So, you are thinking of investing in real estate instead of the stock market? Decisions, decisions! How do you make the decision? Well, maybe I can help.
Historically real estate typically appreciates 3 to 5 percent a year. I know real estate a few years ago was appreciating 24% a year but that was not a normal market and could not continue. Buyers were over reaching just trying to get into the market before they were priced out and taking on loans they figured they could refinance out of in a few years. Well, we all know what happened next. The real estate market declined and declined by about 40 percent sometimes even more.
So, here in todays market we have VERY affordable prices for entry level homes, which make great rental properties. You want to try to find a home that is your typical three bedroom or more two bath home in a nice neighborhood at an affordable price. No swimming pool, because tenants typically don’t know how or won’t take care of a swimming pool.
When investing in rental property, you need to have a 20 percent down payment, unless you purchase a HomePath property or a HUD property then you only need a 10 percent down payment. You can determine if a property “pencils out” as they say, by making some simple calculations.
Take your annual anticipated cash flow from the rental property, deduct your mortgage payments, taxes, insurance, an eight percent management fee if you are going to have a property manager and a five percent vacancy factor if the property is vacant for a month or for repairs and this figure is called your “cash on cash” return or net spendable income. To figure cash on cash as a percentile, divide your annual cashflow by the down payment amount. If this percentage is greater than your return in the stock market then investment property may be right for you.
You may think well, “I can manage the property myself and save the 8% the management company would charge me.” Don’t do it, especially if this is your first rental property. I would highly recommend spending the 8 percent management fee to have a management company handle the property for you. Their services are invaluable. They run credit checks on the tenant, collect the rents and then forward them to you. They take care of any maintenance issues. Who wants to get the call in the middle of the night that there is a backed up toilet? Let the management company handle it for you, it’s a small price to pay.
Hopefully, you will take that next step after homeownership and invest in real estate. It is a great long term investment for your retirement and it really can make you wealthy.