I’m not a personal finance junky, but I do frequently make the rounds on several reputable personal finance sites. One trend I’ve noticed is that investing in real estate as a way to build wealth is a topic that keeps appearing over and over again. What’s amazing (to me anyway) is that this has continued despite the depressed real estate market that has been a thorn in the US economy for the last five years or so.
But is property investment and management all that it is cracked up to be? How much of this PR represents real earning potential, and how much of it is just good ol’ hype? Can average people really make a business out of managing real estate?
I decided to delve into the topic. What follows is a summary of what I found, and at the end is a list of resources for those of who would like much more information than I can offer. I have come to the conclusion that it’s certainly possible to earn money in real estate even if you have only a modest amount of money to invest and even with the real estate market the way it is. BUT, you have to make smart, informed decisions.
The Lowdown on Property Investment and Management
The real game to investing in real estate is to make enough of a return to cover your expenses, such as mortgage payments, insurance, taxes, maintenance, and utilities, as well as justify any financial risk you may be taking. It’s a real world version of Monopoly- except, in this “game” you really don’t want to find yourself going bankrupt.
Yet, it is very easy to see how the uninformed investor could do just that.
Many investors are drawn to real estate because properties can be “leveraged”- that’s financial speak for using borrowed money to finance a purchase. While leverage may allow people to acquire properties that they would not be able to afford on their own and thus significantly increase their potential return, it also significantly increases their risk. In a shaky real estate market, that risk is nothing to laugh at.
For those who are interested in investing in real estate and who are in a position to absorb some risk, there are actually several different categories of real estate investment to choose from. Here are the most popular options:
Residential real estate.
This includes houses, apartment buildings, and vacation homes. Income is generated when people live in these properties and make rental or lease payments.
Commercial real estate.
This typically involves office buildings or office space. Companies can sign a lease in order to conduct business on your property.
Retail real estate.
This includes stand alone retail spaces as well as shopping malls and strip malls. In this case, property owners can not only earn income from standard lease payments, but some arrangements can also include a cut of the tenant business’ sales.
Industrial real estate.
This consists of factories, warehouses, industrial parks where income can be generated via tenant leases, and other service facilities such as, storage facilities and car washes, where income can be generated directly from customers who come to use the services on the site.
Real Estate Investment Trusts (REIT).
REITs are investment products that trade much like stocks. In this case, investors by into a portfolio of properties or real estate mortgages. (Here is a really good article on the REITs from About.com)
7 Ways to Earn Money in Real Estate Investment and Management
There are actually many ways to earn money with real estate investment. Here is a brief rundown of the most popular methods real estate investors use to build wealth:
1. Generating cash flow.
If you have a tenant paying you monthly rental fees, this gives you a flow of cash to pay off any property related expenses or be used for savings and/or purchases.
2. Debt reduction.
If the tenants who rent or lease your property are paying money towards your mortgage on the property, then you have a situation where your net worth is growing. They are contributing towards your equity.
3. Increasing property value via renovations.
You can buy a property and invest additional money to fix it up or expand it and significantly increase its value.
4. Snagging a bargain.
With so many foreclosed properties on the market, many opportunistic investors are buying properties at fire sale prices. The glut of cheap properties for sale has even pushed those people who would not have invested in real estate into the market. Not only can one quickly build equity if there are tenants on the property, but over time the value of the property may rise increasing your wealth even more.
5. Reducing tax obligations.
There are numerous tax deductions available for those who invest in real estate. Aside from depreciation deductions, many of the costs associated with financing, managing and operating a rental property including, mortgage interest payments, real estate taxes, insurance, maintenance, repairs, and utilities, can all be deducted from adjusted gross income on a personal tax return.
6. Rental appreciation.
As inflation and the overall cost of living increases, rental rates tend to increase with it. This means more cash flow for the property owner.
7. Side income streams.
Some kinds of property may allow for additional streams of income streams. A good example of this would be putting vending machines in an office building or mall or vacuum cleaners by a car wash.
Real Estate Investment and Management Best Practices
If you are seriously considering investing in real estate in order to generate income and build wealth, then make sure you keep in mind the following points:
- First of all, you should never buy a real estate investment in your own name. Doing so would put you in an extremely risky situation. If someone is injured on your property and attempts to sue you, then you will personally be held liable, and this means that your other assets could be at risk. Instead, you should set yourself up as a Limited Liability Company (LLC) or a Limited Partnership (LP). This legal entity is relatively easy to set up and won’t cost you so much either. It almost goes without saying, that you should consult with a qualified attorney or accountant to advise you in this process.
- Another trick, suggested by investment expert, Joshua Kennon, is to file a separate LLC for each investment property that you buy. This way, if one investment gets into trouble, you could always declare bankruptcy (if needed) and it won’t pull your other assets down with it.
- If you will be managing several different properties, then it pays to use a good property management software suit. In the U.S., there are several options to choose from. Some of the best include, Propertyware, Appfolio, and Buildium. For my readers based outside of the U.S., online property management software in Australia, the UK, and Canada are pretty common. So do you research to make sure you get the best program to suit your needs.
Real Estate Investment and Management Online Resources
For further reading and other resources on the topic of property investment and management take a look at the following sites:
Real Estate Investment Online Communities
Sites to Help You Locate Properties
- HUD Foreclosures
- Bank of America REOs
- Wells Fargo REOs
- Citibank REOs
- Chase REOs
- Fannie Mae REOs