Compared with other types of investments, real estate investing involves a relatively favorable risk/reward profile, but with relatively low liquidity (ease of entry and exit). Let’s see some of the most important factors to be considered for investing in real estate.
- Location of the Property
Why is it important? The age old punch line “Location, Location, Location” still rules and remains the most important factor for profitability in real estate investment. Proximity to amenities, peaceful conforming areas, neighborhood status, scenic views, etc. are major factors for residential property valuations; while proximity to markets, warehouses, transport hubs, freeways, tax-exempt areas, etc. play an important role for commercial property investor.
What to look for? A mid-to-long term view, about how the locality is expected to evolve over the investment period. Today’s peaceful open land at the back of a residential building may be developed into a noisy manufacturing facility in future, making the residential valuations less profitable. It is advisable to conduct thorough check about ownership, type and intended usage of neighboring areas, establishments and free land in the locality.
- Appraisal of the Property
Why is it important? Real estate financing during purchase, listing price during sale, investment analysis, insurance premium and taxation – all depend on Real estate valuation.
What to look for? Commonly used Valuation Methodologies include:
– Sales comparison approach: Recent comparable sales of properties with similar characteristics– most suitable and common for both new & old properties
– Cost Approach: All cost summation minus depreciation– suitable for new construction
– Income approach: Based on expected cash inflows – suitable for rentals
III. Investment Purpose & Investment Horizon:
Why is it important? Given the low liquidity and high value investment in real estate, lacking clarity on purpose may lead to unexpected results including financial distress, especially if the investment is mortgaged.
What to look for? Identify which of the following broad categories suits your purpose and prepare yourself accordingly:
– Buy & Self-use: Savings on rentals, benefit of self-utilization and value appreciation
– Buy & Lease: Regular Income & long term value appreciation. Requires building a temperament of being a landlord – for handling legal issues & possible disputes, managing tenants, repair work, etc.
– Sell & buy (Short Term): Quick, small to mediocre profit – usually buying under construction properties and selling slightly high once ready
– Buy & Sell (Long Term): Large intrinsic value appreciation over long period of time; solution for long term aims like retirement planning, child’s education, etc
. IV. Anticipated Cash Flows & Profit Opportunities:
Why is it important? The investment purpose & usage influences cash flows and hence profit opportunities.
What to look for? Develop draft projections for the following modes of profit & expenses:
– Expected cash flow from rental income – Inflation favors landlords for rental income
– Expected increase in intrinsic value due to long term price appreciation
– Benefits of depreciation (and available tax benefits).
– Cost benefit analysis of renovation before sale to get better price.
– Cost benefit analysis of mortgaged loans vs value appreciation.
- Be Careful with Leverage – Know the Pitfalls:.
Why is it important? Loans are convenient but may come at a big cost – you commit your future income, to get utility today for a cost of interest spread across many years. Real estate financing needs higher amounts and hence has higher exposures. Understanding it properly allows you to benefit from it to the maximum, while ignoring the risks can lead to major pitfalls.
What to look for? Depending upon your expected & current future earnings and paying capability, consider the following:.
– Decide on type of mortgage loans (Fixed Rate, Adjustable Floating Rate, Interest Only or Zero Down Payment), whichever suits you best.
– Be aware about the terms & conditions and other charges levied by financiers.
– Hunt around and bargain for a better deal – lower interest rates, lower insurance premiums or processing charges waiver, as possible.
- Investment in New Construction vs Existing Establishments:.
Why is it important? New construction properties usually offer attractive pricing, the option of customization, clearly documented amenities and clear titles. The investor has to deal with only the construction company as a counterpart. Risks include delay in possession, increase in costs, no awareness about neighborhood, etc
. Those on resale have vice-versa factors and may need a more thorough check on ownership, documents and legal matters.
What to look for?
– Check past projects and the reputation of the construction company for new construction investments.
– Review property deeds, recent survey and appraisal report for old constructions.
– Be aware of monthly maintenance costs, outstanding dues & taxes from past owners. These costs can severely impact your regular cash flows.
