This entry is focused on purchasing, renting, and reselling residential real estate. “Flipping” has been highly popularized, and I’ll leave that for a separate discussion. You won’t find anything particularly profound or magical in this article. I just thought it would be good to put the basics out there for people who are considering getting into real estate investment. In today’s Charleston Real Estate, investing in rental property is more speculative, because it’s difficult, not impossible, but difficult to have much positive cash flow. For the most part, investors are banking on appreciation to improve thier balance sheets, and their income statements once they sell.
There are a couple of ways to get started. You can look for distressed properties, hoping to gain some sweat equity, or take advantage of a situation where the property is in less marketable condition, and thus, can be gained under market value. What many investors are doing to make the most of their time is buying brand new homes. They look for long build times, so that by the time the home is finished, they have already had some appreciation. Deposits on less expensive properties are usually only $500 or $1000. This option often requires being in the know about when new lots are being released, because many builders have verbiage in their contracts to limit the number of investors in a community, versus resident/owners. There may be only a few opportunties available to investors in a given community, and they may get taken up pretty quickly.
So, how do you calculate your return on investment so you can compare it to just buying CD’s, or investing in a safe mutual fund? You start off with how much cash you have in the deal. Generally, the less of your own cash you use starting out, the better off you are. But 100% or high percentage investment loans are tough to come by, and you’re often rewarded with a lower interest rate if you have more of your money in the deal. So, let’s say you buy a small 3 bedroom 2 bath home in Summerville, Goose Creek, or Moncks Corner for $150,000 and you put down 10%. You have $15,000 in the deal, assuming you were able to negotiate that the seller pay most or all of the buyer closing costs. Let’s assume that your cash flow is completely neutral, so you net zero dollars. You sell the property after four years, for $205,000…not an unlikely scenario, and you pay commissions and closing costs of $14,000 and you put $5000 into the property to replace and upgrade the flooring. You’re up $36,000, right? So, you made $36,000 over 4 years on an investment of $15,000. That is $9000 per year or a 60% annual return on investment. That sounds too good to be true, so let’s do a more pessimistic example. Let’s say your payment on $135,000 was was $1070, and your rent was only $900. And let’s say the property was vacant for three months over the four years. And the renters were pretty rough on the place, and you had to spend over the four years, $20,000 on flooring paint and appliances. And that you were only able to sell the property for $190,000. Well, now I need a spreadsheet to figure all that out… and I don’t have time right this minute…so let’s try this. If you’re interested in recieving a copy of my spreadsheet when I get it finished, just email me at email@example.com, put “spreadsheet” in the subject line, and tell me your name if you don’t mind. I’ll send you the spreadsheet with all the input per this example, and you can use it with any numbers you want.
Some of you are already ahead of me…you’re thinking…but what about depreciation? And what about paying down the mortgage? I didn’t forget…was just trying to keep it simple. It comes together much better using the spreadsheet. The example above might be slightly optimistic, as you’ll see if you do some other scenarios, but if you run your own scenarios, you’ll see that the return on investment is very, very good. And even though you run the risk of having a bad renter trash your place, or have a couple of vacant months…the potential profits are well worth it. So what about depreciation? It’s interesting, even though your property is actually appreciating, the IRS allows you to write off 1/29th of the value of the improvements…i.e. the house every year. So, your $150,000 house has a land value of $40,000, that’s a pretty expensive .2 acre lot, you get to write off 1/29th of $110,000 every year on your taxes, or $3793. If you’re in the 25% bracket, then that’s $948 in deferred taxes. I say deferred, because if you ever want to cash in, and use the money you gained from your investment, you will have to pay taxes on it then. But in the meantime, you have the use of that money, and the IRS doesn’t. Please, I am not a CPA, so make sure you discuss your decisions with them before you act.
So, what’s the catch? The catch is, to optimize your profits, and avoid the possibility of a loss or poor return requires that you have two things. Knowledge and help. You need knowledge to pick the right neighborhood, floor plan, builder, upgrades, etc. A lot of investors over the last three years took advantage of low interest rates and other favorable conditions and bought in The Farm in Wescott. And I mean, a lot. There’s probably a way it can be researched how many homes on a given street are investment properties…that could be another article for another day. What will be the affect of the Wescott Thruway? Probably not too good. (There are currently 58 properties in the MLS actively for sale in the Farm alone. Not all of Wescott, just The Farm. )
You know what you like, but do you know what characteristics appeal to the majority of buyers? Do you know what improvements or upgrades will give you the greatest return? Is it worth $8000 to back up to woods or wetlands?
What about builders? What do these homes look like in 4 years? Is there a significant difference between a Beazer built home and a Centex built home or a KB home once they’ve been lived in? What repairs show up on home inspections on 5 or 10 year old homes?
By help, I mean that there is work involved. You might do some of it yourself, but at some point, you might not want to be the person that goes over to fix the toilet. So, you need reliable people you can count on. And if you’re going to get into the game in a bigger way, you’re going to need the right people on your team…lenders, closing attorneys, Realtors, repairmen, etc. that you can count on to do good work and save you hassles and aggravation.
So, back to return on investment. A lot is going to depend on what you buy and the quality of renters you get. Proper selection involves hard work, weighing the pros and cons of dozens of properties, taking the time to develop your criteria for the house, price and terms. If you’re really serious about investing, I suggest picking up a copy of Gary Keller’s The Millionaire Real Estate Investor. It’s straightforward, and doesn’t have all the hype of the get-rich-quick books and seminars. You can make real money in real estate, but it does require real work and real risk.