Basic Principles of Real Estate Investing
January 10, 2012 Leave a comment
Whether you are a newbie or an experienced investor you can never afford to forget the basic principles of real estate investing.
You can use different strategies in real estate to grow your portfolio. These include investing in rental apartments, single family homes, industrial property, retail real estate, office space, hospitality or overseas properties. You can also gain expertise in flipping houses, lease options, investing in off plan property or buying at foreclosure sale. But these can never replace the fundamental principles of real estate investing.
There can be various strategies and methodologies for creating wealth through properties but the principles of real estate investing are eternal.
I have seen many experienced investors who become over confident and violate these principles. They invariably suffer grave consequences. So please study the following fundamental principles of real estate investing with care.
‘Buy and Hold’ will Make You Rich
Always remember that you buy property for capital appreciation. Real estate first and foremost is a capital business. Rent and cash flow are important to help you own the property for long term.
Investing means owning your real estate for long term. Flipping properties and lease options strategies are used to generate cash to fund your long term investments and should not be confused with the long term goal of creating wealth through capital appreciation.
Real Estate is not a get rich quick scheme. Capital appreciation happens over a period of time. You have to have patience, perseverance and persistence. For this you have to understand the compounding power of real estate investing.
How many times I have sold my property for peanuts only to realize a few years later that I would have made a fortune if I had the patience and wisdom to hold it a bit longer.
Please remember the times you have cursed your ancestors for selling a piece of real estate that would have changed your financial future and of the generations to come. If you can help never ever sell your property.
This is one fundamental principle of real estate investing you should never forget.
‘CASHFLOW’ Funds Your Real Estate Business and Gives You Peace of Mind
My advice is very simple “Only buy Cows that give milk.” It is cash flow that funds your life style and gives you peace of mind. The happiest times of your life would be those when you are able to flush with money to pay your bills, take holidays and meet all your financial commitments. Your worst nightmares come when you are low on cash flow to meet your mortgage requirements even when you owned millions of dollars worth of real estate in your portfolio.
The main reason why people get into trouble, have foreclosure sales and become bankrupt are when they fail to understand and monitor their cash flow.
Whether you buy real estate or stocks……. buy only for cash flow. Capital gain will happen over a period of time with any investment. Cash flow in the mean time will help you fund your life style and keep you and your banks happy.
Never buy ‘negatively geared’ properties. There is no fun in buying properties that you will need to fund from your pocket on a monthly basis. How many properties can you buy if you have to keep supporting them from your hard earned money? What will happen if the interest rates go up? Will you be able to continue supporting these properties? Always buy ‘positively geared’ properties that put cash into your pocket after paying all the expenses including mortgages.
Buy land only if you have adequate cash flow from other sources. Otherwise stay away from land investments as they have little or no cash flow. Most people who got into trouble during the crash of 2008 – 2009 were investors with large land holdings in their portfolios. Stick with rental property investments that are cash cows and you will never go wrong.
Remember the good old saying ‘Buy cows that give milk’. This is the secret mantra to success in real estate investing and will keep you out of trouble when things go wrong.
Do the Math’s
Real estate investing has nothing to do with emotions. It is only the numbers that matter. When you buy a house to live in there are emotions involved. You have to have the comfort level, practicality and pride of ownership. Your house reflects your personality. It provides security and warmth to your family.
Real estate investing is all about getting your numbers right. It is about yields on purchase price or market value and capitalization rates. You have to understand what is market value, Cash on Cash Return, Internal Rate of Return and deposit re-cycling time. You have to take into account mortgage financing costs, out goings or cash deductions to work out pre-tax cash flows. And finally you have to take into account the depreciation and other tax refunds to work out the after tax cash flow.
It is not humanly possible for anyone to work out these figures manually when you are comparing let say five prospective properties to buy one. To do the math’s is very important but you have to temper the mathematical outcome with subjective analysis and human judgment with regard to quality of construction, location, quality of the tenant and lease terms. You should never get carried away by numbers alone but subject them to your common sense judgment.
Location Location Location
If the location of your property is right you will never have problems in finding tenants. There is no point in buying a property that shows a great rate of return on paper but has high vacancy rates. Many investors fall prey to not taking into account the vacancy factor and get carried away in purchasing properties that show high yields.
