Residential Investment Properties
Bank on the ‘KEYS’ to diversifying your investments
Courtesy Resource Bank, Northshore LIVING WELL Magazine
With interest rates for savings and CDs at an all time low, many seniors are looking for ways to enhance their returns and secure wealth. The time for diversification into residential real estate investments may be now!
According to RealtyTrac® the Louisiana market has a higher than average number of properties in default and interest rates to borrowers have fallen to below the risk profile normally associated with investment real estate. While these alone can jumpstart an investment portfolio in real estate, remember these “4 Keys to Success.”
1. Do Your Homework – There are many properties for sale and many look good to the untrained eye. The smart buyer will check the neighborhood. Too many units in foreclosure or listed for rent will create a long-term buyer’s market. Thus, potentially driving prices down and creating excess vacancy for rental. It is also important to find a marketing advantage. Great schools, easy commute, low crime or simply below market rents can set your property apart from the competition. Be willing to put a little hard work into repairs. Sellers, especially banks, are willing to take steep discounts to sell “As Is Without Warranty” for the buyer handling repairs.
2. Don’t Buy on Emotion – You will run out of money long before the market runs out of deals. Just because the property is attractive or located within walking distance of your best friend’s house doesn’t make it a good deal. The numbers don’t lie and cash flow is what truly makes a real estate investment work for the long haul.
3. Have Reasonable Expectations – All real estate investments will provide a certain level of income and expense. If the seller attempts to sell based on what the rent could be raised to, you should exercise caution. If the rent could be raised, why did the seller not raise it already? Furthermore, don’t believe everything you see on TV. Generally, a new coat of paint and some landscaping will not allow you to “flip” a $100,000 investment into $150,000 in 30 days. Many buyers got caught speculating on the growth of real estate and now foreclosures out number sales in these markets.
4. Understand Real Estate Underwriting – This is where your local real estate lender at Resource Bank can be a big help. Real Estate underwriting consists of three major components: (a) Cost and/or value of financing. Whether you are paying cash or borrowing money towards the purchase, a value should be calculated assuming debt. (b) Cost and/or value of equity. This determines what a seasoned real estate investor would want to make for injecting his or her personal cash into a project that contains risk. The number is determined by several factors including: type of property, level of equity required and inherent risk for real estate investing. (c) Expenses associated with the asset. All expenses on residential real estate are generally the owner’s responsibility. These typically include taxes, insurance, management, maintenance and repairs. The cost for these additional items needs to be taken into account for underwriting.
A simple rule of thumb for underwriting residential real estate is as follows:
| Annual Gross Rental Income
Less: Confirmed or estimated expenses Equals: Net Operating Income
Net Operating Income / CAP Rate = Value of Property
CAP Rate (capitalization rate) defines the percentage number used to determine the current value of a property based on estimated future operating income. Assuming a 75% loan and a 25% down payment, the CAP would resemble:
Loan of 75% with an interest of 6.75% = 5.0625 Equity of 25%, with an expected return to the buyer of 20% = 5.0000 CAP RATE 10.0625 |
Example: Property listed for $100,000, which rents for $1,100 per month. Using approximately 30% for expenses, the unit should be purchased for $91,849 or less to achieve the value desired by the investor, not $100,000 as listed.
($13,200 – $3,960 / .1006 = $91,849)
Finally, when it comes to real estate, remember there is no such thing as a risk free investment. Over the past 25 years the market has seen only two real estate busts but many years of growth. If invested in wisely, real estate can be very rewarding and an excellent source of long-term income.
Resource Bank may be reached at 985-801-1888 or online at www.BankOnResource.com.
