This is an excerpt from my forthcoming book, Growing Equity. My goal is to demystify the process of analyzing and buying income producing real estate without the condescension of the “Dummies” books.
I have spent more than three decades in the real estate industry, first as a real estate broker, then as a mortgage originator, the job I do today. For all the changes during my career, I have seen one thing remain constant: the belief that real estate, though battered after the 2007-2008 meltdown, is still a good investment.
I have had hundreds of conversations with clients where they have expressed their desire and plan to build wealth by owning real estate. Some of these energetic and optimistic souls have spent countless hours and many dollars buying distressed properties, hoping to get a bargain, fix them up and sell for a quick profit. Many of these would-be real estate entrepreneurs discover that the actual experience is different from the creatively edited programs on cable television.
There are some who, seeing the equity growth in their own homes, decide to invest in rental homes for the long term. This article is intended for them.
Will Rogers famously said, “I had been putting what little money I had in [real estate], [because] there was only so much of it and no more, and that they wasn’t making any more.” Real estate—especially residential real estate—has had a long history of increasing in value, with only a few notable exceptions, like the crisis beginning in late 2007. Although there were sharp declines in prices (a severe and rapid market correction), residential real estate is climbing in value again; many areas of the country have increased by more than 7% from the same time last year. This appreciation, together with the use of leverage (“other people’s money”) and favorable tax treatment is what makes real estate such an attractive and potentially lucrative investment.
First, let’s talk about what real estate is not. Compared to other investments, like stocks, real estate is comparatively illiquid. While you can sell your 200 shares of IBM for today’s market price with a simple phone call, selling real estate involves far more effort, time and expense. This means that investing in real estate and enjoying the fruits of that investment requires a certain amount of planning, foresight and time.
Real estate also requires some degree of management. If you own a rental home, for example, there are rents to be collected and maintenance to be kept up. As the owner, you have to be aware of the rental market and charge the appropriate rents. You should be a keen judge of character; renting to the “wrong” tenants can cause major heartburn and lost profits. While it is possible to hire an outside company to manage the property professionally, the fee for this service can consume much of the profit generated by rents. Most owners of small residential properties choose to manage their own properties.
(Next: Leverage–how it works, how to use it)