How to purchase investment real estate

This post originally aired on my site: http://www.904living.com/buying/purchase-investmen...

***I'd love some feedback on how to change, add, subtract, etc. to make it more beneficial for someone looking to buy their first rental property.***   Thanks!

Everyone wants to get rich buying and selling real estate right? From late night infomercials to $1,000 online classes, there is no shortage of gurus wanting to cash in on this hunger for easy money.

My personal experience is that making money in real estate is neither quick nor easy. However, with a willingness to take smalls risks, a little bit of money and a fair amount of study, there is a good probability that you become a successful investor!

There are a few different components of a real estate investment.

• Appreciation

• Cash Flow

• Tax Advantages

Let’s start with: Appreciation

For starters, don’t count on appreciation in your real estate investment endeavors. Ask anyone who bought investment property in 2006-2007 to explain.

Most real estate folk will tell you that real estate appreciates at roughly 5% per year. In looking at theCase Shiller Index, which has only been measuring real estate prices for the last 27 years, we see that appreciation on average has been around 3.2%. This did include, arguably, the worst drop in prices we’ve seen in the past 100 years which was the end of 2006 through the beginning of 2012.

For our purposes, let’s assume that real estate for the next 10 years in Jacksonville, FL will appreciate at a rate of 4%. Not too aggressive, but not too conservative either.

Next: Cash Flow

Most people getting in to real estate think that their cash flow is:

Rent
- mortage payment
= Cash Flow

Incorrect! There is more to it than that, and you can go broke quickly if you’re buying properties based on this assumption.

More accurately your cash flow will be:

Rent
– repairs
– vacancy
– management costs (including marketing)
– real estate taxes
– insurance
– financing costs
= Cash Flow

There is a great real estate investment calculator over on the Bigger Pockets website. A general rule of thumb is to assume about half of your monthly rent will be used for vacancy, repairs, and other soft costs (insurance, taxes, etc.). Obviously this amount can vary widely based on the age and condition of the property, but better safe than sorry!

Finally: Tax Advantages

For starters, don’t take my advice as absolute truth, ask your accountant!

Now that we have that covered. Depreciation is one of the great things about owning rental property. You can find all sorts of fun reading about the topic on the IRS site. But, simply put, depreciation allows you to write-off a portion of the value of the building each year. Currently, the IRS allows an owner to divide the building value over a 27.5 year period and use that figure as the annual depreciation. Therefore, you are lowering the income earned by this rental property by that amount each year.

Some will point out that this benefit is wiped out when you sell the home and the basis is much lower. My suggestion for avoiding this issue is to investigate the benefits of a 1031 Exchange.

This can be done in Jacksonville!

I purchased a property on the southside of Jacksonville this past year (2013) for $68k. It’s a quaint little brick/block home that has 3 bedrooms and 2 bathrooms, and is in a desirable area of town near jobs, schools, shopping, etc. I got a bit of a discount. It was probably worth high $80’s the day I bought it (in the same condition).

After about $8k in fix-up it was ready to be rented. It took just over 3 weeks to place a tenant at a rate of $960 per month. The home was built in 1957 (I’ve noticed that many insurance companies won’t insure homes built prior to 1945), but has a newer roof, was re-piped (after I purchased) and has an updated electrical system. That being said, I’m assuming that about 20% of gross rent will be chewed up by repairs and maintenance over the years ($192 per month). So far (knock on wood), there have been no additional repairs needed. But the day will come when you need to dip into the reserve account for a property. So, you might as well prepare for it.

The ability to finance this property should be pretty easy. Assuming 20% as the down payment and a 4.5% interest rate on a 30 year note. You end up with a down payment of $13,600, and closing costs in the $2,000 range. That brings our total cash investment to about $23,600 after repairs.

We then have (monthly figures):

Rent ($960)
- repairs ($100)
- vacancy ($75)
- property management costs (including marketing) ($96)
- real estate taxes ( $135)
- insurance ($55)
- financing costs ($275)
= Cash Flow ($224)

So, you’re clearly not going to “get rich quick” making $224 per month on a cash investment of $23,600. As a matter of fact, your cash on cash return (annually) is only about 11%. But, when you combine the depreciation benefit, the amortization of the mortgage, the appreciation of real estate over time, and the fact that you received a discount when you purchased initially… Things start to snow ball.

Granted, our example does assume that you’re paying for management, is conservative with the cost of repairs, and figures that you’re financing the property. This also does not include any depreciation taken. Primarily because we’re talking cash flow, and depreciation doesn’t really show up until tax time.

A few years down the road when you decide to sell (again I would do a 1031 exchange) your hard work will pay off.

It’s one thing to learn about, talk about, and fantasize about real estate investing. It’s another thing entirely to get into the game and start putting deals together. The best education (in my opinion) that one can receive in the real estate world is just to go out and do it.

This post could go on for pages, but I think we’ll stop here. If you need assistance in finding a home for your first rental, feel free to or send me an email.