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10 Questions New Real Estate Investors Need to Ask

July 23, 2021

If there was a clear and well-defined roadmap that investors could follow to succeed in the world of real estate, just about everyone would jump on the bandwagon. However, while real estate investment brings with it the potential for significant financial growth, it also comes with risks. Given the complexities linked with investing in real estate, getting as much understanding about this asset class as possible is vital.

According to the Emerging Trends in Real Estate report released by PwC that takes the ongoing COVID-19 crisis into account, the value of single-family homes, data centers, and industrial property is expected to increase in times to come. However, investments in hospitality and retail may expect a drop. The report also suggests that just how well the country does in controlling the pandemic will have a bearing on how the real estate sector fares in the long run.

Here are the most important questions new real estate investors need to ask before taking the plunge.

1. Who Will Handle Basic Repairs?

If the property you purchase requires basic plumbing, electrical, or any other type of work, would you be able to carry it out yourself or would you require professional assistance? If you opt for the latter, this expense will eat into your profits. As someone who is starting by investing in one or two properties, it may make sense to try and do minor repair work on your own, provided the work does not require a building permit and you can perform the repairs in a safe manner. When you move forward and build a bigger portfolio, you may put together a reliable team of handymen and contractors.

2. Do You Have a Real Estate Investment Strategy?

New real estate investors should have a strategy in place even before they spend their first dollar. There are several variables and factors that affect real estate investments. Without carrying out the required market research and formulating a suitable real estate investment strategy, getting sidetracked becomes a distinct possibility.

Those who are new to this realm should formulate strategies based on their own investment goals, and stick to them. You might have to fine tune your strategy in the future.

There are three main strategies that real estate investors follow, which include opportunistic, value-add, and core. In addition, investors also need to choose from different types of properties such as land, residential, and commercial. While one investor might benefit by looking for opportunistic fixer-upper homes, another might do better by going the buy-and-hold way.

3. What is Your Financial Goal?

Another question that begs to be answered is whether you have a financial goal as a real estate investor. Do you want to start as a part-timer or do you plan to devote all your time and energy toward real estate investment? In addition, do you wish to purchase and hold on to a property and make a profit after it appreciates, while also generating passive rental income all along? Or would you rather flip a house and make a quick profit?

Before you start investing, try and make as accurate a calculation as possible assessing whether you might end up losing money in the first few months, the point at which you may break even, and how much you might make after three to five years.

4. How Accurate Are the Model Assumptions?

Just about every private real estate investment comes with the promise of high returns at the beginning. However, while a few exceed expectations, there are some that even end up in the red. Unfortunately, tweaking just one or two of many variables gives real estate investment managers the ability to make any investment appear lucrative.

Instances of real estate investment managers building models with the sole aim of attracting investment are not uncommon. On the other hand, there are managers who create model assumptions while being as realistic in their projections as possible. One way to find out if investment managers are following the right approach is to question all the assumptions in their models.

Making note of the projected internal rate of return (IRR) is important. If the same sector presents 10 different opportunities with IRR projections ranging between 15% and 20%, achieving a 30% or 35% IRR may well be far-fetched. Conversely, deals that come with seemingly achievable IRRs might work well for you.

Take a look at the exit cap rate assumption and determine if it comes with a built-in cushion to account for risk through increasing rates. Exit cap rates, more often than not, are 50 to 100 basis points above existing rates.

5. Do You Have a Good Team?

Even though you might think you can handle your real estate investments on your own, you need to understand that people who succeed in this realm have reliable teams. Real estate investors should ideally start building their teams right from the time they’re looking for their first property. In addition, all your team members should be knowledgeable and passionate about this field.

Know that putting a successful team together might take some time, and you might have a few hits and misses along the way. The key is to keep going until you have the best in each class working with you. By the time you’re done, your team should include:

• A real estate agent who specializes in investment property
• An accountant who knows all the nitty-gritty involved in investment property income taxes
• An attorney who has in-depth knowledge of real estate as well as contract law

6. Should You Seek Finance or Invest Your Own Money?

The answer to this depends on any investor’s individual goals. For instance, if you’re looking at generating a positive ongoing cash flow, using your own money might be the way to go. Consider this example – you make a $100,000 investment and end up with 9.5% annual returns (or $9,500) after accounting for rental income, income tax, property tax, and deprecation.

Going the financing way might help you get higher returns. With the same $100,000 example, you pay 20% (or $20,000) as down payment. Using an estimated interest rate of 4% on the $80,000 mortgage, earnings stand at around $5,580 per year after accounting for additional interest and operating expenses. This return of around 30% on the down payment amount is significantly higher than the 9.5% you’d make investing $100,000. However, your cash flow in this scenario would be lower.

6.1 How Do You Plan to Get Financing

One way to get the required funds for your investment property is to tap into the equity you’ve built in your own home. In this case, you might be able to borrow up to 80% of the equity value and use the proceeds to buy your second home.

