Real estate investments - grow rich one property at a time

Real estate investments produce more millionaires that probably any other kind of investments. While they may sometimes - especially during real estate booms - look like an automatic ticket to wealth, they aren't as easy to make and manage as they might look, even if they aren't any rocket science either. I think almost anyone can succeed with real estate, but only through a lot of hard work and willingness to learn, like with any other business.

Real Estate Business

In fact, business is the key word here. When you invest in real estate, most of the time it means directly buying one or several properties, whether you will fix and/or rent them out, or flip them, or do whatever else that results in profits for you. Of course you could just buy into a real estate fund, where you just provide (part of) the financing and the fund does all the work for you. In this approach, though, your profits will probably be very limited compared to direct real estate investments, as the fund will typically take big part of the profit - and not necessarily do as a good a job as you could do directly.

As real estate investments are really a business, rather than just a simple investment, they also mean more work for you than investing in the financial markets. Depending on the type and scale of your real estate business, you will easily spend at least some hours a week and when your business is growing, it may easily become a full time job for you, with employees and contractors helping you out like in any other business. The rewards can be handsome, though, so they are definitely worth the effort, especially if you look at it from the pure financial point of view.

Buy Real Estate

Starting real estate investments is easy: you just buy a property - a house, apartment, condo, or similar - and either rent it out or sell it for profit. However, as it really is a business, it is necessary to understand what you are really getting yourself into, and how to do it profitably. If you have no experience in real estate, I warmly recommend to start by spending time to read through a few good books on real estate investments - and maybe property management too - in order to get an idea of the basics. While this won't make you an experienced real estate investor or property manager, it will give you plenty of ideas what it will be like and what you need to pay attention to. With this, you can learn from others have done and avoid the main pitfalls that could really sink you. Also, many real estate investors miss a great opportunity for high profitability by not doing it properly, In order for you to maximize the rewards of your hard work, it's worth the effort to learn more and be well prepared before you even get started. 

Overpriced Property

The most common reason for missing out on the best possible profits in real estate is probably buying of properties at too high prices. Especially if you are in a rush to buy - for example if you are trying to grow really quickly and have good access to financing - you will easily end up buying your properties at high prices. This may work fine for a while in a boom market where prices keep growing quickly, but when the boom ends - and it always does at a moment when you really don't expect it - you can really find yourself in the kind of mess you could ever imagine. And when the market is just an ordinary kind, where prices grow by average just a bit faster than inflation, buying at high prices will make it much harder for you to make a profit. The reason is a vicious cycle: when you buy high, you have more pressure to keep rents high and expenses low. With this, you will easily price yourself out of the market, and you have a risk of minimizing the maintenance of your properties, which will then decrease the actual rents you can get. This may also lead to lower occupancy rate, which will yet more pressure on your business. Also, if you are flipping the properties rather than renting them out, the problem similar: too high purchase prices will force you to try to sell for higher prices, which will lengthen the time it takes you to close the sales and decrease the profitability of your deals due to increased financing costs.

Less than optimal financing is probably the second most important reason for low profits in real estate business. As property prices don't tend to grow much above the rate of inflation, by average, the key for your profits - besides good purchase prices - is leverage. If you buy a $100,000 property with 100% equity financing, you will have no interest costs to worry about but the annual growth of your equity will only be typically 2-4% - the same as the growth rate of property prices in your area. On the contrary, if you bought the same $100,000 property with only $10,000 equity, while you will then need to cover the interests, your equity will now grow 20-40% a year (i.e. $2000-$4000 on that $10,000 investment). This way you could use the original $100,000 and buy a $1,000,000 property, with your equity now growing $20,000-$40,000 a year. Ten times better than the original deal!

Of course leverage only works if the interest rate you pay is lower than the interest rate you get. Which brings us back to the importance of the purchase prices: for example, buy a $100,000 property with $15,000 of equity, and the property yields $8000 of rents in a year, assume you need $5000 to cover you interests and other costs and get $4000 (i.e. 4%) annual growth in property prices. With this, you get $7000 profit on your $15,000 investment - not too bad, is it! Instead, if you bought the same property for $120,000 with $18,000 equity, the rents would still be the same $8000, but your you costs would be probably close to $6000, and the increase in value would be less (as you bought it at "too high" a price° - actually nothing (or negative) in the first few years. Thus your $18,000 investment would yield only about $2000 profits - shockingly much less than the $7000 that you would have got with the $15,000 investment.

Besides boosting your returns, your form of financing also has a big impact on your cash flow. If you have a conventional type of mortgage which you amortize a bit by bit every month, this will reduce your positive monthly cash flow. As you need your cash flow to minor repairs and other regular expenses, this increases your risk of being cash-trapped from time to time. That's why you'd probably prefer to use a bullet mortgage instead, where the entire principal is paid back at the end of the mortgage period. This also leaves you an option not to pay back the mortgage at that time, but to refinance the property. Of course there is also the other side to this: a bullet mortgage means a higher average rate of leverage and thus somewhat higher risk in case things go south. This is another reason why it really pays to understand well what you are doing, do things properly, and keep your risks under control.

If you buy your real estate investments at good prices and have proper financing for them, then the rest is pretty much up to your property management (unless you flip the properties, of course, in which case there's not much of property management to worry about). If you can manage the tenants well - find good ones, keep them long enough, and maintain high occupancy rates for your properties - the job is already half done. The other half is then to maintain the properties well - so that it's easy for you to get and keep good tenants - while keeping the cost of maintenance reasonable.

While the property market tends to boom and bust on a rather regular basis, real estate millionaires know that it these investments can be a very solid, high-return, and easy-to-manage business, more so than almost any other businesses. If you are interested in an investment that provides much higher returns than the financial markets and ready to put in the effort to learn the ropes and do the required work, real estate investments might just be a key ingredient for your million dollar plan.

Real Estate Investments - back to the top of the page