– Investing in on-lease property (possessed by others)– Is it rent controlled, rent stabilized or free market? Is the lease about to expire? Does it have renewal options in favor of the tenant? Are interior items owned by the tenant or owner? etc. are some of the details to be aware of.
– Quality-check items (furniture, fixtures and equipment), if included in sale.
VII. Indirect Investments in Real Estate:.
Managing physical properties over a long term horizon is not for everyone. There are also a few alternatives to indirectly invest in the real estate sector and aim to reap the benefit.
What are the Options?
– Real estate company stocks– Equity stocks of real estate companies can be bought and sold on exchanges (e.g. Forest City Enterprises FCE.A listed on the NYSE).
– Real estate sector-focused mutual funds/ETFs– Sector specific funds like “Fidelity Real Estate Investment Portfolio (FRESX)” offer the benefit of diversification and professional money management, at the cost of fund expense charges.
– Mortgage bonds– Secured by physical property, they offer lower rates of return compared to corporate bonds.
– Real Estate Investment Trust (REIT)– offer high yields, tax consideration and high liquidity as they trade on stock exchanges.
The Bottom Line.
Real estate investments offer a good high value risk-return profile. Thoughtful consideration of the above mentioned factors in mind will enable investors to reap the benefits while mitigating the risks.
The age old punch line “Location, Location, Location” still rules and remains the most important factor for profitability in real estate investment. A mid-to-long term view, about how the locality is expected to evolve over the investment period. – Sell & buy (Long Term): Large intrinsic value appreciation over long period of time; solution for long term aims like retirement planning, child’s education, etc
. Real estate financing needs higher amounts and hence has higher exposures. – Investing in on-lease property (possessed by others)– Is it rent controlled, rent stabilized or free market?
Going through the mortgage process can be an intimidating, overwhelming experience, even for people who have done it before.
For newcomers, it can be especially difficult. It’s easy to understand why: you’re facing the prospect of entering into an agreement that puts you on the hook for huge amounts of money over a very long period of time.
Mortgage contracts are long, complicated and filled with minutiae. The entire process can be nerve-wracking and many borrowers find themselves anxious to simply get it over with. This mindset isn’t necessarily conducive to obtaining the best home loan.
When engaging in the home loan process, the following set of three basic tips are worth keeping in mind.
Fight the impulse to take the first option available to you. While interest rates don’t appear to differ all that much, a few hundreds of a percentage point can mean the difference of thousands of dollars over the lifespan of a mortgage. Additionally, there are other significant differences to consider beyond the rate of interest. The terms of mortgages vary between lenders and within the variety of different products offered by the same lender. Some options may contain greater payment scheduling flexibility than others. Take the time to investigate the differences between the various choices available.
Dip into the details of the mortgage contract and make sure that you understand all of the potential fees that you may have to pay and the various features of the product. The last thing you want is to find out about some hidden expense or penalty that you’re likely to incur after you’ve signed all the papers.
Establish Your Priorities
Look beyond the rate and the regular payment estimate and take the time to think about what’s most important to you in terms of the mortgage outline and features. If cost certainty is critical to you, you may want to go with a longer-term fixed rate loan, even at a higher rate of interest, rather than a variable home loan. If your goal is to fulfill the mortgage as quickly as possible, you may want to look into a loan with a shorter term of maturity and one that won’t bring penalties for early repayment. The point is to prioritize your goals and be sure to select the mortgage product that will best meet your needs and lifestyle.
This mindset isn’t necessarily conducive to obtaining the best home loan.
Look beyond the rate and the regular payment estimate and take the time to think about what’s most important to you in terms of the mortgage outline and features. If cost certainty is critical to you, you may want to go with a longer-term fixed rate loan, even at a higher rate of interest, rather than a variable home loan. If your goal is to fulfill the mortgage as quickly as possible, you may want to look into a loan with a shorter term of maturity and one that won’t bring
My wife and I are just starting the journey of buying our first home together. We’re both nervous and excited, because a lot can and does go wrong.
One of the first steps I took was to figure out exactly how much house we could comfortably afford to buy. While there are a variety of affordability calculators out there, I wanted to get pre-approved before we ventured out to find our dream home. Turns out, the fact that we don’t plan on moving until next summer made it too early to consider getting pre-approved.
