Yahoo Finance How to Begin Investing in Real Estate
An unusually long and harsh winter is delaying the start of the spring housing market, but for the investment-minded, continued low interest rates and high demand for rentals appear to outline an opportunity.
Institutional investors and their buckets of cash have dominated many markets for the past several years, according to real estate data cruncher CoreLogic. But at the end of 2014, cash sales declined to a national average of 36.1 percent, down from 38.8 percent in November 2013. CoreLogic also reported that the foreclosure inventory declined 34 percent at the end of 2014. That means individual investors are starting to have a shot at lower-priced properties ripe for fixing up and renting, real estate professionals say.
If you are thinking of tiptoeing into real estate as an investment, you have two basic approaches, says Leonard Baron, a lecturer at San Diego State University and author of several self-published guides to investing in real estate.
Buying shares in a real estate investment trust. You can invest in a REIT, but doing so involves buying shares of a portfolio of properties. "It's really more like buying a stock or buying into a fund," Baron says. "It's a completely different animal from owning real estate directly."
"There are three layers of value -- the real estate itself, the management and cash flow that supports the trust, and the fund based on the trust," explains Gary Gastineau, founder of ETFConsultants.com, based in Bonita Springs, Florida. "It's a very different vehicle than buying real estate, but most of us can't just go out and buy 1 percent of a skyscraper."
Adding a REIT to your portfolio can complement stock and bond funds, Gastineau says, but you must be sure you understand how the real estate fund is designed and how its managers will likely extract value from the holdings. You can buy shares of REITs and real estate-based funds, but the performance of the funds is based on both cash flow and gains from occasionally selling properties -- a very different scenario from the typical performance drivers of stock and bond funds.
Direct ownership. This is anything but a passive investment, Baron says. "People think it's easy money, that there's not a lot of work, that tenants will pay on time and that pipes never leak," he says.
Some individuals enter the market by buying a small apartment building, he explains. You should research diligently to find a good deal on a building that produces positive cash flow and has no hidden defects that will require expensive repairs. Don't take investment guidance from a real estate agent, Baron warns. To them, everything is a good investment, because they only win a commission when you buy.
Don't assume your personal experience as a homeowner translates to managing rentals, just on a bigger scale, he adds. From complying with fair housing rental regulations to insurance, to making sure the property complies with building codes and common-sense safety guidelines, property management dominates your wallet and your time. "It's a very complicated asset. But because it's a physical asset, people think it isn't complicated," Baron says. "People way underestimate the number of issues that come up."
One way to test your tolerance for being a landlord is to buy a duplex or a small apartment building, with the aim of living in one unit and renting the others.
A nascent rebound seems to be buoyed by millennials who are edging into the market as owner-occupants. Thin on cash, 20-somethings are finding they can gain a toehold into homeownership by buying a small, multiunit property, such as a duplex or three-apartment building. Their plan is to live in one unit and rent out the others, says John Mosey, president and CEO of Northstar MLS, a Saint Paul, Minnesota-based data service for real estate brokers.
Although this arrangement can stretch down payment dollars, it also demands a Himalayan learning curve: first-time homeownership simultaneous with first-time landlord.
The most important consideration for potential first-time landlords is to not assume today's rising rental rates will lift future cash flow, Mosey says. Today's tight rental market will be eased as projects under construction enter the market. That means rents will level off, so it's best to work cash flow and return numbers using conservative projections, Mosey says.
Key cash-flow factors include not only predictable costs, such as property taxes, but also variables that can affect the appeal of the units to potential renters. For example, Mosey says, you may think including heat and water in the monthly rent will attract renters. But the actual cost of heat and water is quite different for a single occupant compared with a unit shared by three roommates. The more water and heat they use, the less money you keep.
Two new tools provide additional guidance, data and resources for calculating the cost and return of buying investment properties.
TLCEngine estimates the "true lifestyle cost" of owning a property. It is in the process of being included in listings available through Northstar as this spring's listings are brought online, Mosey says.
"The classic spreadsheet is that you consider for homeownership the carrying cost of principal and interest, but there are other factors, such as schools, utilities and commuting costs, that affect the cost of actually living in the property," Mosey says. "TLC calculates those, which can help you figure out how much you will spend monthly if you are living in the property -- and the same costs will help you market a unit to renters, too. It helps you make an informed decision."
Krishna Malyala, founder and CEO of TLCEngine, came up with the idea as he and his wife were struggling to figure out exactly how much house they could afford. "The monthly payment wasn't the end of the story," Malyala says. "I couldn't base my decision just on the mortgage."
Malyala, who is a financial data analyst, created a spreadsheet to calculate the relative cost of owning various properties he and his wife were considering, and he realized other consumers would probably be interested in his tool, too.
Although a consumer version of the tool is underway, buyers can ask their agents to use it to understand the factors potential renters will consider as they look at rentals, and thus how a landlord can market and price a property to cover the actual carrying cost, plus a return. "You can quickly figure out if you can get positive cash flow," Malyala says.
Another new tool, Down Payment Resource, helps buyers find programs that may help them with down payment assistance.
It's a a new service that buyers and lenders can use to find applicable programs. Rob Chrane, president and founder of Atlanta-based Down Payment Resource, says many programs include owner-occupied properties of up to four units, opening the way for first-timers to build equity and capture income, too.
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