The property you buy should be in the right demographic area where employment and population are on the rise. Once you have found the right geographic area focus further on neighborhoods that are close to places of employment, shopping centers, schools and transportation centers.
If the location is right you will have capital growth because of demand.
Some people ask me….. if the location is so great then the price of the property will increase because of demand and will pull down the rate of return. This will have an adverse impact on the cash flow from the property. There is some merit in this argument but astute investors will find ways and means to add value and increase cash flow by making improvements to the property.
Always Buy From a Motivated Seller
You make money in real estate when you buy. You can buy a property below market value only from a motivated seller. If a person has no motivation to sell then you will never be able to negotiate a great bargain price.
You can accumulate great wealth quickly by simply learning the art of finding motivated sellers and purchasing below market value. Supposing you buy a property for Rs 80, 00,000 which is 20% below market value. If you are able to achieve that then you have created an instant wealth of Rs 20, 00,000.
Use Other People’s Money (OPM) to Fund Your Real Estate
No one has ever become rich by using their personal money. Sooner than later individuals and companies run out of money to fund their growth. You have to learn how to use Other People’s Money or OPM to grow your net worth.
The business of banks is to use other people’s money to make profits. They borrow from you and loan it to businesses at a higher interest rate to make money. You should think like a bank and borrow at reasonable cost of finance to fund your real estate business for much higher profits.
Real estate provides you with a great opportunity to use financial leverage to grow your wealth. Banks and other financial institutions love to finance real estate. The only way you can accelerate your growth is by using OPM and using financial leverage sensibly.
Make Use of the Property Cycle
Property Cycle unlike stock prices are very slow moving and comparatively easier to understand.
The simplest thing for you will be to buy real estate at the bottom of the cycle. But in real life things are not so simple or everyone would be rich. The bottom of the property market is very difficult to predict.
If you will wait for the property cycle to bottom out (which is hard to predict) then you will be able to buy properties only once in seven to ten years. You will miss out on all the other opportunities that happen in other parts of the property cycle.
In real estate you make money either through Cash Flow, Capital Growth or Equity. These are known as the three corners of the property triangle. You will rarely be able to achieve all three at a particular stage in the property cycle. For instance when the property prices are moving downward you cannot buy real estate for capital growth but it is an opportune time to buy properties below market value and create instant equity which I think is better than waiting for capital growth.
If you are to be successful in real estate you have to negotiate everything whether it is the price of the property, rent and lease terms with your tenants, mortgage rates with the banks, property management contracts or repairs and up gradation costs with the trades people.
Every time you negotiate you save money and improve your chances of success. For example by negotiating a 0.2% lower interest rate on a 30 year mortgage loan with your bank you can save hundreds of thousands of rupees over the lifetime of the loan.
Everything in business is negotiable. If someone tells you otherwise the person is a fool. Please stay away from him. Real estate negotiation is one skill that you have to master to become successful.
Knowledge of Real Estate Investing is the Key to Success
Knowledge of real estate investing is the biggest leverage you can apply to succeed in real estate. Whether you are a newbie or an experienced property investor you have to continuously upgrade your knowledge.
A brilliant investment property is never seen with the eyes it is always seen by the mind. Thousands of people will pass a property and will see no any value in it. It takes an educated mind to understand what is the real value and potential of a property. Like anything in life education is the key.
You have to constantly read books, watch videos, attend seminars or visit this website regularly for fresh information. You have to acquire knowledge to an extent that it become your second nature. When you reach this stage you will be able to spot a great real estate investing opportunity when you browse the internet, see an inconsequential advertisement in the news paper or during your morning walk.
Taking action is the key to your success. There is no point in having all the knowledge and not applying towards your success.
It is fear that keeps people away from buying real estate. Knowledge to some extent abates this fear. However, no one can reach a state of complete knowledge to overcome fear. You have to act in good faith and intelligence. Inaction will keep you tied to poverty. Once you start taking action your experience and confidence in real estate investing will increase.
Action is always superior to inaction. When I started out I had no knowledge of real estate investing. Believe me take action even if you have limited knowledge about real estate investing. Think big but start small. A few small steps will change the outcome of your life.
Understanding and applying these basic principles is the key to success in real estate investing.