Whether you’re curious about the investment potential of real estate or simply sick of infomercials promising millions of dollars in returns from a new and obscure way of investing in real estate, it is worth learning how wealth is created through real estate.
Location is often the biggest factor in appreciation. As the neighbourhood around a home evolves, adding transit routes, schools, shopping centers, playgrounds and so on, the value climbs. Of course, this trend can also work in reverse, with home values falling as a neighbourhood decays.
Home improvements can also spur appreciation, and this is something a property owner can directly control. Putting in a new bathroom, upgrading to a heated garage and remodeling to an open concept kitchen are just some of the ways a property owner may try to increase the value of a home.
Many of these techniques have been refined to high-return fixes by property flippers who specialize in adding value to a home in a short time.
Residential Property Income
Although it is possible that you may earn income from the installation of a cell tower or other structure, the vast majority of residential property income comes in the form of basic rent. Your tenants pay a fixed amount per month – and this will go up with inflation and demand – and you take out your costs from it and claim the remaining portion as rental income. While it is true that you will get an insurance payout if your tenants burn down the place, the payout only covers the cost of replacing what is lost and is not income in a real sense.
Commercial Property gains value for the exact same reasons as the previous two types: location, development and improvements. The best commercial properties are in demand, and that drives the price up on them.
Commercial Property Income
Commercial properties can produce income from the aforementioned sources – with basic rent again being the most common – but can also add one more in the form of option income. Many commercial tenants will pay fees for contractual options like the right of first refusal on the office next door. These are essentially options that tenants pay a premium to hold, whether they exercise them or not. Options income is sometimes used for raw land and even residential property, but they are far from common.
The most obvious source of appreciation for undeveloped land is, of course, developing it. As cities expand, land outside the limits becomes more and more valuable because of the potential for it to be purchased by developers. Then developers build houses that raise that value even further. Appreciation in land can also come from discoveries of valuable minerals or materials, provided that the buyer holds the rights. An extreme example of this would be striking oil, but appreciation can also come from gravel deposits, trees and so on.
Raw Land Income
Depending on your rights to the land, companies may pay you royalties for any discoveries or regular payments for any structures they add. These include pump jacks, pipelines, gravel pits, access roads, cell towers and so on. Raw land can also be rented for production, usually agricultural production.
Flipping or HOLD?
The question of whether buying and selling or buying and holding is a more appropriate residential real estate investment strategy does not have one correct answer. Rather, the decision to choose one method over another should be part of an explicit strategy that takes the investor’s overall investment goals, as well as the opportunities presented by the existing market, into account. This article will discuss each investment strategy’s advantages and disadvantages. Read on to find out which strategy will edge out the others in the market in which you invest.
The Pros and Cons of Flipping
The most apparent advantage to flipping property investments is the ability to immediately realize gains and to have capital tied up for the least amount of time possible. Also, unlike the stock market, which can turn in the middle of a day, real estate markets are more easily predicted and can produce extended time periods that compensate investors for flipping properties. In this sense, flipping properties could be considered a less risky investment strategy because it is intended to keep capital at risk for a minimal amount of time and because it lacks the management and leasing risks inherent in holding real estate. For most investors, flipping properties should be considered more of a tactical strategy than a long-term investment strategy. Because transaction costs are very high on both the buy and sell side, they can significantly affect profits.
There are two major types of properties that can be used in a buy/sell approach to real estate investing. The first is homes or apartments that can be purchased below current market value because they are in financial distress. The second is the “fixer”, a property with a structural or design issue that can be overcome to create value. Investors that focus on distressed properties do so by identifying homeowners who can no longer manage or sustain their properties or by finding properties that are over leveraged and are at risk of going into default.
Those who prefer fixers, on the other hand, will remodel or enhance a property so that it works better for homeowners or is more efficient for apartment tenants. Using this tactic, the buyer of a fixer is relying on investing capital to increase values as opposed to just buying property for a low basis in order to create high investment returns. Of course, it is also possible to combine these two strategies when flipping properties, and many investors do just that.
The Pros and Cons of Holding
It is a well-known fact that buying and holding real estate is a recipe for amassing great wealth. Most “old money” in the U.S. and abroad was accumulated through land ownership. Even after periods of decreasing land prices, land values have almost always rebounded in the long run because there is a limited supply of land. However, long-term real estate ownership carries a myriad of management and legal issues that investors in stocks and bonds never have to contend with. Real estate ownership is a management-intensive endeavor that is outside the skill set of many investors.
Equity investors have to have the skills to analyze a particular market, a particular company and management’s ability to execute its business strategies. A long-term real estate investor needs the same skills but has the added responsibility of creating and executing those business strategies for his or her properties. Many investors, especially first-time rental property owners, are ill-prepared or ill-equipped to deal with the responsibilities that come with managing rental property.
The process of finding quality tenants and servicing their needs, along with ensuring the maintenance and upkeep of the property, can be a stressful and time-intensive undertaking, but successful property management is necessary for ensuring ongoing cash flows from one’s investment.
The risks inherent in long-term real estate ownership are great, but if mitigated, the investor is well compensated for assuming them. Most of these risks, which include the transnational risks of purchasing and selling properties, risks to the well-being of the property and the risks of finding and maintaining tenants are considered unsystematic risks, or investment risks That can be diversified away if an appropriate number of investments are purchased in a well-crafted portfolio. The problem for most investors is that real estate is so capital-intensive that the amount needed to purchase enough property to diversify away these risks is outside of their abilities.
Although the choice between the two strategies in question depends on one’s particular financial situation and investment goals, the long-term holding strategy is generally more appropriate for those using real estate as a core portion of their overall investment portfolios; flipping properties is more appropriate when real estate is used as an adjunct or a return-enhancement tactic. Investors wishing to amass wealth and to derive income from their real estate investments should consider holding real estate for the long term, using the equity built into the portfolio to finance other investment opportunities, with the potential of eventually selling the properties in an up market. Flipping properties is a tactic that is best suited for periods when prospects in the stock and bond markets are low, or for investors wishing to realize short-term capital gains for as long as the present market will allow.
PLEASE CONSULT WITH INVESTMENT PROPERTY SPECIALIST.