Advantages of Real Estate Investing

Investing in real estate is as advantageous and as attractive as investing in the stock market. I would say it has three times more prospects of making money than any other business. But, But, But… since, it is equally guided by the market forces; you cannot undermine the constant risks involved in the real estate. Let me begin discussing with you the advantages of real estate investments. I found the advantages as most suited and really practical.

Advantages

Real Estate Investments are Less Risky

As compared to other investments, less of misadventure is involved in a real estate property. I will not get away from the fact that just like any investment you make; you have the risk of losing it. Real estate investments are traditionally considered a stable and rich gainer, provided if one takes it seriously and with full sagacity. The reasons for the real estate investments becoming less risky adventure primarily relate to various socio-economic factors, location, market behavior, the population density of an area; mortgage interest rate stability; good history of land appreciation, less of inflation and many more. As a rule of thumb, if you have a geographical area where there are plenty of resources available and low stable mortgage rates, you have good reason for investing in the real estate market of such a region. On the contrary, if you have the condo in a place, which is burgeoning under the high inflation, it is far-fetched to even think of investing in its real estate market.

No Need for Huge Starting Capital

A real estate property in Canada can be procured for an initial amount as low as $8,000 to $ 15,000, and the remaining amount can be taken on holding the property as security. This is what you call High Ratio Financing. If you don’t have the idea as to how it works, then let me explain you with the help of an example. Remember that saying… Examples are better than percepts!

Supposing, you buy a condo worth $200,000, then you have to just pay the initial capital amount say 10% of $200,000. The remaining amount (which is 90%) can be financed, against your condo. It means that in a High Ratio financing, the ratio between the debt (here in the example it is 90% Mortgage) and the equity (here in the example it is 10% down payment) is very high. It is also important to calculate high ratio mortgage insurance with the help of Canada Mortgage and Housing Corporation (CMHC). If needed, you can also purchase the condo on 100% mortgage price.

Honing Investment Skills

A real estate investment, especially when you buy a condo for yourself, will be a pleasurable learning experience. It gives you the opportunity to learn and when I went ahead with my first real estate property, I was totally a dump man. Ask me now, and I can tell you everything, from A to Z. Necessity is the mother of all inventions. I had the necessity to buy the property and so I tried with it, and I was successful. I acquired all the knowledge and skills through experience of selling and purchasing the residential property. Thanks to my job. It gave me the experience to become an investor.

Not a time taking Adventure

Real estate investment will not take out all your energies, until you are prepared and foresighted to take the adventure in full swing. You can save hell lot of time, if you are vigilant enough to know the techniques of making a judicious investment in the right time and when there are good market conditions prevailing at that point of time.

You should be prepared to time yourself. Take some time out, and do market research. Initiate small adventures that involve negotiating real estate deals, buying a property, managing it and then selling it off. Calculate the time invested in your real estate negotiation. If the time was less than the optimum time, you have done it right. And if you end up investing more time, then you need to work it out again, and make some real correction for consummating next deals. You have various ways and methodologies, called the Real Estate Strategies that can make it happen for you in the right manner.

Leverage is the Right Way

The concept of leverage in real estate is not a new one. It implies investing a part of your money and borrowing the rest from other sources, like banks, investment companies, finance companies, or other people’s money (OPM). There have been many instances where people have become rich by practically applying OPM Leverage Principal. As I had discussed under the sub head – No Need for Huge Starting Capital, the high ratio financing scheme gives an opportunity of no risk to the lenders, as the property becomes the security. Moreover, in case the lender is interested in selling the property, the net proceeds resulting from the sale of the property should comfortably cover the mortgage amount.

Now consider a situation, where the lender leverages the property at too high ratio debt say 98% or even more, and all of the sudden the market shows a down turn, then both the investor as well as the lender. Hence, greater is the mortgage debt, more is the lender’s risk, and it is therefore necessary that lender pays higher interest rates. The only way out to ease the risk from lender’s head is to get the mortgage insured. Two companies authorized to insure your high-ratio mortgage debts are CMHC (www.cmhc-schl.gc.ca), and GE mortgage Insurance Canada (gemortgage.ca).

Letme explain you with the help of an example… supposing, you are buying a real estate property worth $ 200,000 at three mortgages, with the first one of $100,000, the second of $75,000 and the third one of $25,000. Possible percentage of interest rates charged can be 3%, 5% and 7%. The last mortgage amount of $25,000 will be accounted, as riskiest; as it would relatively be the last mortgage that you will pay when you finally make a selling deal.

On the contrary, if the first mortgage representing almost 90% of your property price is insured against getting default or as high ratio mortgage, then in the above example, the basic interest rate would be 3%.

