the major exchanges, just like any other stock. A corporation must pay out 90% of its taxable profits in the form of dividends, to keep its status as an REIT. By doing this, REITs avoid paying corporate income tax, whereas a regular company would be taxed its profits and then have to decide whether or not to distribute its after-tax profits as dividends.

Much like regular dividend-paying stocks, REITs are a solid investment for stock market investors that want regular income. In comparison to the aforementioned types of real estate investment, REITs allow investors into non-residential investments such as malls or office buildings and are highly liquid. In other words, you won’t need a realtor to help you cash out your investment.

Leverage
With the exception of REITs, investing in real estate gives an investor one tool that is not available to stock market investors: leverage. If you want to buy a stock, you have to pay the full value of the stock at the time you place the buy order. Even if you are buying on margin, the amount you can borrow is still much less than with real estate.

Most “conventional” mortgages require 25% down, however, depending on where you live, there are many types of mortgages that require as little as 5%. This means that you can control the whole property and the equity it holds by only paying a fraction of the total value. Of course, your mortgage will eventually pay the total value of the house at the time you purchased it, but you control it the minute the papers are signed.

This is what emboldens real estate flippers and landlords alike. They can take out a second mortgage on their homes and put down payments on two or three other properties. Whether they rent these out so that tenants pay the mortgage or they wait for an opportunity to sell for a profit, they control these assets, despite having only paid for a small part of the total value.

In Summary
This article has looked at several types of real estate investment. However, within these examples there are countless variations of real estate investments. As with any investment, there is much potential with real estate, but this does not mean that it is an assured gain. Make careful choices and weigh out the costs and benefits of your actions before diving in.