Real Estate Investment Income Guide
Real Estate Investment Income Guide
Want to increase your income through real estate investing? Check out this free guide to real estate investment income.
By Jan Brzeski
Managing Director and Chief Investment Officer, Arixa Capital
Real Estate Investment Income
Real estate can provide a significant and reliable stream of income compared to other options available in the market. Real estate also allows owners to enjoy a more “hands-on” approach to investing. While no investment is completely safe, and some are inherently quite risky, real estate investing provides a level of tangibility that creates a comfortable and relatable investment vehicle.
The purpose of this guide is to reinforce some of the benefits to investing in real estate and to address the following key questions:
What type of investor are you?
What kind of cash flow can you expect from a real estate investment?
How should you approach the underwriting factors involved in a new real estate investment?
Do you want to realize active or passive real estate investment income?
What are the inherent risks and rewards associated with real estate investing?
A guide to real estate investing can provide a firm foundation from which to enter into the real estate market. This guide contains concise, relevant information to help you evaluate opportunities and take the first step.
What are the other common investment alternatives?
If you are a savvy investor and are looking for an investment that will generate a significant income stream, you would be well served to consider real estate. That said, there are other investment opportunities available today that offer alternatives to the real estate market. Let’s look at some of these and determine the risk-versus-reward factor for each.
Bonds
Generally considered fixed-income securities, bonds essentially in debt an organization or government entity to you for a specified time frame. You will receive interest on the money that is lent out and you will eventually receive a full repayment of the principal. Most investors who are looking to make appreciable yields bypass this option. Most bonds are assumable at almost no risk (especially if purchased from a stable government organization), so the resulting yields are often minimal.
Investment Growth Stocks
Becoming an overnight “part owner” of a business seems like a compelling proposition, doesn’t it? While most stock holders do not necessarily think of themselves as a fractional partner in a business, purchasing stock in a company does provide a miniscule equity position in the company. While bonds provide a steady income stream, stocks fluctuate in value by the minute. This means that you may see a tremendous return on investment (ROI) in a short amount of time. You also run the risk of losing a significant portion of your principal investment quite quickly. Volatility is the name of the game – so be prepared to lose some or all of your stock portfolio should the market take a serious downturn.
Mutual funds
Mutual funds are a blended holding of a group of stocks and bonds. Along with a pool of other investors, you select a professional fund manager to identify and invest in a group of securities. The goal is to achieve a balanced and high performing blend of a variety of stocks and bonds. Mutual funds deliver the benefit of not having to conduct research or draw upon many years’ worth of experience to make a sound investment choice. Mutual funds will often return moderate yields but can certainly lose value.
Alternative investment choices
Investing in gold, or other precious metals, options, futures, and other alternative choices, certainly provides a prospective investor with the ability to make significant returns, albeit with a serious level of risk. If you are new to investing or are risk averse, it may pay to stay away from these peripheral options.
What are some of the key benefits of real estate investing?
Now that we have examined some of the other investment vehicles available, let’s revisit real estate as a source of consistent income. Here are eight compelling reasons why investing in real estate makes sense for the majority of individuals today:
Positive cash flow for life
Provided that you make sound investments, your real estate holdings should generate positive cash flow for as long as you hold onto them. Unlike a 401k or traditional retirement investment, you will see money flowing in each month that can be used as you see fit – savings, reinvestment, leverage for other opportunities, etc. Furthermore, you do not have to run the calculations as to when your 401k money will run out – your real estate holdings can generate income for quite some time!
Near-immediate returns
Investing in stocks, bonds or even your 401k, does not often result in any appreciable ROI that can be exercised immediately. However, real estate holdings can generate returns almost immediately through monthly rental or lease payments or by conducting a quick “fix-and-flip” process to net a lump sum of money.
Easier access to market “insider” information
Those who buy and sell stocks or bonds with insider knowledge of the related business or industry have actually committed a crime. Those who have garnered powerful insight into a particular real estate market have spent the time studying their particular area. You can become, and should be, well-versed in your local real estate market in order to net the most reliable returns on your investments. This local expertise makes you an “insider.”
Valuing real estate investments is simple
The value of a stock is thrust upon you, while the market value of a real estate investment can be determined by financial analysis, studying comparable homes or commercial properties in the immediate area, and by performing thorough physical inspections. You have the ability to determine if the particular real estate investment makes sense for you and whether it can deliver an appropriate ROI based on the initial investment amount.
You can buy below market value
There is really no way to purchase stock below market value. What you pay today is the contemporary value for the particular stock. While there are ways to purchase stock on margin – a practice that is not only risky but also requires significant vetting from a stock brokerage firm prior to them granting you margin privileges – you still have to pay full price for the stock. Taking a cue from the Warren Buffet method of real estate investing can help you only invest in properties that are significantly undervalued or represent an otherwise lucrative investment. According to Mr. Buffet, act as though you only have the ability to make twenty investments over your lifetime and that those investments must provide sufficient gains to keep you comfortable. Using this logic, one will often pass up an investment opportunity that does not feel perfect.
You can add value to a real estate investment
Consider what many investors have successfully accomplished: putting $25,000 worth of upgrades into a property that needs rehabilitation to see that these improvements net a $50,000 increase in value. There are many ways to spend money on an investment property that will drive a larger ROI. Swimming pools are notoriously poor investment choices, while upgraded kitchens, baths, and curb appeal-enhancing landscaping can enhance value.
Leverage your cash!
