Four Universal Keys (plus one) for Investors to Buy a House Right
In my last post, I discussed four universal keys to buying real estate right. In that post I addressed those who are buying a house to live in. Today, I will address those who are looking to buy a house as an investment. I will show you how those same four keys apply, but in a slightly different manner.
Why do I give different advice to investors than for homebuyers? Because there are different tradeoffs each faces. For the investor this is business (or it should be) while for the homeowner pleasure plays a big role.
As you will see from my discussion, savvy investors must always consider cash flow on a property. Homebuyers should consider affordability, but also consider the pleasure they get from living in the home. Since the investor rarely lives in a home they buy, the cash flow has to be enough pleasure.
So, lets get to the discussion.
To recap, there are four universal keys in buying a house right. The first is to avoid falling in love with the house. The second is to not overpay for the house. The third is to avoid overborrowing (overleveraging). The fourth is to not overpay for the loan. And for investors there is a fifth, critical key, never buy for appreciation.
I. Don't fall in love with the house. If the numbers don't work, then don't work the numbers, just move on. This is business, not pleasure. This house is not your one, true love. There will be other houses. It is an investment and one day you will sell it.
II. Don't overpay for the house. Never pay retail. When you buy a house for investment, your calculus is different. You must start with the retail value of the home and work backward to figure out what is the most you should pay. Here is the calculation if you plan to sell the house:
- Retail Value - Seller Discount - Cost of Repairs - Carrying Costs - Desired Profit = Maximum Offer
- (Annual Rent - Operating Costs) / Purchase Price = Return on Investment (aka ROI)
- Annual Rent - Operating Costs - Debt Payments - Reserves = Net Income Before Taxes (aka annual cash flow).
- Net Income Before Taxes - Depreciation Deduction = Net Taxable Income (in this case a negative number is not a bad thing)
III. Don't overborrow. Many real estate investment course tout buying property with no money down. That can be done, I have done it. But, it is often a dangerous game and can lead to financial disaster for the unwary. When you buy a property and you owe 100% of what it is worth, you have no room for error. Also, if you look at the formulae above you will note that debt payments play a role in determining your net income. If you cannot earn $1.20 in net income for every dollar in debt payments you are making, you should probably not make the investment. If you borrow so much that every dime of net income has to go to pay your debt, you don't have any income to make your life better. You can be a real estate millionaire and not have two nickels to rub together - You are four tires away from bankruptcy.
IV. Don't overpay for the loan. Borrowing to purchase investment property is a different animal from borrowing to buy your own home. Rates are higher, payment terms are often shorter, and the demand for a down payment is much stronger. The best way to keep your lending costs low is to borrow private money. It is good for you and it is good for the lender. The only loser in this scenario is the bank, because they don't get to turn your money and the lender's money into their money. There is a lot of great win-win opportunities with private lending. I will discuss it in another post or you can go to the "Investors" tab at http://www.buyahousebelowmarket.com/ and request an information packet.
V. Never buy for appreciation. This is the single biggest cause of failure for real new estate investors. If you buy a property and are figuring that you will make all your money on the deal when it goes up in value and you sell it, you are not investing, you are simply gambling. I know of people who bought a duplex that they could not rent for enough money to cover the mortgage payments. "It's OK!" they said, "with the market in this area, we will sell it in six months and make back all our money and still get a huge payday." The market collapsed and they lost the duplex, their savings, their credit rating, and much more.
I started actively investing in real estate in 2001. I weathered this market downturn without a problem because of this one simple rule. I never buy a property that does not have a reasonable expectation of giving me a positive cash flow.
At http://www.buyahousebelowmarket.com/ we sell beautiful homes to home buyers. We also sell package deals to investors - a beautiful home with a tenant already in it at a price that will cash flow.
Tom ~
Why Pay Retail?
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