Investing in Real Estate = Being all Grown Up
I don’t know about you, but there is alot of talk these days about buying a second home, a vacation home, a launch pad for the kids, or even taking their current house and making it a rental.
Back in 2012, our family lived in a cute little house in Highland Park (an up-and-coming Seattle neighborhood) that we were quickly growing out of. Because the market was in downturn, we literally couldn’t afford to sell. Instead, we turned it into a rental and purchased a larger house in a nearby neighborhood. Today, the value of that house has more than doubled, we are getting more in rental income than our mortgage, and the area is perfectly walk-able to nearby restaurants and bars that have popped up. If our kids ever needed a home after they are grown or if our parents need to be close by, there is an option to consider. We fell into this position, and are so glad.
Buying an investment property can be a surefire way to build long-term wealth. But so many people don’t move forward because they aren’t sure how to choose the right property, aren’t sure what expenses they will have, are not sure about the tax implications, and are not even sure about how the investment will pay off. There are a few different ways you can analyze a property’s potential and I would be happy to sit down with you and explain more if this gets you thinking!
· Appreciation – How much is that property going to be worth in one year, five years, ten years or more? Let’s say that an investor wants to buy a property worth $400,000 and he or she puts down $100,000 (or 25%). The appreciation gained is on the whole property, not just 25% that the investor owns. If that investment appreciates at 5% per year, in five years, it will be worth $513,343 and the investor will have gained $113,343 on their initial $100,000 investment.
· Cash Flow – Each property will have income and expenses. Income includes rent while expenses include any utilities paid by the owner, property taxes, HOA or condo association dues, insurance, and property management fees (if the owner is not managing on his or her own). Some people include “debt service” (mortgage payment) in expenses and some don’t (although I do for this simple exercise). Remember, both sides of the equation can rise over time, so I recommend looking at cash flow year one and at least up to year five.
· Cap Rate – Cap rate is a tool that investors use to determine how quickly they can expect a return on their investment. It is calculated by dividing the net operating income by the value of the property. Continuing with our above example, in year one, the cap rate of this property would be 1.33% - not nearly enough to get savvy investors excited. According to NOLO, 4-10% is a reasonable expectation for an investment property.
There are other ways as well to evaluate an investment property. Don’t let opportunity to build your investment portfolio pass you by. Let’s get together and work on your investment goals in 2019.