Real estate has been one of the primary sources for investors to place their money for the last thousand years. There have always been investment opportunities for money lenders (a.k.a. banks) of all kinds, but real estate has been one of those investments which includes your home, and this is where the story starts.
Most real estate investors own their own home, and may have either purchased or inherited a rental home or small complex, apartment community, or building that houses their business.
But is operating rental properties profitable?
Statistics provided by the bureau of census for multi-family properties in a report authored by Howard Savage using 1995 information deduced the following:
“Overall, 58 percent of multi-family properties made a profit or broke even. About 27 percent had a loss and 16 percent of the owners did not know whether they made or lost money. About 58 percent of the small- and medium-size properties made a profit or broke even, compared to 51 percent of larger properties.”
This should encourage you to reflect again on your investments. I am guessing that those who did not know if their investments made or lost money ran their investments through their home checkbook, and did not separate their investments from their business or personal finances (not a strategy I recommend).
So how does this tie in to setting goals? Goal-setting means setting measurable goals. If you can’t measure your progress, what good is setting goals? In other words, you need monthly and annual financial statements on your property to establish if you are making the right decisions.
Are you one of the 58% making money, or one of the 42% possibly losing money? Is this a better track record than the stock or bond market? Could you make more money by investing in your own business? Is real estate recession-proof?
You need to start setting income goals for the business you are in. Remember that Ray Kroc of McDonalds Hamburger fame only started making money once he owned his own locations instead of leasing them. You should probably also seek tax advice before you start investing. An hour with an educated and experienced CPA that understands real estate (and possibly has a few rentals of his own) can help you direct your whole future. Bear in mind that this first visit may cost you more than $50/hour with your tax preparer, but this one hour will help set the stage for your lifetime.
Let me give you an example: Just last week a client came to visit me to review his investments. We sold him a 16-unit property 5 months ago, and he was looking for advice for the future. This client earns more than $250,000 a year, but I did not know that when we were looking for a property for him. I assumed he was making under $150,000 a year. He went into the investment highly leveraged and was looking for a break-even proposition plus tax shelter for his income using the depreciation holdbacks provided for.
He did not see a CPA until after his purchase, and discovered that he made too much money to find tax shelter in real estate. Now he is reviewing his decision (the property has a small positive cash flow, but fortunately is in great condition in a good location and is fully rented).
This brings us to you, the reader of this article. Investing in real estate is not for the risk-adverse. Before you buy, you need to invest. You must see a CPA, and you must compare your options. Leverage is good, but you need to decide if you can feed your property if there are high vacancy rates. With the employment cutbacks, the concurrent shrinking of many businesses, the lack of available jobs in many markets, accelerated construction of subsidized housing and assisted living facilities, plus low interest rates, real estate has been attacked by some of the highest vacancy rates in years. In some markets residential and commercial vacancy rates exceed 15%. This makes high leverage investing a more dangerous game. With your CPA you must map out a strategy that fits your income and risk tolerance.
Then you should probably go to your attorney and establish a limited liability company (LLC) to protect yourself in this environment of litigation and finger-pointing. Insurance companies are covering less and less. This means that you need to place into reserve at least the amount of your much-higher deductible as insurance rates are also rising, as well as some additional funds to help you keep your property in perfect condition to avoid/prevent accidents. Prevention is 9/10 of the way to keeping your operational costs and litigation expenses in line.
Now you can visit your local real estate investment counselor because you know what you want to accomplish. The capital flight from the stock market has super-heated the demand for real estate investments — resulting in many investments that may not suit your criteria. What does that actually mean? It means that you have to be patient. Don’t buy the first thing that looks great — it needs cash flow. Maybe you need to put more money down, or maybe you need to invest in a different marketplace, but don’t expect all real estate to make money. Remember that only 58% of multi-family investors made money in 1995. Where does that put you?
Finally, when you invest, realize that real estate is affected by the economy just like the stock market. Purchase carefully. Maybe your first investment should be small so you can make mistakes and learn from them. Many people have become wealthy investing in real estate, but they did it carefully and they did it by playing their strengths. Because they had goals, they knew when to hold them and when to fold them
Written by Clifford A. Hockley