Home, Sweet Home(s): Investing in Real Estate
In his celebrated 1822 song, Home, Sweet Home, playwright John Howard Payne profoundly and firmly holds his own home as a more revered spot than a royal palace (even if the said home is a “lowly thatched cottage”). While you may not know Payne by name, you’ll undoubtedly be aware of his brilliant and imperishable line from Home, Sweet Home as presented by Dorothy in 1939’s movie masterpiece, The Wizard of Oz: “There’s no place like home, oh, there’s no place like home!” Payne’s words (and accordingly, Dorothy’s) resonate as much now as they did nearly two hundred years ago when he first put those words to paper.
Our homes bring meaning and value to our lives, and they are where we make memories, our family and friends gather, and where we are likely to spend more time than anywhere else. And, as the largest purchase most people make in their lifetime, there’s a lot of pressure to get it right, whether it’s a starter home, a step-up, or a second home. An investment in a home can make financial sense, but how does one find and buy a home?
Where to Start
Before you start looking for a house or property to buy, ask yourself some questions. Be sure to consider your objective, time frame, and your tolerance for risk to ensure that you are on track with your overall financial goals:
- Amount: How much can you invest in real estate?
- Time Frame: When do you need the money from your investment?
- Risk: Can you afford to lose the money you invest?
- Taxes: What taxes will you pay on your real estate investment?
- Investment Mix: How will your real estate investment affect the rest of your assets?
It’s good for your financial well-being to know where you stand before you make a real estate investment, and doing so will help you stay on course toward your goals. For help answering these questions, reach out to your Signature Wealth Strategies advisor today.
Why Invest in Real Estate?
Real estate is property; it may be a single-family home, commercial building, retail shopping center, or raw land. Making money in real estate is no different than in other investments. You can make money in the real estate market from buying and selling at a profit or from the income your investment brings in.
When you consider why to invest in real estate, it’s an attractive choice for various reasons. Rental property investments are one of the most common forms of investing in real estate. Besides providing an income through collecting rent, holding onto the property long-term can also be an investment strategy since home prices have steadily risen, historically speaking.
You may benefit from an investment in a rental property through:
- Market Appreciation
- Rental Income
- Tax Advantages
Market appreciation is when the price of a real estate asset such as a single-family home goes up. Home prices typically go up (appreciate) when the demand for homes increases, mortgage rates go down, or the property’s location becomes more attractive (say, a new school nearby).
Rental income is money made by collecting rent from tenants. How much you charge for rent is dependent on factors such as the location and size of the property, demand for rental properties, and the availability of competing for rental properties. Some investors use the rental income they collect for improvements and maintenance, while others use it to finance the home purchase by paying the mortgage.
Rental real estate may also offer tax advantages for you as the owner. You may save on your tax bill from deducting expenses for things like home insurance premiums, loan interest, and repairs, among others. Be sure to check with your tax professional for relevant real estate tax regulations and how they may impact your financial situation.
Steps to Becoming a Real Estate Investor
If becoming a real estate investor sounds like something you’ll want to do, you’ll go through the process of buying and renting a home. You’ll need to find a suitable home to buy, make initial repairs and upgrades if necessary, find a qualified tenant, collect rents and make required repairs after the tenant moves in. This can be overwhelming for some investors, so be prepared for all the responsibilities of owning and renting a property.
As a property owner and landlord, you can expand how you earn income and profits from appreciation. Thus real estate investing is a way to diversify your investment portfolio. If the stock market takes a turn south, for example, you’ll still have income generated from your rental property. But you do take the risk of not renting the property if the economy slows down and you can’t find a renter.
Finding an Investment Property
If you’ve decided to purchase real estate and rent it, there are some things to think about before buying. What kind of property are you looking for? You can rent single-family homes, apartments, or commercial buildings. When you’re new to investing, you may want to stick with a property that has profit potential and requires the least amount of real estate experience, the single-family home.
The location of your real estate purchase is perhaps the most crucial part of successful real estate investments. A good location can make a difference in what you can collect in rent and whether or not you can profit when you sell it. Location is, as they say, everything. The price you pay for a home is typically based mainly on its location.
You’ll need to know how much you can afford to spend as a down payment or to buy the property outright with cash. Most of us don’t have that kind of money, and you’ll need to explore a mortgage to finance your purchase.
Finally, do your homework. Know upfront what you’re buying. Consider the investment as a whole. That is, not only the money needed to buy the property but the amount you’ll need to make the property attractive to renters. This expense can be significant if the house is not in a condition ready to bring it to potential renters.
Everyone has a unique tax situation; talk with your tax professional to understand how to manage your tax needs best.
Paying For It: Mortgages
A real estate investor needs funds to have ownership rights in a property and the potential profits and income from the investment. Our financial system provides loans that investors pay back over time to help with these large purchases. These loans are, of course, mortgages.
There are many types of mortgages, just like there are many types of houses. Mortgages may offer different payment arrangements and required down payments. It’s essential to shop around for the best mortgage terms, such as the interest rate and length of the loan (both of which affect your mortgage payment). Also, consider how much of a down payment you’ll need to get the mortgage to buy the property, which usually runs from zero to 20 percent.
Rental Real Estate
Investing in residential real estate is the most common form of real estate investing and the most familiar concept to most investors. In its elementary form, you invest in a home and rent it to tenants.
