Investors 101
There is not necessarily a great deal to learn to be a successful real estate investor. Really there are a few key pieces of information that need to be examined in order to reach your investment goals. If you are interested in retail, or commercial investment it is crucial that you understand cap rates.
Investment Capital
Virtually all lender are going to require a 20% cash down payment on your real estate investment. I know, many of your are saying it can be done with less with creative financing. But for the the majority out there it is going to take 20% down to get started in real estate investing. So if your looking buy a $4,000,000 commercial property, you are going to need to have $800,000.
Cap Rates
Cap rates are very often used to arrive at the fair market value, or what an investor is willing to pay at that moment in time. Generally a good investment should have an 8% minimum cap rate. Here how it works. Say I have an investment with a net income of $200,000 and an asking price of $2,000,000. Divide the net income ($200,000) by the asking price ($2,000,000), which would give you a cap rate of 10%. However, does that mean that I will make $200,000 a year off that investment. Sorry, but no, you still have to deduct the debt service of the loan. Your yearly payments would be $127,778. So, in this example you might clear $72,222. But, you might ask, didn't you forget property taxes, and insurance that I will have to pay monthly. Well, the good news is that with many commercial investments the tenant pays them for you in the what is call a triple net lease(often seen as NNN lease).
Triple Net Lease
A triple net lease (NNN) is where the tenant pays the property taxes, insurance and common area maintenance. For a strip center with 5 spaces leased out, the NNN cost would be allocated to each tenant based on their portion of space lease. For example, say there is 10,000 square feet available and each tenant leases 2,000 square feet. Then each tenant is responsible for 20% of the NNN.
Tax Benefits
With a commercial property it can be depreciate over a period of 27.5 years. So taking adding to our cap rate example above, say we get to deduct $72,727 as an expense. In this simplistic example that would mean rather than having a tax liability at the end of the year, we would have a tax credit of $505 that we could deduct from our other income.
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Residential Hold Strategy
Cap rates do not really come to bare on a residential hold strategy. Some investors buy properties that are costing them out of pocket on a yearly basis. However, with this strategy you are not concerned about the yearly cash return. You are looking the appreciation you will accrue over time. For example, say I purchase 3 homes for $300,000 each and lease them all out. I am happy after I get them all lease out even though I am not making any money. Why, in 10 years I get all my properties appraised and find out that they have appreciated by 5% a year and are now worth $1,466,005. I have made $566,005 in ten years. I can now borrow against that equity and invest in some other investment vehicle. Additionally, there is a tax break for many, but not all residential investors. With the tax break, you might even be realizing some income from the properties. However, Your income level can influence the tax consequences and you should consult a tax professional before investing.
Residential Fix & Flip
This can be more complicated that many investors want to get into. But, you an investor can always partner with someone that takes car of all the details and headaches. You are simply providing the investment capital. I know many are thinking that fix and flip in this market is insane. Well, Donald Trump did not think so during the last real estate market downturn. He and his father jump on all the failed condo and apartment building projects they could afford to get into and made a fortune. The beauty of fix and flip is its ease of enter. You don't have to have a huge amount of investment capital. You can start small with a single house and as little as $80,000 (buy a house 150,000 house with $30,000 down and put $60,000 into it. Then, if you bought right and in the right location, you sell for $300,000). Your original investment was $230,000 plus realtor fees of $15,000 to sell and your net profit is $55,000. Of course you could also be creative and partner with a few other investors and be more more aggressive.
For more information and a free consultation on your real estate investing please give us a call at 916-474-0390, or email us.
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