Making Cents: Want to invest in real estate?
By: John P. Napolitano, CFP®, CPA, PFS, MST
It seems like only yesterday that we were writing about the woes of investment real estate. Owners of investment properties were wishing they didn’t own them and buyers had all but dried up. Obviously, a lot can change in 10 years. Today on the other hand, people are lined up to buy properties and realtors almost expect each listing they put up to get bid up over asking price in a frenzied few days of offers and negotiation.
I can’t say whether this is a good time or a bad time to purchase investment real estate. I can say, I believe that you would have bought at a much lower entry point 8 – 10 years ago then today. But when markets like real estate get hot, everyone wants in, so let me refresh your analytical side on areas to consider on whether an investment in real estate may be suitable for you.
The first criteria would be sustainability. Can you afford to own this property through a few market cycles where things may get very slow? To refresh your memory, a slow real estate market means fewer buyers and fewer renters along with reduced prices for both sales and rental income. If the next downturn is also accompanied by a lending crisis as we saw last time, the cycle could endure longer than your ability to stay afloat.
One way to own a sustainable real estate business is with low leverage. Growth investors want the exact opposite. They want debt so they can buy more property and eventually make more if market prices rise. But for sustainability, use as little debt as possible. In fact, test the cash flow of the investment forecast for what your net rate of return would be if you had no debt. Be conservative and be sure to include repairs, maintenance and deferred maintenance. If you are not sure how to do this, you need to go to school or stay away from real estate investment.
Don’t count on appreciation in the first few years. Of course, it may happen but don’t forget that transaction costs can be 5–8% for both the buy and the sell. You’ll also have lease up costs in terms of advertising or realtors. That adds up to a lot of cost for a short term hold and would require almost 20% of appreciation just for you to break even.
Don’t think that owning real estate is as easy as other investments that you may own. Real estate is almost a living breathing thing that will need attention. If it is your attention, understand that you are trading in free time to become a landlord and fix up person. If that’s your thing, then no problem. If not, you better get reliable trade people to respond to potential, and eventually likely short notice service needs. In the hot real estate market that we now have, it is hard to get a call back from a sub-contractor let alone having one who can drop everything when your call arrives.
John P. Napolitano CFP®, CPA is CEO of U. S. Wealth Management in Braintree, MA. Visit JohnPNapolitano on LinkedIn or uswealthnapolitano.com. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. John Napolitano is a registered principal with and securities offered through LPL Financial, Member FINRA/SIPC. Investment advice offered through US Financial Advisors, a Registered Investment Advisor. US Financial Advisors and US Wealth Management are separate entities from LPL Financial. He can be reached at 781-849-9200.