5 Financial Considerations Before You Begin Real Estate Investing
Real estate prices are rapidly increasing.
One major reason behind this is a shortage of good properties, which makes real estate an excellent investment opportunity.
Benefits of investing in real estate include tax advantages, crazy financial and capital gains, predictable cash flows, and portfolio diversifications, to name a few.
Just like the benefits of real estate investment, its risks are substantial as well.
To help you hedge against these risks and make a good return, here are 5 financial pointers that you must consider before you start investing.
How much capital are you willing to invest?
Answering this question will help you decide your investment strategy and your investment goals.
For example, if you have a low appetite for risk or are just starting out, you can look for underpriced apartments in the less expensive part of your city. You can then make some tech-based home improvements and sell them for a higher price.
Opposingly, if capital isn’t an issue and you can afford to tie it up for years to come, you can buy a commercial property and rent it out. This way you’ll earn money through rental payments while also benefiting from the appreciation in your estate’s value.
Setting out your budget also gives you an idea of the amount of profit you can expect to make.
Just a word of caution. While planning your budget, don’t forget to account for the implicit costs of buying a property. These might include the commission of your real estate agent, taxes, and renovation costs.
2. Your credit score
A good credit score will get you a good mortgage deal, which might be necessary for investment.
A credit score is basically a measure of your ability to pay off your debts. The score ranges from 300 to 850 and is based on factors like repayment history, the current level of debt, and your credit history. Although scores above 800 are considered excellent, anything above 740 can also get you good deals.
If you have a low credit score, you need to improve it before you start investing. Some effective ways of doing this are:
- Always pay your bills before they get due — setting up an automatic payment system can help in this regard.
- Stay under 30% of your total credit limit.
- Fully repay all of your outstanding debts, including your credit card bills.
- Don't put requests for new credits very often. A credit request is always accompanied by a hard inquiry, which adversely affects your credit score.
3. Investment loan options
Real estate investment has an initial cost. People who don’t have enough savings to finance it might need to consider an investment loan.
These investment loans can take several forms and choosing the wrong kind might put you in a tough spot. That is why it’s extremely important that you understand the pros and cons of each investment financing option and select the option that suits you the best.
The most common option is a conventional bank loan. This is where you pay a down payment (for investment property, it’s 30% of your purchase price) and set up a mortgage to pay off the remaining amount.
You might get a better deal by going for a private loan. Although most private loans are given by friends and family, you can also get one from local private money lenders. Whoever you decide to deal with, make sure you’re getting favorable loan terms and (not scammed).
Another option is to tap your house’s equity by opting for a cash-out mortgage refinance. Here, you replace your existing mortgage with one that’s greater in amount. The difference is that you get paid in cash.
4. Expected profits
Calculating your expected profits for a real estate investment will tell you if that investment is worth it. To do this, just add all your estimated costs and subtract them from your expected selling price.
The 1% rule can help you analyze expected profits objectively. It says that only those properties that can generate an income of at least 1% of their total value should be invested in. Although this rule has some caveats, it can still become your guiding principle for some of your early investments.
Whatever your risk appetite is, just remember that your job as an investor is to maximize the profits you make while minimizing the level of risk you’re exposed to.
5. Indirect investment opportunities
If actively managing properties is not your thing, you can try buying real estate investment trusts (REITs).
REITs are basically companies that own and operate income-generating real estate. They work similar to mutual funds. These companies collect capital from numerous investors and use this pool of money to finance their investments in real estate. Any profits made from these investments are then shared through dividends.
Some REITs can also be traded publicly. This means you can buy and sell them through a dedicated exchange, which makes them highly liquid and suitable for people who can’t tie up their capital for long periods.
Some other ways to invest in real estate indirectly are:
- Stocks of real estate companies
- Mutual funds and ETFs that are focused on the real estate sector
- Mortgage bonds and mortgage-backed securities