Wednesday, April 27, 2011

Make Money in Real Estate?

You can make money in Real Estate, but it takes hard work.

This article on CNN talks about a couple buying Rental Real Estate properties on the Texas Gulf Coast.

Can you make a lot of money in Real Estate as a landlord?  Yes, you can.  But it is not easy money, nor is it free.  You need to work hard, have a little intelligence, and a little luck.

And yes, in the present market and for the next few years, we should see some bargain properties come on the market.

Why do I say this?  Because I saw the same thing happen between 1989 and 1998.

In 1989, we had a Real Estate meltdown - housing prices plummeted after several years of double-digit increases.  Then a number of savings and loans went insolvent.  Many "little people" lost a lot of money, and there was a call for tighter regulation of both the housing and banking industries.

Sounds very familiar, don't it?

I bought most of my investment properties from 1995-1998, when the market bottomed out.  That's right, it took nearly a decade for the Real Estate Market to hit bottom.  But by 1998, things started turning around, with a vengeance.

Today, I think we will see the same thing.  There is talk of a "double dip" in housing prices, as a backlog of foreclosures hits the market and buyer incentives and other efforts to prop up the market expire.  Housing will remain flat for a year or two more - at least.

Why is this?  Not strictly economics, but emotions.  Markets are irrational, and home buyers - individuals - are the most irrational of the lot.  Back in 1995 when I bought properties, my friends all said, "You're crazy!  I lost my shirt doing that!  You need to get into this "Dot Com" deal instead!"

And of course, they were wrong. 

Today, I think the same thing will happen - people will be "scared off" by their bad experiences in Real Estate.  People who went bankrupt or lost their life's savings will shy away from owning an investment property.

And this is probably a good thing, too.  Those are the folks who drove up prices and bought properties with huge negative cash-flows and sometimes never even rented them out!  They thought the equity was the whole deal, and neglected the income aspect of it.  They never should have been investors in Real Estate.

Can you make money in Real Estate?  Yes, but there are some caveats:

1.  You have to have a neutral or positive cash flow:  If you buy a house or apartment or other rental unit that has a monthly carrying cost of $2000, then you have to have at least $2000 in rental income to offset that.  The idea that you will make it all back in appreciation (or through reduced taxes in depreciation) is nonsense.  You cannot guarantee a rate of return on equity, but you can with income.

2.  Vacancy Kills:  If you buy a place, fix it up, and then decide to double the rent - good luck!  Because you can't dictate rents to the market.  But if you can rent out a unit at an attractive price, it will stay rented all the time and you will make a modest amount of money.  One month's vacancy every year is enough to sink your ship, so make sure you factor this in to your cash flow calculations.

3.  You Have to Have Good Tenants:  Being an amateur landlord isn't easy.  Being an amateur slumlord is murder.  Walk away from renting homes in the ghetto or in bad neighborhoods.  You will have vacancy, vandalism, and evictions - but never rent paid on time!  Prosperous areas and vacation rentals are far safer bets, and what I would recommend for the smaller investor.

4.  You Have to Be Handy:  Or at least know a good handyman.  But if you can fix a leaky faucet or replaced a recalcitrant light fixture, you can save hundreds of dollars in service calls.  And while this may not seem like a lot, it often is the difference between profit and loss.  Can't change a light bulb?  Think carefully before buying five houses.

5.  You Have to Be a Good Bookkeeper:  Keeping track of the books is essential, to know whether you are making money, and also for tax purposes.  So much is deductible from your taxes, so you cannot simply pay for things out of pocket and say "It was a small expense, no need to log it".  You'll go broke that way.  Understanding the tax code and how the Depreciation Deduction works is key - you can get a lot knocked off your taxes by owning rental properties.  Of course, they recapture this on the back end, in terms of Capital Gains taxes.  There are, of course ways around this (turn a rental into a personal residence, for example).

6.  You Have to Be a Ruthless Landlord:  This does not mean abusing your tenants, but rather not letting them abuse you.  We never had any problem tenants, but if you do, you have to evict and be businesslike about it.  You cannot be "friends" with your tenants, or use your position as a chance to enact any of your cock-eyed social or political ideas.  You'll go bankrupt in short order - and problem tenants will flock to you, sensing your weakness.

Should you jump into investment Real Estate and make a million bucks?  I did, but then again, I wasn't afraid to sheet-rock a kitchen or install a new toilet.

In the coming years, we may see some opportunities to buy properties and rent them at a profit from nearly the get-go.  It is not necessarily a bad gig - and when the prices drop to the point where you think, "This is a ridiculously cheap property, I can rent this at a profit!" it might not be a bad time to buy.

But it can be a risky business, and you should think carefully before you jump in.  If you over-pay for a property and over-estimate the potential rental income (two newbie mistakes) you could end up with a negative cash flow that could drag down your personal finances and end up bankrupting you if you can't sell the property for more than you paid for it.

Landlording is a RISK-TAKING business, and if you are approaching retirement, think carefully as to whether you can afford to take the risk.

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