9 Key Factors to Keep In Mind Before Investing in Real Estate
Real estate investing is indeed a lucrative venture. Not only does it offer long-term returns, but it also offers a great deal of independence and autonomy for investors. It’s among the most popular ways to fund your real estate ventures, and many different types of investments are available in this field. That said, investing in real estate is more complex than it seems. There are multiple factors you should consider before buying a property. Read this article to learn more about the key considerations you need to remember when investing in real estate.
1. Do your Research
Real estate is a complex and highly speculative asset class. Due to its sheer size and complexity, most investors fail to succeed. This can be attributed to poor practices that lead to high risk and low returns.
Additionally, real estate is one of the most expensive asset classes. Thus, it is important that you “know your stuff” before diving in. There are diverse ways you can do this. One way is to take a course on real estate investment. If you have the time, go through the topic in-depth. It will allow you to understand the real estate investment process in-depth.
1. Stay Diversified and Cautious
Real estate can be a very risky asset class. As such, individual investors must stay diversified. When investing in real estate, it is crucial that you never put all your eggs in one basket. Instead, spread your investment across many different properties. It will help limit your overall risk.
Additionally, you must stay cautious with your real estate investments. Remember that real estate is inherently speculative and comes with a high level of risk. It is important that you don’t become overconfident and over-invest.
2. Consider Property Location
Real estate can be a very risky asset class. As such, individual investors must stay diversified. When investing in real estate, it is crucial that you never put all your eggs in one basket. Instead, spread your investment across many different properties. It will help limit your overall risk.
Additionally, you must stay cautious with your real estate investments. Remember that real estate is inherently speculative and comes with a high level of risk. It is important that you don’t become overconfident and over-invest.
3. Consider Property Location
There are many great reasons to buy a property in an investment neighborhood. However, you should always be mindful of the property’s location. Real estate is very location-specific. Thus, you must consider the location of the property you’re considering investing in.
Also, consider the valuation of the property. Every real estate investment comes with a valuation. This is the amount you’ll receive when you eventually sell the property. It is crucial that you get this valuation correct. If you get the valuation wrong, you’ll end up making a loss on your investment.
4. Investment Purpose and Investment Horizon
Real estate is a long-term investment. Thus, it is crucial that investors consider the purpose and horizon of the investment. This can be a major differentiator between real estate investments and other asset classes.
Investment purpose and investment horizon in real estate investment are two important factors that should be considered before investing. Regarding real estate investment, the first and foremost concern is generating a sufficient return on investment. Hence, choosing the right investment purpose and horizon is important.
Investment purpose is the primary objective of an investment, which specifies the kind of return that a real estate asset is expected to fetch. The investment horizon denotes the period for which an investment is expected to generate returns.
Considering these two factors, it is clear that investors should opt for an investment purpose that would fetch them a higher return on investment. Moreover, they should be in possession of a fixed duration for which they require returns.
5. Expected Cash Flows and Profit Opportunities
It is very important to recognize the expected cash flows and profit opportunities when buying and investing in real estate. It is not just about calculating the profit after the sale; it is about assuming that your investment will provide you with steady monthly cash flows over a while. You can buy a property with the expectation that it will provide you with a regular income.
- A vacant property without any income sources will require a significant outlay in keeping it up to code, in repairs and maintenance, insurance, and taxes. If you can rent this property at a fair rate, you will earn an income before you even begin to cover your expenses — just from keeping it up and running.
- The monthly cash flow would be used to cover your annual expenses (mortgage, taxes, maintenance, repair) as well as the down payment on another investment or for education or travel. The remaining funds could be reinvested into more properties or used for other purposes.
The purchase price would likely be paid off in less than ten years as the principal and interest are paid regularly via the cash flows from the rental.
6. Be Careful with Leverage
Leverage can help you increase your investment and make more money, but it also comes with risks. Before using leverage in real estate investing, make sure you understand all of the risks and the tax implications.
Leverage allows you to use the money from other sources to purchase more property. In addition to your own money, you can use debt financing or lines of credit from a bank or a lender.
- The interest on that debt is tax deductible, but only up to a certain point. The interest that is tax deductible is the interest that accrues while the lender owns the property. As soon as the property is sold, that interest stops being tax deductible and becomes ordinary income that is taxed at regular tax rates.
- When investing in real estate with leverage, you are essentially borrowing money. You can use this money to buy more real estate or pay off some of your original loan amounts. The key to leverage is to not let it overwhelm you and cause you to make poor investment decisions. Thus, it is important that you keep leverage in check while investing in real estate.
7. Indirect Investments in Real Estate
There are a number of benefits of investing in real estate through an indirect route. Firstly, it’s a stable investment option. Unlike equities, real estate does not fluctuate in value. Thus it is better to invest indirectly into a property rather than directly buying one.
Also, you can save tax on the entire yield generated from the property. As such, in many cases, the overall tax outgo from such investment is lower than that from direct property purchase.
You can also leverage your money by investing through a financial vehicle like financial leasing. This way, you don’t have to worry about maintenance or repairs of the property as well as you can benefit from low-interest rates on such loans too.
8. Assess the Real Estate Market
Real estate is extremely dependent on the overall market. This means that if the overall real estate market goes down, so will the profits of real estate investors. Real estate is extremely sensitive to market changes. It is important that investors keep this in mind when considering real estate investments.
- Having an idea about future value is good for all investors, but it’s even better for real estate investors who are looking to generate a return on investment (ROI). You can assess the market in real estate by looking at the current values of comparable properties in the area, as well as rents and tenant mix.
- The current and projected values can be used to estimate the future value of the investment property. Calculating a mortgage repayment estimate for your property is a good place to start. This will provide you with a rough idea of how much you and your lender need to put aside each month toward the principal and interest on your loan.
- Once you know how much you will need to put aside each month toward your principal and interest payments, you can figure out the time frame it will take you to repay the loan with your monthly savings. This also will offer a general idea of when you can expect to start making some money back on your investment.
9. Your Credit Score
Investing in real estate comes with a number of challenges and risks. This is especially true for investors who choose to leverage their investment in real estate. Thus, it is important that you get a good credit score before diving into this asset class. Your credit score affects your ability to borrow money from a lender. If you have a low credit score, it will be challenging for you to borrow money for a home purchase.
Conclusion
Investing in real estate is a significant way to build wealth over a period. However, it also comes with its own unique pitfalls and risks. So, it is imperative that investors keep in mind the challenges and risks that come with real estate investments. If you’re planning to invest in real estate, ensure to take these key factors into account first.
