So you want to invest in Real Estate…
What’s the right way to invest in real estate? How do I decide a good investment from a bad? This question is best answered by you and how you want to manage your real estate portfolio. To better understand what kind of properties you want in your real estate portfolio, we have to first understand the different types of real estate properties to invest in. We will go down the list, then we will break down numbers and how it makes sense from an income standpoint.
Single Family Residence Home:
Investing in a Single Family Residence home may not be the most profitable but it’s the safest real estate asset that appreciates in value and the most desirable for renters. Single Family homes appreciate at a higher percentage than condos, multi unit properties, and other type of properties. Single Family homes only house one party which keeps maintenance levels low and usually family oriented. These type of renters are ideal, as families are typically stable and stay for a longer term. Lower turnover rates, ultimately limiting vacancies and being the preferred type of property choice for renters.
Townhomes:
Townhomes provide a very similar feel as a Single Family Residence home while being easier to maintain. HOA costs must be factored in from an income standpoint but this typically means that the exterior of the home is maintained by the HOA and not the owner. Townhomes typically garner similar monthly income as a Single Family home minus HOA fees. The biggest factor to consider when investing in a townhome is the HOA fees. This fee can make or break an investment from being a great investment to a not so good one.
Condos:
Very similar to townhomes, condos have the same pros and cons. The biggest difference is that condos will typically have a unit above or below, meaning it is typically a cheaper investment compared to a townhome. Exterior maintenance is included with HOA so you will only need to worry about the interior. Renters may see condos as a glorified apartment.
Multi Unit Properties: (2-4 Units):
Multi unit properties that have between 2-4 units (Also known as Duplex, Triplex, and Quadruplex) are considered residential income property which typically require a minimum of a 15% down payment. When considering multi unit properties there is a lot more work required as you have to attend to more tenants. The pros of having multiple units means you don’t have all your eggs in one basket and having one vacancy will not drastically affect your income. Whereas, having one vacancy in a townhome or SFR home means you will have to come out of pocket for the whole month’s mortgage. It’s a balance and some owners will look to occupy one of the units which will allow them to put less than the minimum 15% down payment. (More on this in another blog) Multi units tend to cost more than a SFR home and a lot more factors play into a multi unit property. Some factors to consider: Number of units, Configuration of each unit (Beds/Baths), Expenses, Tenants, Rental Agreements (Yearly or Month to Month), Security of tenants, Common grounds, Conditions, Maintenance, Insurances, Potential Management Company.
Multi Unit Properties (5+ Units)
The biggest difference from a Residential Income Property with 1-4 Units and a Residential Income Property with 5 or More Units is the minimum down payment. Properties with 5 or more units are no longer classified as residential income and they are classified as commercial income. The minimum down payment for a Commercial Income Property (5+ units) is typically 30%-35%. Significantly more than the minimum 15% for a Residential income property. This could be an indication that this type of property may not be the right type of property to invest in at the moment. Also since there are a lot more units to manage, it can be time consuming and many individuals look to hire a management company to take on all the duties a landlord is expected of.
Commercial Property
Commercial Real Estate are buildings, strip malls, gas stations, etc. that are rented out to businesses. There are different types of commercial property such as retail, industrial, mixed-use, and it is important to check with the city what that specific land/lot can be used for. Commercial properties tend to have longer leases and can ask for more depending on how the property accommodates the businesses/tenants. This may seem like a steadier route but can come along with higher expenses, insurances, and down payment.
Raw Land and Building
This takes a lot more knowledge and an understanding of all the ins and outs of building a properties. Building materials, architecture, city permits, and a lot more capital to get into this side of the business.
Appreciation vs. Cash Flow
The Appreciation and Less-Problematic Play
These are properties that tend to hold value as they are in nicer areas and are less problematic because they cater to higher market rents. Higher rents = Higher paying tenants = Tenants with Steady Income = Higher Standard of Living (Less maintenance) These properties are more expensive and tend to have smaller percentage of profits relative to the purchase price.
Cheap High Cash Flow Properties
Cheaper High Cash Flow properties are typical of multi unit properties in not so great areas. For example South LA. Rents are relatively low but if you can keep units occupied and you place tenants who are paying every month, this route can be highly profitable. Takes work to stay up to date making sure all units are occupied and keeping the property properly maintained but it’s definitely worth it. I’ve seen properties have monthly payments of $5,000 after 35% down and cash flow another $4,000 per month.
EXAMPLE:
Understanding the numbers and choosing what’s best. We will take a look at an example overview of all the expenses for a typical residential multi unit property. Say this is your first investment and you don’t want too much work but you want to be profitable. You are looking for a Duplex in a somewhat nice area that can command higher market rents because you see that the area is gentrifying more and you believe in the area.
The Duplex consists of:
3 Bed 1 Bath in one unit & 2 Bed 1 Bath in the other which were recently renovated.
Purchase Price is $850,000
20% Down $170,000
3.75% Interest Rate
Your estimated monthly mortgage comes out to $3,150
Now what expenses do you have to account for ?
These are basic expenses to account for. Not all are required and in our example the landlord will pay for only water for the utilities.
In our example the estimated monthly costs for expenses total to $1,312. Add this to our monthly mortgage and the total monthly cost comes out to $4,462.
Now comes your preference… Since the duplex is in a nicer area you understand that the profits are not as high but you get better tenants who are less problematic. Also we took note that the property has been recently renovated so that eats into your profits (Higher Purchase Price = Higher Mortgage Payments) but it also means less maintenance and upgrades are needed. You are ultimately looking for an investment property that has minimal maintenance and high promise to appreciate in the future. Because of these factors you want to net $1,000 per month in passive income.
You do the research and learn that the market rents for the 3 Bed 1 Bath is $3,100 /month and the 2 Bed 1 Bath is $2,400 /month. This totaling your monthly revenue to $5,500.
Estimated Monthly Net Profit is $1,038 /month.
Not only are you pocketing $1,038 /month but you are also building equity in the home. Each month the tenants are paying towards your duplex increasing your percentage of ownership.
In the future, you can always refinance and pull out some equity out of the property to purchase another property which we will save for another day…
This example can be used for all residential type properties. It can be used for single family residence homes, townhomes, condos, and multi unit properties. For townhomes and condos we would factor in HOA fees and those will typically replace exterior insurance, gardening, and sometimes water and trash.
To get started here are some questions to ask yourself.
1. How much time do you plan to spend on taking care of the property? Would you want to manage tenants, collect rent, schedule maintenance and repairs, find new tenants?
2. How much do you have available for a down payment?
3. What profits/cash flow are you looking for? (Reasonable)
4. What areas are you considering?
5. Would you hire Management?
6. Consider a fixer/project? Build equity into the property?
From here we can begin to curate the right investment based on your goals and expectations.
If this is something you are looking to do, contact me for a full consultation to advise and assist you in selecting the right property for your portfolio.