The on ramp to real estate investing often starts with a residential property. Sometimes a homeowner keeps a first house to rent out as they "move up" to the next house. In other cases, an investor buys a property for the specific purpose of investing. Real estate typically generates a profit in three different ways: monthly cash flow, appreciation, and paying down the debt. To find the right investment an investor needs to consider: market trends, property analysis, and financing options.
Market Trends
Beacon posts monthly market trends for residential in our blog, and we analyze the commercial market quarterly by the four major property types. The market trends can be found by clicking here. Key market trends to consider are showings, number of active listings, number of closings, median home price, and months of inventory.
Showings are a leading indicator for market health. A high volume of showings and the number of closings tells us about demand. The number of active listings tells us about supply. The months of inventory is a calculation comparing the active listings to the closings. This metric tells us whether prices are going up, going down, or staying flat. Let’s move on to property analysis now.
Property Analysis
This is a lot of fun for spreadsheet junkies like me but can be done by anyone. The key components of basic property analysis hinge on: purchase price, rental rates, taxes, insurance, maintenance, management, utilities, and reserves.
Purchase prices are readily advertised for properties. Right now, properties, on average, are selling for the seller’s list price but there are variations. Some houses are priced high and sell for less. Other houses are priced well and are selling at or above the list price. A professional realtor can tell help with valuing a property.
Rental rates can be found by using a variety of online tools including the MLS, Zillow, Homesnap, and others. Looking closely at asking rents and closed leases helps to determine what rental rates are. Again, a professional realtor can help with assessing the rates.
Property taxes are paid annually and can be found through a public record search or in an online listing. It is important to note that property taxes are increasing right now on the heels of large home appreciation over the past few years.
Insurance rates are also increasing because the cost to repair or rebuild a home is more expensive because of inflation.
Maintenance is an important aspect to understand. Houses deteriorate if left unattended to. For example, houses need exterior paint every 5-7 years in Colorado. Also, appliances, flooring coverings, and plumbing fixtures wear out in time.
A new investor will need to consider whether they will manage the property or hire a professional property manager. Denver is regularly changing laws so it is important to follow legislative sessions.
Depending on the type of lease, a tenant may pay for the utilities but in some cases the landlord or HOA does.
Cash reserves are very important. Real estate can be a great passive investment but sometimes, real estate eats cash! By that I mean, if a property is held long enough, the day will come when large repairs are needed such as a roof, sewer line, or a complete remodel.
Over the years, I have seen great cash flow years plus great appreciation, but I have also seen property values decline and owners coming out of pocket $8,000 to $16,000 to fix up a property.
Moving on, let’s take a look at financing options.
Financing
There are a variety of reasons why some people opt to keep their first house to rent out when they "move up" to a new house as they start investing in real estate. It is important to consult with a CPA when considering this because there are some pitfalls to this strategy.
First, the first house already has financing in place. If someone took advantage of the covid refinance boom, they likely have a mortgage rate in the 2.3% to 3.5% range. This is a very low interest rate compared to the 7% loans today. Furthermore, the if the replacement house will be a primary residence, the investor can get more attractive financing. For example, a primary residence has a lower down payment and lower interest rate, compared to an investment loan.
Typically, investment mortgages have intertest rates that are 0.5% to 1% higher than the prevailing mortgage interest rate for a primary residence. Also, investment down payments are typically in the 20% to 25% range.
Good credit is a must as well as a good income. Also, mortgage lenders often require an additional stockpile of cash for a reserve fund. This can be 6 months of mortgage payments.
Now we will wrap up this post.
Wrapping Up
A clear understanding of market trends, property analysis, and financing options can help an investor make an informed decision. Market trends show us what is happening today and in the past as we look toward the future. Basic property analysis considers the purchase price, rental rates, taxes, insurance, maintenance, management, utilities, and reserves. Complex property analysis dives even deeper! Understanding the financing options is very important to understand so the investor can avoid negative cash flow.