Let me explain you the leveraging concept by taking another example.

Supposing, you are buying a real estate property worth $200,000, and made down payment of 10%, equitable to $20,000, while financed the rest amount of $1,80,000. Over the year’s time, the value of your property appreciates by 10%. In this case, what would be the total return that you’d incur on your down payment of $20,000? It would be 200%. Yes 200%. Putting in simpler words, the down payment of $20,000 made by you has an appreciation of 10% over it, i.e. (10% increase of original home price of $ 200,000), 200% return on your down payment investment of $20,000.

On the contrary if you invest all the money in buying the property of $200,000, and in wake of appreciation of 10% over the year ($20,0000 would then be accrued to as 20%.

Synonymous with leveraging is pyramiding, where you borrow on the appreciated value of your existing property. Pyramiding applies the principal of leverage that enables you to purchase even more properties. This appreciated value over the real estate property in some selected areas results in accumulation of rich financial virtues.

Real Estate Appreciation

An appreciation is an average increase in the property value over original capital investment, taking place over a period. There are some neglected real estate properties that have an appreciation below the average mark, whereas, some of the properties located in maintained geographical areas, showing high demand, have an above average appreciation. In such centrally located and high demand areas, the average appreciation can reach up to 25% in a year. I will discuss appreciation in the chapter on real estate cycles. For now, for general understanding, appreciation is what goes up.

You Make Your Equity

As you gradually pay your mortgage debts, you are creating your equity. In other words, you would be reaching to original house price on which you have no debt. Your equity is absolutely free of percentage increase in appreciation. From the investor’s perspective, in real estate market, equity is the amount that is free of debt and it is the amount that an investor holds. When you sale your property, then the net money you get, after paying all the commissions and closing costs, becomes your equity. Lenders don’t want to take risk by allowing a loan on over 90% of equity. Therefore, in this manner, the lenders take the safety measures in wake of their loan being defaulted.

The Federal Bankruptcy act says that all the first mortgages of over 75% of the appraised or purchase value must be covered under high-ratio insurance schemes. However, there are certain conditions, wherein, CMHC offers the purchasers of real estate property qualifying the insurance, a mortgage of up to 100% of purchase price over your principal house value. In the wake of an event where borrowers want more money from the lenders, they would ideally settle for second and the third mortgages.

Low Inflation

Inflation is the rise in the prices of the products, commodities and services, or putting it another way, it is the decrease in your capacity to buy or hire the services. Supposing, a commodity was worth $10 a decade back, will now cost $ 100 as the result of inflation. For people who have fixed salaries feel the real brunt of the dollar, as the inflation rises. In Canada, the inflation rate varies and it varies every year. There was a time when Canada had a double-digit, but it was controlled to single digit, after the regulation of policy.

If we analyze closely, the land appreciation value for the residential real estate is 4% to 5% higher than inflation rate. Therefore, when you invest in real estate, then you are paying mortgage debts in high dollar value. Now as you are getting more, salary to pay less amount than the amount that you had paid in the original mortgage.

Tax Exemptions

You get various tax exemptions on your principal and investment income property. The tax exemptions available in real estate property investment are more than available in any other investment. In other investments, you lose terribly on the investments in your bank in the form of inflation and high taxes therein, but in real estate; you don’t actually have such hindrances.

Various tax exemptions available are:
•The interest receivable from your bank account, term deposit or guaranteed Investment Certificate (GIC) is completely taxable as income. A little math here will do the magic work for you. Supposing, if you get an interest of 8% on the deposit, and the on going inflation rate is 5%, the Real Return Rate will come out to be settled at 2%.
•You get completely tax-free capital gain on principal amount of your residential real estate property.
•You have the opportunity to ward off principal amount of your residential real estate property against the home expenses incurred by you.
•You can easily ward off the property depreciation against your income.
•You can cut the expenses incurred in real estate property investment through your income
•Tax rate reduced to approx. 50% of the capital gain.
•And many more

Net Positive and High Income is Generated

If taken in right direction and played seriously, a real estate investment can be your virtue making endeavor now and in times to come. You will not only be having additional assets building in your favor, but also with positive cash flow, your real estate property value will increase automatically.

Getting Started in Residential Real Estate Investing

Residential real estate investing is a business activity that has waxed and waned in popularity dramatically over the last few years. Ironically, there always seem to be a lot of people jumping on board with investments like stock, gold, and real estate when the market’s going up, and jumping OFF the wagon and pursuing other activities once the market’s slumping. In a way that’s human nature, but it also means a lot of real estate investors are leaving money on the table.

