The truth: It can be. But it can also be one of the safest investments you make. The key is to know how to remove the risk from your real estate investments.
Follow these five rules to help remove the risk from real estate investing and build a sound real estate investment portfolio that will produce steady positive cash flow and build long-term wealth.
1. Invest in deals, not markets
Too many novice investors try to time the market and ride the waves of market appreciation.
Certainly buying and selling at the perfect time (the old “buy low, sell high” cliché) is the easiest and most lucrative way to invest in real estate. It’s also the most risky because it’s virtually impossible to see into the future and know for sure what the market is going to do.
Instead of trying to guess the bottom and top of a market, stick to specific deals that make sense for you regardless of what the market does.
They don’t ring a bell at the top or the bottom of a market, so while timing can be the icing on the cake, the cake itself is the deal you get on the house – buy it cheap, buy it for income, and/or buy it with good financing.
2. Stick with metropolitan areas
Housing markets are driven by people and people tend to go where there are jobs. It’s much easier to sell or rent a property in areas that have large, diverse populations and economic drivers.
Study the trends of your metropolitan areas too. Are people moving in or out? Are companies expanding or leaving? Is supply of housing higher or lower than demand?
Do your homework before you invest in a particular area.
3. Buy the worst house on the block
A good rule of thumb for investing is to buy the worst house on the block in a decent neighborhood. Here’s why: Most people consider the neighborhood first, and they’d rather live in a lesser house in a better neighborhood than in the grandest house in an undesirable area.
Also, it’s generally easier to push up property value from the lower end of the spectrum than on the high end.
In terms of neighborhoods generally, buy in areas that are priced at or just below the median for the city. These are often called “starter home” areas or “bread and butter” neighborhoods. These sell quickly and rent quickly.
Don’t go too far below the median price though… you don’t want to invest in ghettos with high crime and low desirability.
4. Go for the fixer-uppers
Properties that need fixing up are almost always a safe bet if you buy them right. They tend to have less market appeal than houses that are in good shape, and that translates to a lower purchase price.
Make sure you get at least a $3 discount for every $1 of repairs needed. In other words, don’t pay $180,000 for a house that needs $20,000 in repairs and is worth $200,000 fixed up. You have to get some profit for the hassle of doing the fixup work. You should be paying more like $120,000 for that house described above (or less).
A word of caution: Be sure you know what to fix and how to estimate the repairs, so you can determine whether a fixer-upper is worth the effort. Some properties need too much work to be worth it considering the profit you’ll make. Using the above example, if the property needed $60,000 in rehab, and your net profit was going to be $15,000, it hardly seems worth the risk.
The larger the repair budget, the more potential for cost overruns. If you are going to sink $60,000 in repairs into a house, you should be netting $25,000-30,000 (or more) for the commensurate risk.
5. Know what to avoid
In general, avoid buying new or pre-construction houses as investments. Stay away from resort areas and smaller towns that have one major employer. A particular residential property class to avoid is upper middle-income homes, which can be difficult to rent if you can’t sell them.
Also, avoid houses older than 1950, unless they are larger and/or “charmers.” An old Victorian restored to its original condition is a very desirable property. An 800 square foot bungalow from 1930 is not worth bothering with (unless it’s in a PRIME neighborhood).
Like most things in life, there are no absolute guarantees when it comes to real estate investing. But the above five rules are key steps you can take to minimize risk and increase the chances that your real estate investments will be successful and produce the results you desire.
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