Investing in Real Estate
If you are a skilled businessperson, investing in real estate can be a great opportunity. Unfortunately, many people take real estate investing too lightly. Real estate is a business. Many people have rental property that they manage as a lifestyle business. They might live in one of the units or rent out an old family property or a previous home, but they don't consider these formal businesses. They should, because the rest of the investors in the real estate market do.
Whether you own one property or several, it's important to treat real estate investing like any other business. Establish a business plan for each property. Decide what income you need to be profitable, including the time you spend managing the building. Plan in advance the price that you would eventually consider selling at. Create separate bookkeeping and bank accounts for each property to make the income and expenses of each easier to track. Don't use equity from one building to invest in another unless you've decided to own the properties as a group and have analyzed the risk. Be diversified — don't buy too many of the same type of properties in the same geographical area or that cater to the same demographic.
If running a business wasn't what you had in mind, but you would like to add real estate to your investment portfolio, look for real estate investment trusts, called REITs and pronounced “reets.” REITs are pooled accounts that invest in real estate such as apartment buildings, office complexes, and strip malls. The income earned by the REIT is passed through to the shareholders. Professional management and diversification is a big appeal of REIT investments.
Pricing a home is easier than pricing an investment property. After all, you get to live in a home; the investment property doesn't offer that advantage. Income property is valued based on its annual net operating income, or NOI. The NOI equates to rent, less maintenance and other similar costs and an allowance for vacancies. The cost of your mortgage on the property isn't figured into the NOI. Divide the NOI by a rule-of-thumb number called a cap rate. The cap rate is akin to the annual rate of return on the property and will vary based on the location and amenities such as school districts and ocean views. Most advisors suggest dividing NOI by a cap rate of 9 percent or 10 percent to account for the risk.
How do I calculate the value of the building I'm considering investing in if the cap rate is 9 percent?
Divide the annual NOI of the building by the cap rate. A building with a NOI of $14,000 would be worth $155,555 after dividing $14,000 by 0.09.
Remember that NOI doesn't include the mortgage costs of owning the property. Double check that you can cover your mortgage payments and still maintain the building if there are vacancies.