Owning a home and renting can provide a stream of investment income. The income can be used to pay down the home’s mortgage, or you can take the rental income and invest it elsewhere. Let’s look at an example of a house you hypothetically bought, rented for a year, and then sold.
Say you buy a single-family home for $350,000 and rent it to tenants under a one-year lease for $2,000 a month. The real estate market in your area is strong, and there is robust demand for the home you bought. After one year, instead of renting it again, you take advantage of the sturdy demand for housing in your area and sell it for $400,000.
Over the 12-month lease, you’ve brought in $24,000 income from monthly rent payments (for the simplicity of this example, let’s omit taxes, repairs, and expenses, covered elsewhere in this article). Your take from the $400,000 sale would be a combination of $50,000 from the price appreciation of the house plus $24,000 in rental income. In this hypothetical example, you’ve made a 12-month profit of $74,000.
What If No One Is Home?
You’ve bought an ideal investment property and are enjoying the prospects of profiting from your real estate investment. The money you laid out to repair and upgrade the house was even less than you thought. Securing the first tenant for a year was no problem. Then the lease ends, and the tenant vacates the property. What if you don’t find another renter? This concept is called vacancy risk. It’s an unavoidable risk you assume when you own a piece of property for rent.
If you temporarily cannot find a renter, then there’s no rental income from the investment. Be sure you have the savings to pay for upkeep and the mortgage for your investment home. And remember that there could also be gaps between tenants where no rental income is coming in. You’ll need this time for repairs and marketing the home to potential renters. So be prepared for this potential income gap.
The Turnaround: Flipping It
Investment homes needing repair are sometimes called “fixer-uppers.” But “flipping” a house is a bit different than a typical fixer-upper. Flipping is a real estate investment (typically a single-family home) bought, repaired quickly and economically, and sold for a profit. Flipping normally operates under the constant twin pressures of time and money, meaning it is not for everyone and has some risks. It’s essential to recognize the three areas of house flipping that impact your gain or loss when you invest in real estate to flip.
First, buying a house at a good value (cheaply, that is) is a key to profiting on a flip since owning the property long-term is not desirable. The lower the price you pay when you invest in the house, the more you potentially profit when you sell the home.
Prices of houses are typically about the same as comparable houses in an area. But homes that are not in a similar condition or with comparable features as other houses in the area tend to sell below the value of comparable homes. In other words, if the house for sale needs repair or renovations, it’s likely priced below other dwellings. These homes, therefore, are perfect flip candidates.
Some foreclosures are good candidates for buying a home cheaply. Foreclosures come about when a homeowner can no longer pay the mortgage. Lenders, like banks, take ownership of these homes but do not want to be homeowners. They sell these homes as foreclosures and often do so at cut-rate prices to quickly get them off their books. You can find foreclosures for sale by searching for them on real estate listing websites, subscribing to a foreclosure listing service, or visiting municipal property records offices.
The second key to profiting from a flip is keeping your costs down in repairs and improvements before the sale. Before you purchase the home, it’s crucial you know the expected cost of repairs and improvements. If you underestimate the cost of improvements to make the house ready for a buyer, you risk losing money on the flip.
Finally, to maximize the profit opportunity as a flipper, you’ll need to sell the house as quickly as possible. Getting the house into the hands of a buyer quickly reduces the expenses you’ll have if you stay on as the owner. These expenses may include property taxes, utilities, regular maintenance and upkeep, and homeowner’s association dues.
Real estate investing as a flipper is risky and requires a hefty commitment, as you’ll be very involved in the investment from start to finish. Your profit or loss from flipping will depend on finding a home at the right price, putting the money and effort into repairs, and selling it quickly. If any of these parts go wrong, you can be in for a significant loss. Get them right, and you can make a sweet profit from your investment.
Taxes and Real Estate
Tax obligations of owning real estate may impact your profit or loss. Consider these three types of taxes in real estate investing: property tax, income tax, and capital gains tax.
Property taxes are local taxes based on the value of the property and land. The local government collects these taxes for uses such as schools, roads, and law enforcement. It’s essential to understand the property taxes on a real estate investment before you invest.
If property taxes go unpaid, the governing authority uses tax liens to secure their interest in the property. In other words, the government puts a legal hold on your property, so they get the unpaid tax money. Unpaid property taxes and tax liens can cause many financial problems, including preventing the sale of a property.
When you earn income from a property you own, say from the monthly rent paid to you, you’ll likely have to pay tax on that money each year as income.
Capital Gains Tax
When you sell a home for a profit, and the house is not your primary living residence, you’ll be responsible for paying capital gains tax. This tax varies depending on how long you’ve owned the property and your income.
Potential Tax Advantages
While paying taxes is part of all kinds of investing, you may qualify for tax advantages from investing in real estate, such as tax deductions. Since everyone has a unique tax situation, talk with your tax professional to understand how to manage your tax needs best.
Find Out If There’s a Place Like Home in Your Investments
Not long ago, only kings and tyrants owned the land and everything on it. To own real estate, you had to be born into royalty or be a conqueror of the land. We’re fortunate that we now have the freedom to own real estate for our personal use or as an investor. You have the potential to make money with real estate—if you know how to invest in real estate.
How can investing in real estate help you lead a Signature Life? If you’re ready to find out for yourself if there’s a place like home in your investments, contact a Signature Wealth Strategies advisor today.