Investing in Real Estate
Is It For Me?

Introspect before Inspect

You may be attracted to the idea of investing in real estate based upon an amazing story about somebody making a ton on a real estate investment. And probably the same in the stock market. But keep in mind that most people who profit tend to 'shout it from the roof tops', boasting of their good fortune. However, those who lose do not loudly lament their losses. Where some have gained, many more have experienced misfortune.

Before investing in real estate, and even prior to beginning your research, calculations and property inspections, I suggest the first thing you do is a little self examination.

Ask yourself a few questions.

What are your stress tolerance levels?

Why are you drawn to investing in real estate?

What is your ultimate goal of investing in real estate?

Do you feel the investment in your principle residence insufficient?

Do you want yet another property to manage?

Your Principle Residence

... is a great investment because, unlike a corporate stock, bond or Guaranteed Investment Certificate, you can physically live in it. Simple appreciation in real estate market values will enhance your investment, but you can also increase its value by physically improving it. Develop the landscaping, or upgrade the features by renovating. You get to enjoy the immediate benefits of an improved home, and subsequent owners may pay more because of your extra effort and expense.

Renovating specific parts of your home is an great way to increase its beauty and functionality, and possibly, at least in part, at the expense of someone else. Wisely choosing the best projects for enhancing your home, may result in a significant portion of the renovation expense being passed on to the next owner by way of a higher sale price when it's time to move.

If you're planning to list your home for sale soon, to ...

Enhance Your Investment

... it's a good idea to properly prepare it beforehand. Make sure you've got the basics that a buyer will expect, like a good roof and furnace, a dry basement, a fresh coat of paint, minor repairs handled and everything else you'd expect if you were viewing a home. If you don't, then prepare yourself for some possible tough negotiations, or even worse, no interest from buyers. Often, with the expert guidance of their own REALTOR® and home inspector, a buyer will pay a discounted price to reflect their cost of doing those same repairs. They may not be able to afford the work because all their ready cash is committed to the down payment.

Another way to enhance your investment is to improve the ...

Curb Appeal

... of your property. You never get a second chance to make a first impression. And since a large part of a buyer's decision to offer on a home is emotional, it's important to provide a positive first impression as they approach your property. While these improvements may not add much monetary value, they may add a little, and will certainly contribute to a faster sale. So, invest some time and effort into greening your lawn and planting flowers and shrubs. Fix your driveway and repair that broken screen door. Inside, replace the worn carpet, damaged counter-top and chipped bathroom sink, and clean all the windows.

Regardless of the renovation project you're considering, keep in mind that when you bought your principle residence, you weren't just investing in real estate by buying a house - you purchased a home. If you intend to live there long term, invest in improvements that excite you regardless of how they may eventually affect the market value of your investment.

To learn more about assistance in renovating, click here.

If you're still enthusiastic about investing in real estate property in addition to your home, it's important you understand the concept of ...

Return on investment (ROI)

ROI on an investment property or renovation project is directly related to, not only the type and calibre of the project, but also the condition of the local economy and real estate market. Certain projects, such as the addition of a sundeck, a kitchen or bathroom renovation, window replacement or landscaping, usually have a greater ROI than, say, the installation of a swimming pool or new roof shingles. I've actually seen homes with pools sell for less than that realized by an identical property minus the pool. Many home buyers do not want pools, and discount the price if they even offer on it, to cover the cost of having to maintain it, or even remove it.

Having said this, in most cases, a homeowner or investor is unlikely to recover the full cost of a renovation project. In my experience, the highest returns (60-85%) usually result from beautifying projects, like kitchen replacement and major landscaping. The moral of the story - don't do the big projects just prior to listing for sale. Do them earlier and have the opportunity to enjoy them yourself for awhile.

