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Insider Secrets to Financing Your Real Estate Investments
What Every Real Estate Investor Needs to Know About Finding and Financing Your Next Deal
By Frank Gallinelli
The McGraw-Hill Companies, Inc.Copyright © 2005The McGraw-Hill Companies, Inc.
All rights reserved.
Identify Your Comfort Zone
There is an old saying—if you don't know where you're going, any road will get you there. Succeeding as a real estate investor, or as anything else for that matter, requires that you develop a plan and then follow it. The very fact that you want to succeed as an "investor" establishes that your main purpose is not to flip properties for a quick profit but rather to select investments that will provide a meaningful return—and gain—over time.
Part of your plan should be to establish basic guidelines concerning properties you'll try to acquire. Be proactive rather than reactive—define what you're looking for; don't just respond to whatever crosses your field of vision. Especially if you are working toward your first real estate investment, you want to seek out a property whose cost, location, and type will fit best with your financial resources, skills, and experience. The first step then in finding a suitable investment property is finding your comfort zone.
1. Identify a price range
How much cash do you have available to you? How much financing are you likely to obtain? (We'll talk about this topic in greater detail in a later section.) If banks are offering loans at 80 percent of a property's value and you have $50,000 to work with, then $250,000 would represent a reasonable purchase price. You might choose to look at properties with asking prices approaching $300,000.
Keep in mind that, depending on the type of property and its condition, you might be wise to hold back some cash as a reserve to deal with unanticipated repairs or with a loss of rent income.
2. Choose a location
You will certainly read somewhere about the virtues of scouring the country looking for great investment deals. As the argument goes, if you make a spectacular deal you'll be able to afford the services of a local management company to run the property. Actually, there is a lot of truth to that argument but there is also an important caveat. If you are a relative novice at real estate investing, this is not a prudent way to start. If you have never tried to manage a property yourself, then it's very difficult for you to have a sound, long-distance sense of how matters are going. Is the local employment market or business climate changing? Is the rental market changing? Is the management company doing an acceptable job? Is the property being kept clean and in good repair? With experience, you learn to stay attuned to these issues. However, if you start off owning properties you seldom or never see, occupied and managed by people you seldom or never see, then you miss the opportunity to develop that kind of experience.
If starting off with properties in a remote location is a bad idea, then starting off with properties nearby must a good idea. Distance is one consideration, but not the only one. Yes, the property should be close enough so you can get in your car and go there without having to pack a bag. Equally important, as the anvil salesman in Music Man says, "You gotta know the territory." When you purchase an income property, it can be very valuable to understand the neighborhood dynamics and demographics. If you are looking at property in a residential area, is it characterized primarily by owner- occupants, tenants, or a mix? Is there very little turnover among rental units or is it an area favored by students, with frequent turnover? What is the typical rental rate? If the property is commercial—say, retail—are stores doing well? Are there vacancies? Is parking adequate? Do businesses seem to come and go? Is there an apparent "dead spot?" (Just about everyone has seen a place where a dozen restaurants have tried and failed.)
These are some but not all of the questions you want to answer about a neighborhood. The more of an expert you become in the dynamics of a given area, the more success you are likely to achieve, both in selecting and in managing income properties. In short, the more you know about the territory, the more comfort you'll find in your comfort zone.
Sometimes, buying property locally is just not an option. During a recent lecture tour I spoke with quite a number of people who said, "Real estate prices have risen so dramatically here that it simply isn't possible to purchase anything that can even support its own financing. We have no choice but to look outside the immediate area."
If you must buy outside your area—far enough outside that you cannot visit regularly—then you need to have an alter ego or two that you trust implicitly. Essentially, this is similar to my "know the territory" advice except now you'll have to rely on other knowledgeable individuals to be your eyes and ears. You will need a good local broker who will take the time to make sure you understand the dynamics of the area; and you will need a reliable property manager to rent the property and handle landlord-tenant issues. For long-distance investing to work, you have to feel confident that the broker and manager are capable and honest beyond reproach.
3. Select a type of property
You certainly don't have to purchase the same kind of property every time, but if this is your first purchase then you should consider how a particular type of property might suit your personality and skills. If you have experience in business, you might feel right at home with commercial property. If you're comfortable dealing with people, perhaps you'll start with a small, multifamily property. If you're good at delegating responsibility and measuring performance, you might do best with a larger apartment building where you use a property manager.
Let's look at some of the most common choices along with their pros and cons:
a. Single-family residence or condominium
i. Among the easiest types of property to manage because there is just one tenant.
ii. They are abundant; you have plenty to choose from.
iii. If you already own your own single-family home, then there should be nothing about the physical property that is unfamiliar to you.
iv. You can negotiate a lease where the tenant is responsible for all utilities, yard care, snow removal, even property taxes. Obviously, the more extras the tenant must pay, the lower the base rent he or she will expect to pay. The difference might still be worthwhile to you as the landlord because passing these expenses through reduces your uncertainty as to operating costs and reduces your management responsibilities.
v. At some point you might choose to move into the property yourself. Under the current tax code, living there for two years could earn you a significant capital gains tax break (as in, "no tax").
i. Single-family residences might be more difficult to rent than apartments because the rental rates are typically higher (see ii. below).
ii. Single-family residences typically are valued not by their ability to produce income but rather by market data—that is, sales of comparable homes in the area. Even though you might charge rent that seems high compared to that of an apartment, the maximum rent you can achieve may still not be enough to cover your mortgage payments and expenses. You might only realize a positive cash flow after several years of ownership and only realize a meaningful profit from the eventual resale. To estimate whether you are likely to cover your costs with a single-family investment property, you will definitely need to develop cash flow projections. You would be wise to make such projections with all of your potential income-property investments and you'll see how to do so in a
Excerpted from Insider Secrets to Financing Your Real Estate Investments by Frank Gallinelli. Copyright © 2005 by The McGraw-Hill Companies, Inc.. Excerpted by permission of The McGraw-Hill Companies, Inc..
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