April 12, 2009

Understanding Real Estate Investing and How to be Good at It

This article assumes you have the desire and money to launch a real estate investing career. So we'll simply focus on helping you to better understand how real estate investing works and steps you must take to do it successfully.

A) Start With the Basics

Real estate investing involves acquisition, holding, and sale of rights in real property with the expectation of using cash inflows for potential future cash outflows and thereby generating a favorable rate of return on that investment.

When you invest in real estate, you can use other people's money to magnify your rate of return and control a much larger investment than would be possible otherwise. Moreover, with rental property, you can virtually use other people's (tenant's) money to pay off your loan. Therefore real estate investing is more advantageous then stock investments, which usually require more investor equity, because it offers the advantage to leverage.

Aside from leverage, real estate investing provides other benefits to investors such as yields from annual after-tax cash flows, equity buildup through appreciation of the asset, and cash flow after tax upon sale—not to mention non-monetary returns such as pride of ownership, the security that you control ownership, and portfolio diversification.

B) Understand the Elements of Return

Real estate is not purchased, held, or sold on emotion. Real estate investing is about a return on investment. As such, you should always consider some basic elements of return to determine the potential benefits of purchasing, holding on to, or selling an income property investment.

1. Cash Flow – Cash flow is the amount of money that comes in from rents and other income less what goes out for operating expenses and debt service or loan payment. And real estate investing is all about a property's cash flow. You're purchasing a rental property's income stream, so be sure that the numbers you rely on later to calculate cash flow are truthful and correct.

2. Appreciation - This is the growth in value of a property over time (i.e., the future selling price minus original purchase price). The fundamental truth about appreciation, however, is that real estate investors buy the income stream of investment property. It stands to reason then, that the more income you can sell, the more you can expect your property to be worth. Therefore, when you're considering an investment real estate opportunity, be sure to make a determination about the likelihood of an increase in income and throw it into your decision-making.

3. Loan Amortization - This signifies a periodic reduction of the loan over time in turn leading to increased equity. Because lenders evaluate rental property based on income stream, present lenders with clear and concise cash flow reports when buying multifamily property. Properties with income and expenses represented accurately to the lender increase the chances you will obtain favorable financing.

4. Tax Shelter - This signifies a legal way to use real estate investment property to reduce annual or ultimate income taxes. No one-size-fits-all, the prudent real estate investor should check with a tax expert to be sure what the current tax laws are in any particular year, and be aware that tax shelter is one of the true benefits of real estate investing.

C) Understand How to Prepare

1. Develop the correct attitude. Foremost, bear in mind that real estate investing is a business, and that you are about to become the CEO of that business. You are not a homebuyer. So look beyond curb appeal, exciting amenities, and desirable floor plans unless they contribute to the income and focus on the numbers. Real estate investment property is a matter of the head, not the heart. So lay emotions aside, and prepare to make your investment decisions based on the property's cash flow and rate of return.

2. Develop an investment goal with meaningful objectives. Have a plan with stated goals that best frames your investment strategy. What do you want to achieve? By when do you want to achieve it? How much cash are you willing to invest comfortably, and what rate of return are you hoping to generate? A stated investment goal with meaningful objectives is one of the most important elements of successful real estate investing. Have it prepared and worked out in your mind before you start purchasing.

3. Research the real estate market. Understand as much as possible about the conditions of the real estate market when you plan to invest. Learn property values, rents, and occupancy rates. You can turn to a qualified real estate professional to run a comparable market study for you, or have the county tax assessor help you. You must always be prepared to recognize whether an investment opportunity is fairly priced or not; whether it offers a potential to make real money or not.

4. Learn the terms and returns and how to compute them. Get familiar with commonly used real estate investing terms, reports, and rates of return. Learn the formulas and calculations. There are sites online that provide free real estate investing help and information, so prepare to do some homework and gather as much data on the terms and returns as you can. It will keep you from looking like a deer staring into the headlights of a car when hear them discussed.

5. Invest in real estate investment software. Having the ability to create your own rental property analysis gives you more control about how the cash flow numbers are presented and a better understanding about a property's profitability. So prepare to purchase quality real estate investment software. The benefit it will provide you is well worth the meager investment.

6. Locate a specialized real estate professional. The emphasis here is to work with a real estate agent that knows the local real estate market and understands rental property. It won't advance your investment objectives to spend time with an agent unless that person understands the nuances of real estate investing and is adequately prepared to help you make wise investment decisions. If you're planning to get assistance from a real estate professional, prepare to seek out a real estate investment specialist.

Here's to your real estate investing success.

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