Investing in Property
Land, they’re not making any more of it. That’s why investing in property started the road to riches for many of the world’s great fortunes. Even those who made their money elsewhere invested in real estate. For instance, Bill Gates is the largest private farmland owner in the country. If you’re thinking about property investments, here is what to know before taking the plunge.
Pros of Investing in Property
Real estate is the classic way to build wealth. Rented property generates a steady stream of monthly payments. The property owner must pay the mortgage, property taxes and maintenance costs. However, the net cash inflows should prove significant.
Real estate builds equity. Most real estate appreciates in value over time. This provides a hedge against inflation. Of course, real estate can decline in value. That’s especially true if you purchased the property at the height of the market during a real estate bubble. When that bubble bursts, it can take years before the property is worth what you paid for it.
Investing in property offers tax advantages. For example, if you receive rental income from a dwelling unit, you can deduct various expenses. These include:
- Mortgage interest
- Property taxes
- Operating expenses
- Travel expenses relating to management
Then there is depreciation. Commercial buildings and improvements are depreciated over 39 years. You can deduct 1/39 of the building and improvement costs annually for that period. Residential rental real estate generally depreciates at a rate of 3.63 percent for 27.5 years. Depreciation starts as soon the property is rented. Land is not depreciable, only the value of buildings.
Cons of Investing in Property
Although there are exceptions, investing in property is not a get-rich-quick endeavor. First, you need considerable capital to get started. And those funds are usually tied up for a great deal of time.
Maintenance is necessary. Lack of maintenance devalues the property and may cause hazards. You never know when a maintenance issue may arise, and it’s often costly. Leaky roofs, burst water pipes, lack of heat and similar issues all require immediate attention.
Investing in property means managing those investments. If you cannot do this yourself, you can hire a property management company. Keep in mind those payments of between eight and ten percent of the rents eat into your profits. Even so, you will spend time consulting regularly with the property manager.
Real estate is not a liquid asset. If you need to sell quickly, you could sell at a loss, or end up losing the property at a sheriff’s sale if the mortgage and taxes go unpaid. Many real estate investors seek out such distressed properties to get the best deal. That’s fine for them, but not for the owner who had to unload the parcel.
With property ownership comes the risk of liability. A tenant or guest may sue the landlord if injured on the property. Fortunately, investors can purchase landlord insurance policies to protect themselves and their assets.
Extreme due diligence is required before purchasing a property. That’s true whether you are buying an existing building or raw land. It especially applies to tenants. Whether you invest in commercial or residential real estate, there is always the possibility of ending up with the tenant from hell.
One of the easiest ways to get started investing in property is by purchasing shares in a Real Estate Investment Trust. REITs allow individuals to purchase shares of income-producing real estate. Such properties are part of the REIT’s investment portfolio. One great advantage of certain REITs is liquidity. Since these are publicly traded on a stock exchange, shares are bought and sold like equities. Purchase REITs from a broker. As with many equities, investors must pay dividends and capital gains on their REIT income.
There is one caveat. Not every REIT is publicly traded. Non-traded REITS are illiquid. They are not readily sold on the open market. The share value of non-traded REITs is often difficult to discern. Typically, REITs that are not publicly traded do not have to provide a per-share value estimate until 18 months after their offering’s closing. That means you cannot assess the share price or your investment’s volatility for a significant period of time.
Types of Property for Investment
Residential rental real estate investment refers to buying single-family homes or semi-detached housing. With the latter, the landlord may live in one unit while renting out the other units. These properties are small-scale. And generally consist of two to four units. In other words, these are properties the landlord could manage on their own.
Other types of residential real estate are akin to commercial property investing. This includes investing in apartment complexes and senior living facilities.
Investing in commercial properties has greater income potential than investing in residential rentals. Commercial property tenants are usually businesses. So the relationship between the property owner and the tenant is usually more professional than that of a residential tenant.
Commercial properties include:
- Shopping malls
Becoming a Landlord
Many real estate investors start out by becoming landlords. Along with purchasing properties for rental, some landlords seek out properties for sale that already have tenants in place.
The online real estate marketplace company Zillow has advice for those thinking about going the landlord route. First, look for rental properties within your budget and without need of major repairs. Crunch the numbers to make sure there’s a potentially high investment return.
Always budget for unexpected costs, including tenant delinquency. In addition, remember you still have to pay expenses even if the unit sits empty. Understand your local landlord-tenant laws, which vary by state. You must know what you can and cannot do in the event of a tenant dispute.
After ensuring the property is in move-in condition, start advertising for tenants. Always perform a thorough background and credit check on any applicant. Have a real estate lawyer review your lease before the tenant signs it. Keep the property maintained.
Investing in Property Considerations
Investing in property takes a lot of time and effort. You can make a lot of money, but you’ll put in a lot of work. Even if you aren’t a hands-on manager and hire professionals, there’s still a great deal of oversight necessary. Still, you could well have a property that provides steady income and produces a substantial profit when it’s time to sell.
About Jane Meggitt
Jane Meggitt specializes in writing about personal finance. Besides investing and planning for retirement, she writes about insurance, real estate, credit cards, estate planning and more. Her work has appeared in dozens of publications, including Financial Advisor, Zack’s, SF Gate and Investor Junkie. A graduate of New York University, Jane lives on a small farm in New Jersey horse country.