Leverage is a simple concept that is easily summed up when comparing a stock purchase with a real estate transaction. Let’s say that you purchase a stock for $10 and it appreciates to $11 in one year. The transaction requires you to commit the entire $10, for one year, in order to earn $1. A real estate transaction often requires no more than 20% down (meaning that you are only committing 20% of the value of the property to be able to secure it). A property that appreciates by the same percentage as the stock (a $100,000 property would increase in value to $110,000), would only require a $20,000 investment to realize the $10,000 profit. Tying up just $20,000 to make $10,000 in profit is a pretty compelling argument for real estate investing.
You’ve decided to invest in real estate – but what type of investor are you?
Investors do not always fall on one end of the spectrum or the other. There are many intricate variations on the characteristics of today’s investor. Some are more apt to undertake risky investments, while others like sticking to options like the bond market, where one can invest in relative safety and reap consistent, if minimal, yields.
Most real estate investors lean toward either active or passive investing.
Active investors are “roll up your sleeves” types. These investors proactively seek real estate deals, take pride in planning, scheduling, and managing rehabilitation projects and other restorative work, and are generally involved with the entire process of the real estate venture.
Passive investors, on the other hand, are content to fund real estate projects, then sit back and enjoy the steady stream of cash flow that often results from a wise investment. These investors tend to hire a management services company to dedicate the time, energy, and resources to the real estate investment as opposed getting involved themselves.
Which investor type are you?
In the end, active real estate investing can be quite rewarding and can eventually allow you to amass a real estate portfolio that produces a lot of passive income!
Cash flow analysis is vitally important when considering a real estate investment opportunity Cash flow can be summed up succinctly by stating that it is “the movement of money into or out of a business over a specific time period.” When identifying a property that has historically been rented or leased, it is important to gather all of the financial documents that the existing management firm has on file in order to conduct your own cash flow analysis. These documents can be used to show how much revenue and expenses have been realized over the previous twelve month period, at a minimum, (a good starting point to conduct the cash flow analysis) and will often reflect a fairly accurate estimation of future cash flows.
When sourcing a real estate investment, keep in mind that sellers will often tell you that they have been collecting “below market” rent amounts or that expenses have been out of control recently. They are doing this to make you think that if you raise rents and more effectively manage expenses, then you will realize better margins. Most operators of commercial or residential units charge fair market rents and manage expenses wisely. You are wise to at least assume that they do when forecasting the cash flow figure.
Underwriting is the key to making sound real estate investment choices When you have identified a property that feels like a good investment, you will want to begin to crunch the numbers and apply a variety of underwriting principles that will clarify the potential of the subject property.
Underwriting, in general, refers to collecting enough data to either walk away or offer a price that makes sound financial sense. Some of the key tenets to completing a sound underwriting analysis are:
Analyze the previous year and look at a five year spectrum to gain an even better “big picture” view of the operating efficiencies of the property. Look for anomalies in expenses or spikes in income. A commercial property that had to replace a section of roof or had to undertake a major construction project may show less operating income than during another time in history. Understand the drivers of these spikes and use them to help deliver a more accurate forecast of revenue, expenses, cash flow, and ROI.
Hire an expert to analyze the property and do NOT rely on a selling broker to deliver key stats. Anyone who profits from the sale of the property makes a poor source for hard data. Spend the money on an independent review. In doing so, you will gain a much clearer picture of the potential of the property.
Analyze existing tenants (especially in large, multi-business properties) to determine the age and renewal factors of their lease, their general payment history, and the health of their business. Are they looking to leave as soon as their lease expires? Are they closing other retail storefronts in nearby commercial properties and will this location be next? These questions are vital when dealing with larger commercial real estate investments.
You’ve decided to invest in real estate – but what are the inherent risks involved?
There is no such thing as a completely safe investment. You certainly have the option of parking your money in an FDIC-insured savings account to net a quarter of a percent in interest annually but that isn’t investing! Earning less than the inflation factor drives losses, not gains. Real estate is not a sure bet but it has historically driven reliable yields through market appreciation and rental income. Physical improvements can also drive value appreciation.
Some of the basic risks associated with real estate investing are:
Costly repairs or component failures
Even the smartest investors cannot foresee every mechanical failure or component issue. Costly repairs can eat away at profits and reduce cash flow. Economic downturns: Real estate values can drop, reducing your equity position and minimizing your ability to leverage equity for other investments. Some properties have fallen in value so much over the past ten years that they are have been sold at a loss which can result in penalties or deficiency judgments being filed against the seller.
Natural disasters or personal injuries
Though insurance policies generally offer a substantial level of protection for the property owner, deductibles and other out of pocket costs can pack quite a punch. Plus, personal injury cases can extoll huge sums of money before a verdict is reached.
Overpayment during purchase
By conducting due diligence and hiring the appropriate third-party experts to complete a variety of underwriting calculations, you’ll minimize the risk of overpaying. Neglect to do this, and you run the risk of committing far too much capital to a property that may not be able to deliver sufficient ROI. Also, negotiating loan terms that require significant upfront capital commitment can eliminate the liquidity that you may need to handle property maintenance issues or to invest in other real estate opportunities.
While no investment is perfectly safe, investing in real estate can be exciting, rewarding, and – to a greater degree than stocks, bonds, or alternative investment options – controllable. You determine how much to invest in a particular residential or commercial property. You can conduct a full-scale underwriting of the deal using your own experts and you can determine when to sell, when to raise rents, and when to commit to capital expenditures.
The great thing is that you can start small and learn how to approach the exciting world of real estate investing one property at a time. Whether you want to be actively involved in sourcing, analyzing, and funding real estate deals, or you want to become more of a passive investor, the choice is yours.