In a perfect world real estate investors would be able to buy and flip properties on a regular basis, banking significant short-term returns. In reality, investment in real estate should be seen as a long-term proposition and only those who are prepared to take above average risks should engage in short-term speculative investment. In many ways the real estate TV programmes showing how you can buy property, renovate and flip it for a significant profit in just a matter of weeks do the industry no favours.
So, what should you focus on with regards to long-term investment in real estate?
Always negotiate on price
The sale price you see for any property should be seen as negotiable and never set in stone. Those who fail to negotiate will likely pay a full price for a property which will reduce their long-term returns. If the bidding for a property gets out of hand and moves to unrealistic levels, simply walk away. There are some who would suggest paying just a few thousand dollars extra is neither he nor there when looking long-term but every dollar of savings counts. Don’t let your heart rule your head!
Cash flow is vital
Rental income is a vital element of any real estate portfolio as it allows you to pay down mortgage borrowings and fund the maintenance of properties going forward. When looking at a potential purchase, if the rental income does not cover a minimum of your mortgage payments then this may not be a viable investment going forward. Each property you purchase should, in theory, be self-financing through rental income. So as you purchase additional properties they also become self-financing building up equity and reducing mortgage debt. We will highlight the cumulative impact this has in the longer term later in this article.
Occupancy rates
While there are a range of rental yields available across the US real estate market, there should be more focus on occupancy rates as opposed to just basic rental yields. If a property offers an above market average yield but occupancy rates are poor then it may not be as attractive as it looked at first glance. Sometimes short-term leases in particular tend to attract higher rental rates but low occupancy figures. There is also the additional cost of advertising for new tenants as previous tenants move out.
Finding a reliable long-term tenant for your rental property is the Holy Grail of investment as this helps to create strong cash flow.
Maximise debt and assets
As you build your real estate portfolio, in the longer term you will pay down your debt (with rental income) and increase your equity. In the future there may also be opportunities to refinance properties and release additional equity where there have been increases in property values. The strategy of maximising debt and utilising assets makes perfect sense but must be done within the financial constraints of an investor. There needs to be a degree of “headroom” which is best described as the difference between financial liabilities and assets.
The cumulative impact of rental income on a growing real estate portfolio can also strengthen your hand with regards to raising additional finance. This won’t happen overnight, you will need to have a strategy in place but the potential for capital growth and strong long-term cash flow is very attractive.
Summary
We would all like to acquire a property today, renovate and sell in a few weeks for a significant profit but in reality there are potential large risks involved. If you take a more long-term approach to real estate investment this reduces the risks as rental income will help to pay down debt and increase equity in a property. The cumulative impact of long term real estate capital appreciation and rental income from numerous properties can help to leverage future funds available for investment. However, this must all be done within the financial constraints of an investor so there are no forced sales in the event of difficult markets.