By understanding the dynamics of your residential real estate investment marketplace, and acting in opposition to the rest of the market, you can often make more money, as long as you also stick to the real estate investing fundamentals.

Real estate investing, whether you’re buying residential or commercial property, is not a get-rich-quick scenario. Sure you can make some fast cash flipping houses, if that’s your bag, but that is a full time business activity, not a passive, long term investment. The word “investment” implies that you are committed to the activity for the long haul. Often, that’s just what it takes to make money in real estate.

So, while the pundits are crying about the residential real estate market slump, and the speculators are wondering if this is the bottom, let us return to the fundamentals of residential real estate investing, and learn how to make money investing in real estate for the long term, in good markets, as well as bad.

A Return To The Fundamentals of Residential Real Estate Investing

When real estate is going up, up, up, investing in real estate can seem easy. All ships rise with a rising tide, and even if you’ve bought a deal with no equity and no cash flow, you can still make money if you’re in the right place at the right time.

However, it’s hard to time the market without a lot of research and market knowledge. A better strategy is to make sure you understand the four profit centers for residential real estate investing, and make sure your next residential real estate investment deal takes ALL of these into account.

Cash Flow – How much money does the residential income property bring in every month, after expenses are paid? This seems like it should be easy to calculate if you know how much the rental income is and how much the mortgage payment is. However, once you factor in everything else that goes into taking care of a rental property – things like vacancy, expenses, repairs and maintenance, advertising, bookkeeping, legal fees and the like, it begins to really add up. I like to use a factor of about 40% of the NOI to estimate my property expenses. I use 50% of the NOI as my ballpark goal for debt service. That leaves 10% of the NOI as profit to me. If the deal doesn’t meet those parameters, I am wary.
Appreciation – Having the property go up in value while you own it has historically been the most profitable part about owning real estate. However, as we’ve seen recently, real estate can also go DOWN in value, too. Leverage (your bank loan in this case) is a double-edged sword. It can increase your rate of return if you buy in an appreciating area, but it can also increase your rate of loss when your property goes down in value. For a realistic, low-risk property investment, plan to hold your residential real estate investment property for at least 5 years. This should give you the ability to weather the ups and downs in the market so you can see at a time when it makes sense, from a profit standpoint.
Debt Pay down – Each month when you make that mortgage payment to the bank, a tiny portion of it is going to reduce the balance of your loan. Because of the way mortgages are structured, a normally amortizing loan has a very small amount of debt pay down at the beginning, but if you do manage to keep the loan in place for a number of years, you’ll see that as you get closer to the end of the loan term, more and more of your principle is being used to retire the debt. Of course, all this assumes that you have an amortizing loan in the first place. If you have an interest-only loan, your payments will be lower, but you won’t benefit from any loan pay down. I find that if you are planning to hold the property for 5-7 years or less, it makes sense to look at an interest-only loan, since the debt pay down you’d accrue during this time is minimal, and it can help your cash flow to have an interest-only loan, as long as interest rate adjustments upward don’t increase your payments sooner than you were expecting and ruin your cash flow. If you plan to hold onto the property long term, and/or you have a great interest rate, it makes sense to get an accruing loan that will eventually reduce the balance of your investment loan and make it go away. Make sure you run the numbers on your real estate investing strategy to see if it makes sense for you to get a fixed rate loan or an interest only loan. In some cases, it may make sense to refinance your property to increase your cash flow or your rate of return, rather than selling it.
Tax Write-Offs – For the right person, tax write-offs can be a big benefit of real estate investing. But they’re not the panacea that they’re sometimes made out to be. Individuals who are hit with the AMT (Alternative Minimum Tax), who have a lot of properties but are not real estate professionals, or who are not actively involved in their real estate investments may find that they are cut off from some of the sweetest tax breaks provided by the IRS. Even worse, investors who focus on short-term real estate deals like flips, rehabs, etc. have their income treated like EARNED INCOME. The short term capital gains tax rate that they pay is just the same (high) they’d pay if they earned the income in a W-2 job. After a lot of investors got burned in the 1980’s by the Tax Reform Act, a lot of people decided it was a bad idea to invest in real estate just for the tax breaks. If you qualify, they can be a great profit center, but in general, you should consider them the frosting on the cake, not the cake itself.

Any residential real estate investing deal that stands up under the scrutiny of this fundamentals-oriented lens, should keep your real estate portfolio and your pocketbook healthy, whether the residential real estate investing market goes up, down or sideways. However, if you can use the real estate market trends to give you a boost, that’s fair, too. The key is not to rely on any one “strategy” to try to give you outsized gains. Be realistic with your expectations and stick to the fundamentals. Buy property you can afford and plan to stay invested for the long haul.