How to Generate Income with Real Estate

This is a continuation of our REAL ESTATE series.

Where should I start to begin investing in real estate?

First, consider the various kinds of commercial real estate. You could buy a house or an apartment, and rent it out. Maybe it pays for itself in 15 years; if so, that was likely a great investment vehicle. This is a fairly common technique to build wealth.

Also consider looking at warehouses, or apartment buildings, based on your vision, or perhaps shops that can be rented out.

Regardless of which type of real estate you'd be looking at, it's always the same rule with investment: you must understand what you're getting into. Whether it's a storefront or a condo, there's the same questions as you would ask if you were buying a residential property for yourself:

1. What are the costs to keep that company going, or that property going? Even the AirBNB needs somebody managing it and cleaning it. It's important to have an idea of maintenance costs, like utilities, and also consider expenses such as reimbursing:

2. Your Professional Network - Real Estate Agent - Property Managers: This a big consideration with commercial properties. Are managers hard to find or plentiful in the area, at the time you are considering a purchase? - Cleaning Services - Attorneys for legalities - Accountants, especially as taxes get a lot more complicated with commercial properties

3. What is the depreciation?

4. Who is your tenant? What are the demographics, are they changing? Are they making more money? Are they making less money? And what is happening to that tenant in the economy at this time?

These are important factors to consider before getting into how much money you want to make.

Yes, but how do I establish how much money I can make on my real estate investment?

All investments involve risk. Real estate is not as liquid as stocks or bonds. It's not as safe as owning a US government security. First look at what you make on a 10 year government bond from a reputable country. You want to make more money than that because, otherwise, you can just take your money and buy a bond.

Then you can look at corporate bonds. They give you a baseline of passive income; you can just put your money in and walk away, doing nothing else to get that return. Real estate takes more resources: legal issues, tax issues, time. Start by comparing what your money can be doing in other places. Research a few different things. You'll find alternative investments (stocks) on average return 10% a year since 1930. Now, we've had a couple of bad years, but on average, you can earn 10% in the stock market. Right now you can earn 5% on a six month government bond. What would make you take the money out and put it into real estate? Start looking at how much you're going to make on your rental income, and anything else you could make out of that property. That rental income has to be more than you would be earning on something that is safe or liquid. That's your starting point.

Your starting point feeds right into your purchase price. If you want to make a certain amount of money from the property, start with the value you expect to earn from rent. When you know how much you can generally get from rent, and say you want to make 10%, then you know that you can't spend more than X amount of money, if you want to make that 10%.

If you want to make 10% on your investment:

1. Estimate how much money you can earn on the property per your research

2. Establish an occupancy rate (i.e. how much the property will be occupied during a year) - if you are renting out on Airbnb look up averages, if you are an annual renter, assume downtime for renters moving in and out

3. Multiply the monthly rent by 12, and then by the occupancy rate to get your total expected income. For instance, if you expect to make $1,000/month and expect to have an 80% occupancy rate then multiple $1,000*12*.8 = $9,600. 

4. Use that number to decide how much you can pay for the property and still make your targeted return on investment (ROI)  ROI=income/cost of asset

5. If you would like to make 10% a year before costs like tax, insurance, and maintenance, insert your figures into the formula: $9600/.10 = $96,000.00.   ROI=income/cost of asset  10%=$9,600/cost of asset  = $9,600/10% = $96,000     At 10%, your asset will be paid for in 10 years  (100% / 10% return per year =10 years)

6. If you want your annual costs covered as well, deduct them from the Cost of your asset:

   $96,000 - (tax + insurance + maintenance) = amount willing to pay 

7. If the amount you come up with is lower than the going market price, decide if you want to pay up and accept a lower rate of return. 

   
   

*Return on Investment is expressed as a percent to help you compare this investment with things like Treasury bonds and dividends on stocks.

ROI = Annual Income / Cost of Asset

Momentum Markets

Be wary of "momentum markets," where everything is moving really fast. And they're like, "Well, if you don't pay up, you're gonna you're gonna miss it." At some point in momentum markets, the music stops. If you don't know you've been swept into an momentum market until the end of it, you could wind up paying 100 grand for a property for which you wanted to pay 80 grand. All of a sudden, there's no one there to rent the property, and your return evaporates. So, again, as my friend said, "You always make your money on the purchase price". Be really clear on how much money you want to make, how much yield you want to make, how much money you think your tenants are going to pay. Be conservative in your estimates to allow for times of vacancy, and then start to establish your purchase price based on that figure.

Exit Strategy for Investment Properties

Exit strategy considerations for investment real estate are similar to those for personal residential properties:

1. Know your Buyer You have to know who would potentially buy your property. For example, if it's a warehouse, who would utilize the space?

2. Know the Area What other industries are operating in the area? Are there industries moving in or moving out? Also, on a granular level, what individuals are moving in or out? In intersection with the first point, consider who else operates in that area so that you know that there are ready buyers around, ready to invest in your property.

3. Know the Zoning Could the property convert to something else? i.e. If it's a commercial building that leases to retail offices, or retail, or offices.

How much of my investment portfolio should be real estate?

This is a subjective, personal decision, not a rule like the 50/30/20 budgeting guideline. Some people gravitate towards real estate, and some people gravitate towards stocks. I've always owned stocks because I worked in the stock market. I have three friends who only own real estate as their investments, and they do well in it. I've always tried to get them into the stock market camp. There's no hard, fast number. I think real estate should be in everyone's portfolio because it's wise to have the balance of a hard asset.

Owning a Second Property

You're always having to sell your house if you want to make money on the real estate markets. I always think you should own a second piece. I would always own real estate because this way you always have a place to call home. I always like owning a second piece because I figure if I've invested in a neighbourhood, I've made a call on that neighbourhood so it's good to own another piece in that neighbourhood. Other people might say, "Well that's too much risk in one place." It's about comfort level and confidence. There's no hard and fast rule. Ultimately, part of your portfolio in real estate, and part in stocks, is the best way to go.

Like any other investment, real estate deserves respect. Balance your practical and emotional sides. Think about what you can afford, and how much money you want to make on the investment. Balance those figures with the emotional aspects of your dreams, goals, and life situation.

Be sure to subscribe to our newsletter to get more great financial wellness content.

If you have questions, or are ready to embark on your financial journey with Afirefi, reach out to us at any time at support@afirefi.com.