The advantage of investing in real estate in your own home is the pleasure derived from the improvement while you're living there. But if you're not planning to keep the property for long, it's a good idea to avoid major projects. Just maintain it well, and perform relatively inexpensive upgrades like painting, flooring, counter-tops and minor landscaping. Also, consider the tastes of potential buyers by choosing projects that will have mass appeal. Think neutral colours. Your dream bedroom with padded and upholstered chartreuse walls and mirrored ceiling is probably not a safe bet.

I describe return on investment, as it pertains to investing in real estate, in a little more detail later in this article.

From an investment perspective ...

Don't Over-Improve for Your Neighbourhood

You don't want to improve your property to the point where its market value excessively exceeds the average market value of adjacent properties. It's much smarter to be the smallest home on the street than the largest.

If you're investing in real estate and plan to remodel a ...

Rental Property

... the cost of the renovation may be recovered by a higher eventual sale price, but also possible higher rents in the interim.

To address the question of what stress levels would be tolerable for you, consider what's involved in the long term picture of ...

Being a Landlord

It's not all profits and roses. Being a landlord can be stressful. And it can be a full-time job unless you've got sufficient cash flow to hire out the administration and drudge work.

Now, I'm thinking only residential here, as that's where my experience lies. It could be single family dwellings, like detached, semi-detached, townhouse or apartment homes. Or it could be multiple unit residential buildings (MURBS) with rental apartments.

To learn more about renting a property prior to investing in real estate, click here.

Unless your real estate investment generates sufficient positive cash flow to hire a property management company to look after the myriad details of the on-going daily business of maintaining the building and grounds, as well as tenant concerns, you'll have to do this yourself. Generally, a small real estate investor who buys, for example, a condomium apartment or townhouse, where all exterior and building maintenance is taken care of by the condominium corporation, would just have to deal with renting the unit, collecting rent on a regular basis, occasionally inspecting the unit and performing any interior repairs and maintenance. Of course, your tax return will look a little different, but your accountant can handle this aspect of investing in real estate.

MURBS, on the other hand, unless you're retired, usually require the services of a management company because of the larger volume of responsibilities. So, don't forget to factor in this added expense.

The next question is regarding your motivation for getting into real estate investing. Are you looking for a ...

Quick Flip

... of the property for a speedy return?

The advantage of the quick flip is that you can earn a nice annualized ROI with a few strategic improvement projects, and without the responsibility of a long term commitment. But you must have the right market conditions, buy a property in poor condition at a bargain price, and hopefully do most of the remodeling work yourself. If you have to hire a contractor, it's less likely your real estate investment will be profitable. Carefully choose the renovation work that will provide the most value for the least amount of effort and cost.

New siding, kitchen and bathroom remodeling, paint, floor replacement or refinish, new windows, sundecks, new sod and driveways, and living space additions are some of the most beneficial projects.

Also, you don't want to carry it empty for long as this would not only increase your stress level, but would also reduce your ROI. And remember that, unlike a principle residence, any capital gain is taxable. So, you'll need to address this with your accountant.

Another advantage to the flip is you'll not have to deal with the Ontario Residential Tenancies Act , or its counterpart in other provinces or the USA, and all the ramifications of being a landlord. Aside from the legal implications, in my experience, tenants often don't take the same care of a property as an owner does. So, by flipping the property, you get to avoid the potential heartache and repair expense of a damaged property.

There are possible disadvantages, though, to investing in real estate of this type. In a normal balanced real estate market, prices don't rise through the proverbial roof over-night. And since you may own it for a period of time while renovating it and then awaiting a sale (unless you're lucky enough to sell it before the scheduled closing date), the costs of carrying it will eat into your return on investment.

Let's assume you 'stole' the property, and it didn't require much repair work. You'll still have purchase and sale ...

Expenses

Investing in real estate involves legal fees and disbursements. Land transfer tax applies on the purchase and real estate commission on the sale. You'll have to carry it until the closing date of the re-sale. So, factor in payments for the mortgage, property taxes, utilities, insurance, maintenance, and if it's a condominium, monthly condo fee.

