A common approach is to purchase an income-producing property such
as a single-family home, an apartment building, an office or retail
building or farmland with the intent to rent the property or units within
it. By having tenants, investors benefit from not only any appreciation
over time, but also the rental cash flow. There's also some inflation
protection because as operating costs increase, rents can increase as
well.
What to watch for:
First, consider what kind of expertise you bring to the table. For
example, contractors can renovate a property; lawyers might write up
leases.
"Everyone brings a certain amount of sweat equity," said
Kyle Cascioli, an adjunct professor of real estate at the University
of Denver's Burns School of Real Estate and Construction Management.
Or maybe your value is on the management side. Those thinking about
becoming landlords should do some soul searching before deciding whether
they can handle the job, said Thomas Lucier, a Florida-based real estate
investor and author of "The No-Nonsense Real Estate Investor's
Kit." Nine out of 10 people aren't suited for the business of managing
tenants or the constant upkeep that the property will require, he said.
And for an investor with a modestly sized piece of real estate, hiring
a separate property manager can eat deeply into the bottom line, said
Rebecca McLean, executive director of the National Real Estate Investment
Association. After all, income-producing real estate isn't just an investment
-- it's a small business.
You'll want to tap the knowledge of a local real estate professional
for help in finding and evaluating an investment property, McLean said.
It's best to contact a broker or Realtor who works regularly with investors,
she added.
Alternately, it's possible to go it alone, but get ready to do some
research.
Location will always impact the value of any piece of real estate.
In residential properties, the health of the local economy and school
district are necessary considerations. Meaningful due diligence is also
required on commercial properties; leases usually span longer than a
year, and research on current tenants is a must.
Deciding whether the property is affordable involves a little more
homework.
Budget every cost that will be tacked on to the price, including closing
costs and insurance. If the property is a fixer-upper, inspections should
prove its structure is still sound; make sure to add improvement estimates
into the equation, including a cushion for unforeseen extras.
Just as important as having a plan to enter the market: having an exit
strategy. Investors should estimate how long they expect to hold the
asset, said Joseph Fisher, president of Indianapolis-based Real Estate
Investment Services Corp., which specializes in developing, leasing
and managing investment real estate.
And despite the income scheduled to hit the books each month, don't
plan to keep every dime, said Lisa Moren, an Oakland, Calif.-based real
estate investor and author of "Real Estate Investing for The Utterly
Confused." Moren advises having an escrow account for required
fixes that pop up and disruptions in cash flow resulting from vacancies.
What to watch out for:
Overpaying for the property
Good research is the key to avoiding this mistake. "You make your
profit when you buy, in most cases, because you buy below market value,"
Lucier said. Some investors can profit by buying properties that need
a little work. Properties that have positive cash flow without any required
repairs may have other areas for improvement, which make mismanaged
properties attractive investments, Lucier said.
Overlooking rules and regulations
Rules abound in the housing sector, from federal fair housing regulations
to laws that spell out how lead paint is to be disclosed. The fines
for noncompliance can be hefty, so do your homework, McLean said. Also,
be aware of a property's building code issues.
Not screening for good tenants
Check tenants' credit and their employment to make sure they can afford
the monthly payments. Also, the longer a tenant stays the better. Every
time a renter moves out and a new one moves in, it costs about two-and-a-half
months' worth of rent -- "whether in marketing, down time and/or
repairs to the property," McLean said. The figure assumes that
there isn't severe damage to the premises.
Taking on too much, too soon
You may want to start small, perhaps with a studio, to decide whether
this type of investment works for you, Lucier said. Also, don't go overboard
on improvements. Major spending in areas that won't provide a decent
rate of return on investment cuts into your bottom line, McLean said.
Entering into a bad partnership
Many investors partner with others to afford a purchase, but you'd
better be comfortable with the arrangement, Fisher said. Sometimes a
partnership teams up a novice with a real estate professional who has
knowledge of the business. Especially for the newcomer in this scenario,
review a real estate investor's past performance before agreeing to
work together
