You hear the commentary – “Diversify your Investments!, ” “Buy Low and Sell High!,” “Real Estate is a Strong Investment,” etc., etc., etc.
So, perhaps you are a 40 something year old and have wondered, How do I do that? Where are the risks, what would it cost, is it feasible?
Relax. We will spell out some examples on how to do this, and demonstrate why so many investors like Real Estate in their portfolio!
So, where do we begin?
The easiest place to start is to figure out your budget. Investment homes have to be treated as if you will need to make payments on occasion, so it is prudent to figure out what you can afford if this happens. Banks like to use a “back end ratio,” where they take your monthly payments and divide them by your gross monthly income. So, if your monthly gross income is $5000, then multiply this by 45% or .45, and your maximum out go of payments would be $2250.
Thus, if your new payment is going to be $1000 per month, ask yourself, could you afford that if there was no tenant?
The second place to look is the purchase price and down payment options. When considering these, the majority of the research is focused on the loan choices – do you want the lowest payment possible in case of tenant issues? Or, can you manage the higher payment of a 30 year fixed in return for a stable, low risk mortgage? The answer usually lies in how long you anticipate keeping home – so if you are a shorter term investor – say, 5 years and out, then a 5 year adjustable loan is likely the best fit. However, if you are thinking longer term or are unclear about when you would sell, then the 30 year fixed is often the best fit.
There are lending options that will allow as low as a 10% down payment, which means less cash into the deal, but more financed and in turn a higher monthly payment.
If you can commit more to the down payment, then you are entitled to more lending flexibility. How much would it take to get a positive cash flow each month? This is a critical question to answer so your investment produces the desired return.
So, what are my choices?
The standard loans are either fixed interest rates or adjustable interest rates. The lower the monthly the payment, better the likelihood you will have a positive cash flow. This is a primary reason that people choose adjustable rates, since the starting interest rate is lower,often substantially lower than fixed rate mortgages.
So, a standard investment purchase is 25% down, with the remaining 75% being financed. So, if you are purchasing a $300,000 home, the loan amount would 75% of that, or $225,000. Assuming an interest rate of 3% on an adjustable, the monthly payment would be $948 before adding taxes and insurance. If the insurance is $75 per month and the taxes are $313 per month, the total monthly obligation is $1336. If this home can draw $1500 in monthly gross rent, your positive cash flow is $164 after paying the mortgage, taxes and insurance. If the real estate market is on an upward trend, then the home is gaining value AND you are having a positive cash flow!
That is the primary reason for investing, where you produce a monthly income AND see your asset increase in value. The real estate market is a roller coaster, however – so this can be a tricky conversation. If market values are stable, or worse, going down – how long would you tolerate the investment?
The fine print…..
Here are the caution or red flag concerns to carefully consider:
Market values – are they stable or increasing? What is the projection for the next 5 years? Realtors are a great source of insight when answering this concern, as they watch the trending of markets for a living and are well versed in information.
Tenants – this is a constant concern: Will they take care of the property? How long of a lease can you get a commitment for? Where do you find tenants? Do you want to manage the property, or have someone manage it for you and pay a monthly fee instead?
Adjustable rate mortgages – when will it adjust? What are the max adjustments or caps? How would the cash flow look if rates adjust 2%? Can you still manage the payment?
Goals – what are your expectations for value gain, interest rates, how much cash flow are you counting on? All of these expectations are important to weigh.
Real estate is a term investment, as long as you take into consideration all of the risks and goals involved. There are periods where you can see dramatic value gains, and times where it stabilizes or even drops. Have a conversation with a realtor to get a clear sense of the market, and have a conversation with a lender or mortgage broker to have a clear sense of the loan details. Information is always a good thing when making such a large investment.
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