If you plan to fix and flip a home, thoughts about getting a fix-and-flip loan or a hard money loan might cross your mind. While these short-term loans are typically more easy to qualify for than a Conventional property investment loans, they come at a considerable cost. This is because interest rates and associated fees can be staggeringly high.

Getting an investment loan to purchase a property is not the same as getting a loan to purchase a second home. To qualify as a second home, the property you purchase needs to be at least 50 miles from your primary residence. With an investment loan, there is no such limitation. However, getting an investment loan to purchase a home might require that you pay at least 20% as down payment, and that you have two or more years of experience in managing properties.

7. Where is the Property Located?

The location of the property you wish to invest in has a bearing on your long-term expenses. For instance, will commuting to and from the property require no more than spending on gas, or will you have to pay additional transportation fees such as airfare, or train tickets? In addition, the further away a property is from your existing home, the longer you will spend commuting. Consequently, you might also lose out on productivity.

New real estate investors are typically better off choosing properties that are closer to where they live.  As long as your property is no more than a drive away, dealing with tenants and service providers remains fairly easy.

If you wish to invest in out-of-state properties, consider waiting until you get more experience. However, this rule is not set in stone, and there may be exceptions where out-of-state investments are the way to go. For example, the region you live in might not offer a desired IRR, and looking further might be the order of the day.

8. Have You Weighed the Pros and Cons?

Just about any financial decision requires that you determine its pros and cons at the very onset. As with other types of investments, real estate investments also come with their share of rewards and pitfalls.

Pros

• You get time to focus on your regular job while earning passive income at the same time
• An increase in real estate value translates into higher returns
• All the interest you pay toward a loan for an investment property is tax-deductible from investment income
• The Social Security tax does not include the rental income you earn in your taxable income
• You can include your real estate investment in a self-directed IRA (SDIRA)
• Barring major turmoil in the market –as experienced during the financial crisis of 2007-2008, – the real estate market typically displays more stability than the stock market
• Real estate investments are tangible

Cons

• Dealing with tenants can seem daunting, and hiring a property management company comes at a cost
• You might have to deal with high entry and exit costs
• You cannot depend on your rental income to cover for your mortgage payments
• In the absence of tenants, you still need to keep paying relevant taxes and spend money on maintenance
• If you need money quickly or if the market is taking turn for the worse, selling your property in haste might not be possible
• If your adjusted gross income (AGI) exceeds $200,000 in case you’re filing as an individual or $250,000 if you’re filing as a married couple, you need to pay a surtax of 3% on all your investment income (rental included)

9. Have You Thought About Getting a Real Estate License?

Getting a real estate license comes with advantages and disadvantages. Having one gives you unhindered access to countrywide multiple listing services (MLS), and it opens up a completely new channel for networking. A license also gives you the ability to take home a larger cut, because you don’t have to pay a percentage of your profit to the agent who might otherwise have worked for you.

A distinct advantage of not having a license is that diversifying your deals becomes simpler because you can then work with multiple agents who specialize in specific areas. Besides, getting a real estate license comes at a cost, and you will also need to devote time and energy to the process. The decision eventually boils down to your investment goals.

10. How Will You Structure Your Company?

Individual real estate investors have the option of registering as sole businesses or S Corporations. However, most real estate businesses in the U.S. are structured by forming limited liability companies (LLCs). This is because LLCs operate as distinct and separate legal entities. Simply put, an LLC can use its own name to carry out business, open bank accounts, and get a tax identification number. LLC owners, referred to as members, have limited liability. This typically ensures that they do not hold personal liability for the LLC’s liabilities and debts.

Conclusion

Since real estate investments come with risk, doing your homework is crucial, and it is equally important that you keep learning. As a new investor, start by picking a single niche so as not to complicate matters in the early stage of your venture. Once you become comfortable, move forward.  Make sure you never stop networking, because the more the relationships you manage to build as a budding investor, the better off you’ll be when you begin experiencing growth.

Bear in mind that it is normal to get inundated by doubts and questions as a beginner.  However, once you’re clear about why you’re entering this realm in the first place and what your goals are, the path becomes simpler. If, at any stage, you are unsure about the way forward, seek professional assistance, be it through an investment manager, a mortgage provider, a real estate agent, or a real estate attorney.

DISCLAIMER:

30-YEAR FIXED-RATE MORTGAGE:  THE PAYMENT ON A $200,000 30-YEAR FIXED-RATE LOAN AT 3.875% AND 80%LOAN-TO-VALUE (LTV) IS $940.14 WITH 0 % POINTS DUE AT CLOSING. THE ANNUAL PERCENTAGE RATE (APR) IS 4.026%. PAYMENT DOES NOT INCLUDE TAXES AND INSURANCE PREMIUMS. THE ACTUAL PAYMENT AMOUNT WILL BE GREATER. SOME STATE AND COUNTY MAXIMUM LOAN AMOUNT RESTRICTIONS MAY APPLY.