Before you begin your first investment venture, you need to have your finances in order. This means that you need to have your strategy lined up, your budget in place, a timeline for the investment, and a plan for your renovations/rental. This may sound like a lot of work, and it is. However, it will save you a lot more time and work in the long run.
Once you know where you stand financially, you can start assessing viable properties. Try to narrow it down to a few and weigh up the pros and cons of each. From here, you should be able to find a front-runner as well as some alternatives if you’re not successful. Be prepared to negotiate on the price, and for the possibility of a bidding war.
With patience and planning, you’ll soon be able to purchase your first real estate investment. From here, your careful preparation for your next steps will make the whole process a lot easier.
Choosing a Location and Tenant
Location is another key factor in the decision-making process. Philadelphia and the Delaware Valley have an incredibly varied range of locations. Some of these will be more sought-after than others, and prices will fluctuate accordingly. When you’re making an investment, you want to consider not only what the area is like now, but also how it will develop over the coming years.
Consider the type of location you’re thinking of. What are the amenities it has near? Are there good schools? Is it suitable for businesses? All of these will determine the type of investment you make, and the type of tenants you will be marketing to after you make a purchase. If you’re planning on a property appreciation strategy, you’ll ideally want to pick an up-and-coming area. These have the greatest potential for long-term gains. Conversely, if you’re attempting a re-sell, you should look for a cheap fixer-upper in an already established location.
The type of tenant you choose should also reflect your investment strategy. If you’re planning on buying a residential property, consider the kinds of people who already live there. Look at demographic figures, socio-economic factors, and other similar metrics. If you’re buying in a business hub, think about the types of businesses that are thriving in the surrounding areas.
Cash Flow & Costs
As with every investment, your cash flow and costing will play a big part in your overall success. Regardless of the type of investment you make, whether residential, commercial, or land, you will need to spend money on it. You should have a clear plan in mind of how you want this to progress, and what your budgets and ROI (Return on Investment) are.
• Value the Property
One important aspect of cash flow and cost is to value the property ahead of time. There are plenty of estimator tools online, which can give you an initial guide for the price. Alternatively, you can ask a broker to give their opinion or access a competitive market analysis. These generally provide an accurate and more detailed overview. Another option is to hire a professional appraiser to do the task for you.
• Basics for OPEX and Cash Flow
If you’re planning on renting out your real estate investment, you need to get familiar with cash flow and operating expenses (OPEX). You will have to assess the likelihood of renting out the property, and how much you’ll be getting per month. Next to this, you’ll have to look at how much it will cost you to maintain the property, pay taxes, and secure the tenancy. Don’t forget, you’ll also likely have to pay your mortgage back.
Calculating your net operating income will give you a clearer understanding of how much you can potentially make from your investment each month. To work out this net, you’ll need to take your gross operating income and minus your OPEX.
• Using leverage
Leverage is a term that refers to the use of your finances or borrowed capital to increase the value of your real estate investment and its potential returns. Essentially, you use borrowed money to improve your buying power and therefore increase your yield. As the popular explanation goes, leverage allows you to make money from other people’s money.
To demonstrate the power of leverage, let’s look at the example steps below:
- You have $50,000 to invest in a property. You can either buy a property for cash or put the $50,000 towards the purchase of a $100,000 property.
- Property prices increase by 5%.
- If you invested $50,000 in one property, your portfolio is now worth $52.500, an increase of $2,500.
- If you put your $50,000 towards a $100,000 property, your portfolio is now worth $105,000, an increase of $5000.
As you can see, using leverage means you can increase your gains in investment. However, the opposite is also true. With the same example in mind:
- Property prices decrease by 5%.
- Your $50,000 property is now worth $47,500, a loss of $2500.
- If you used leverage to invest in a $100,000 property, it’s now worth $95,000, a $5000 loss.
However, leverage can work well. In fact, most mortgages that require a down payment are effective forms of leverage. It’s about making prudent investments and not over-stretching your initial capital. If your entire portfolio is built on leverage and depends on all of your tenants paying their rent on time, one default payment can send the whole portfolio crashing down.
Back to the Complete Beginner's Guide.