That said, the effort wasn’t completely wasted. I learned three things that every prospective home buyer should know in order get their house in order, so to speak– things that will make for a smooth process when applying for a loan.
- Get Your Credit House in Order
Home buyers need to do everything in their power to boost their credit score before applying for a mortgage. This means paying down credit cards and making sure your credit is as squeaky clean as you can get it.
It’s a good idea to check out your credit reports well in advance of applying for a loan to make sure there are no issues you need to address. You can pull reports from all three major bureaus for free at annualcreditreport.com. (Everyone whose income is going to be considered in qualifying for the loan needs to do this.).
If there are any issues, start fixing them immediately. Some red marks– even if they are due to inaccurate reporting and not because of your bad credit management– can take a while to clean up.
When I pulled my credit report I was pleased to find that my credit score is still in healthy shape. It could be better. I have too many accounts carrying balances. To get my credit house in order, I plan on paying off the one card that’s holding a balance from our last vacation, despite the fact that it charges zero percent interest.
- Protect Your Credit Reputation.
Once your credit house is in order, protect it. According to John Laymac of CBC National Bank, there are several things we can do between now and when we buy our new home:.
“Do not let anyone pull your credit, pay everything on time, do not close any accounts you may pay down to zero, do not apply for any new credit (besides the mortgage), do not buy a car, do not make other large purchases on credit and do not carry a balance on any revolving account that is more than 25 percent of the card’s limit. Use a mix of cards if you have more than one and pay the balance off or below 25 percent of the limit when the bill arrives.”.
That pretty much sums up what you need to do to avoid accidentally dinging your own credit before you start shopping for a loan.
What’s probably most surprising is that paying or closing accounts off a term loan are actually a very bad idea, especially before applying for a mortgage. Closing a major credit card can actually do damage to a credit score. Lenders look at the balance on revolving credit accounts in terms of its ratio to total available credit. Closing an account can have the unintended consequence of raising the ratio. Paying off a car is the same story; lenders want to see a long-term credit history. So, it’s actually better to put any extra money toward a down payment rather than paying off the car.
One other thing Laymac recommended we do is go to OptOutPrescreen.com and register to electronically opt out of electronic offers (spam and junk mail) of credit for five years. He said that “this is similar to the do-not-call list and the credit bureaus see it as a positive.” Bottom line: Prospective homeowners should do all they can to protect their credit before applying for a mortgage.
- Open a Separate Account to Hold Your Down Payment Funds.
It goes without saying that a new homebuyer will be forking over money, and lots of it, at the closing. What you might not know is that the funds set aside for a down payment and closing costs shouldn’t be kept under the mattress, nor should those funds be in your main checking account.
Instead, homebuyers should open a separate account specifically for the down payment. I asked Laymac to explain why the separate account, and he said:.
“To avoid delays, establish a dedicated account for the down payment and closing costs and have all transfers into that account final at least 60 days before you start the process. Any non-payroll deposits into asset accounts must be explained in detail and any cash deposits can cause a loan to be declined. Banks typically only ask to see the two most recent months of account statements, so transactions prior to two months are not scrutinized. If you have no transactions in the account over two statements, there is nothing to explain and no additional documentation to provide.”.
Sell that stock or get grandma to send the Christmas money early. (If a money gift comes in later, you may have to provide your lender with a note from the gift giver stating that the money was a gift and no repayment is expected.) Then sock it away in a separate account that has been designated for the down payment.
Following these three steps should make the mortgage application process less intrusive and painful. Buying a house comes with enough issues of its own, so why complicate matters with a mortgage mishap?
When I pulled my credit report I was pleased to find that my credit score is still in healthy shape. To get my credit house in order, I plan on paying off the one card that’s holding a balance from our last vacation, despite the fact that it charges zero percent interest.
Closing a major credit card can actually do damage to a credit score. Lenders look at the balance on revolving credit accounts in terms of its ratio to total available credit. Bottom line: Prospective homeowners should do all they can to protect their credit before applying for a mortgage.