How to Safely Invest in Real Estate. Part 6

Real Estate Agent with Fore Properties

Now that we have narrowed our search down to a specific neighborhood (Part 5), we need to start to look at specific properties. I will be using rental houses in my examples, but the same logic applies to mini-storage, office space, retail, etc.

Finding properties that meet your general criteria is easy enough to do. Simply contact the Realtor in your Mastermind Group (Parts 2 & 3), or do the work yourself by cruising the neighborhoods, searching the local papers, surfing on, etc. The best, and in my opinion, easiest way to eliminate properties is using financial spreadsheets, which I'll cover in Part 7. This eliminates a lot of legwork and wasted time looking at properties that will never meet the criteria necessary to make a good investment property.

That brings up something important. You need to be able to answer a question about your motives and investment philosophy. Why are you investing in real estate? There are two basic ways to create income and wealth through real estate--appreciation and cash flow.

Appreciation is the process of allowing the rising tide of the general market to raise all ships, including your investments. This is a good strategy overall, but can backfire if the market goes south, as it has in several areas across the country. If, however, you can hold your property through the temporary downturn, not to worry. Cash flow is when the monthly income on a property exceeds the monthly outgo. It is difficult in my market to achieve both good appreciation and positive cash flow, so I make my investment decisions based on which avenue I want to pursue.

For appreciation, I buy new or nearly new homes in nice neighborhoods and try to cover all expenses with rental income. In 3-5 years, the market will have grown to the point that I can sell for a profit or re-finance and make money available for other investments. Another way to glean appreciation is by purchasing homes that need work and investing "sweat equity" into them, then flipping the houses when you're done. The best flip markets are in areas that have steady job creation, without much new construction, which creates a supply shortfall. The Cardinal Rule for Appreciation Investing is, "You make money when you buy the property." In other words, you have to be careful not to pay too much on the front end with the expectation that appreciation will overtake your imprudent decision. That false assumption has led many investors into foreclosure in the recent past.

For cash flow I buy low-income, Section 8 housing. Generally, I can buy these properties for about $30,000 and rent them for $600, which covers my principle, interest, taxes, insurance (PITI) and all other expenses and still allows for a net cash flow of between $150-$200 per month per property. It's not much, but it adds up quickly, and because I have an awesome property manager as part of my MMG, I have almost no headaches. It is almost totally passive income with very little cash, read risk, invested in any of my properties. In addition, there are still a lot of loan programs for a small investor. All of my Section 8 properties are on 90%, 30 year fixed mortgages. Be aware, however, that once you have between 8-10 properties, you will not qualify for most of these programs. You will then fall into the commercial loan arena, which has tougher financing requirements, such as 70% Loan-to-Value (LTV), shorter amortization periods and Prime + interest rates.

In the next blog, I'll discuss Cash-onCash, Internal Rate of Return and how to evaluate one investment over another.



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