And since you're hoping to sell it quickly, you'll not easily be able to rent it. Most tenants want a lease for an extended period, like a year. So, there will be no revenue to off-set the expenses. If you do succeed in renting it on a month-to-month basis - great! But keep in mind that not only will you require the tenant's cooperation with showings to prospective buyers, when you accept an offer to sell it, the buyer will most likely want vacant possession. You must then rely upon the tenants cooperation to vacate on time. If you're unable to provide vacant possession upon completion, then you're in default of the contract, which could be trouble.

No Vacant Possession = No Closing

Or are you more interested in investing in real estate as a ...

Long Term Investment

The advantages here are basically two-fold. You can create (taxable) income, that is a positive cash flow (which is the difference between income and expenses). And if you keep the property long enough, not only would you likely create a sizable capital gain (once again taxable) when you eventually dispose of the property, but your ...

Tenant Will Pay Off Your Mortgage

The possible disadvantages of investing in real estate for the long haul are that you're responsible for long term management, including maintenance, repairs, replacements and improvements. The furnace, air conditioning, roof shingles, electrical and plumbing systems all will need attention from time to time, and at considerable expense. The same for rural property, with a few other items. Plus you'll have the responsibility of regularly collecting rent cheques, dealing with defaults, evictions, and having to replace tenants. And think about midnight telephone calls in the winter from a tenant when the furnace breaks down. And don't forget about the potential physical abuse of the building by disrespectful, uncaring tenants. You may some day regret ever investing in real estate. Or you may celebrate.

Investing in real estate requires sufficient cash for a down payment which will allow you to have at least a revenue neutral cash flow, unless you're looking for some type of tax deduction, which is not my area. Lenders usually want a larger down payment as well.

One last suggestion is that if you're investing in real estate with a single family home that contains a ...

Basement Apartment

... keep in mind that the vast majority of these essentially two-family homes are in violation of local zoning, fire and building codes. So, if you buy one that is 'illegal', you may be surprised with an order to evict the tenant. This can lead to more trouble.

I suggest you consult with your accountant in this regard before you head out with a REALTOR® in search of the perfect investment property.

Before taking the plunge by investing in real estate, you may want to consider what return on investment will satisfy your needs.

What does Return On Investment Mean?

It's basically a performance measure used to evaluate the efficiency of an investment. To calculate an ROI, the benefit, or return of an investment is divided by the cost of the investment, with the result being expressed as a percentage or a ratio.

From the gain on investment, deduct the cost of the investment, and divide the result by the cost of the investment.

The gain from the investment refers to the proceeds obtained from selling the investment property. That's easy to calculate. The cost of the investment is another matter.

Real estate can create gains from rental income and market value appreciation. Rental income simply has to be added to the gain as it's realized. From this, deduct the initial cost of the real estate investment, and any and all expenses incurred while maintaining the investment property. Property taxes, insurance premiums, repairs, improvements, general maintenance and the cost to rent or sell the property would be included in expenses.

If an investment does not have a positive ROI, or if there are other opportunities with a higher ROI, then you should seriously consider passing on it. For example, if the ROI is expected to be only 5% annually, then you might want to just put your money in an investment vehicle like a Guaranteed Investment Certificate at your bank or trust company. Your return is guaranteed, and there's no risk, expense or maintenance.

When you hear stories about a real estate investor boasting about a huge ROI after selling their real estate investment, they're often exaggerating, or have erred in their calculations. They've probably just used the market value appreciation and possibly the rental income, and ignored, innocently or otherwise, all their costs like mortgage interest, property taxes, insurance premiums and improvements.

Investing in real estate can be profitable, but often, it's not.

So, now you have a better idea about real estate investing.

Is Investing in Real Estate For You?

Absolutely, at least if it's just in your family home. Unless, of course, you want to be paying rent when you're 64.

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