Thanks to cable home improvement and other channels, house flipping has become part of the investing and popular culture. Investors find old, worn-down properties and transform them into homes with appeal to home buyers.
House-flipping is one form of real estate investing. You can also explore buying properties to generate income and otherwise add to your overall investment portfolio with stocks, bonds, mutual funds and other products. Due to the nature of real estate, you will notice certain advantages beyond the prospects of income or gains. There exist also potential traps or challenges that might not present themselves with other types of investments.
Why Might You Invest in Real Estate?
Income. With a house or commercial space, you have a stream of rental income. Even farmland attracts tenants who wish to cultivate crops.
Rental income often supplements your wages, salaries, profits from a business or even your retirement nest egg. In addition to passive income from renting, real estate affords you a place to run a business. These enterprises may include a restaurant, bed and breakfast, salon or professional office.
Tax breaks. Many tax advantages come with real property ownership. Property taxes and interest on home mortgages or home equity loans that buy or improve real property provide deductions from income taxes. If you rent out space, you can claim breaks for taxes, upkeep, maintenance, insurance and other expenses associated with generating rental income.
Promoting Investor Discipline. Declining values may prompt quick and unnecessary sales of property. Typically, the value of an investment or portfolio will rise in the long haul. Therefore, as a general rule, you’re better served holding onto investments than selling them.
Unless you’re buying a house to flip, real estate lends itself to the more prudent buy-hold strategies as opposed to buy-sell strategies. A real estate transaction involves more than the exchange of money and a deed. The buyer likely will want a title search to ensure the absence of judgments, taxes and claims by other would-be owners against the property. Your contract may come with other contingencies, such as the ability to make a particular use of the property. Speaking of contracts, you or your broker may negotiate extensively on the price and other terms. The cost and time of buying property makes transactions less frequent compared with securities and commodities.
Inflation Protection. Inflation refers to the increase in the price of goods, services and other items over a period of time. As the cost of items or living rises, money’s purchasing power diminishes.
Inflation, at least in part, increases real estate values. In other words, your real estate becomes more valuable as the cost of living increases. Since you tend to hold real estate longer, you have an asset that can at least soften the blow of inflation.
In theory, you should expect the same outcomes with stocks. However, investors’ worries over the erosion of buying power often drive down values. Inflation may also make companies appear more profitable or financially healthy than is actually the case. With the value of stock being tied considerably to perceptions about company performance, periods of deflation could cast companies as less profitable.
Real Estate Investment Options
How you invest in real estate depends largely upon your goals.
Turning A House and Profits. To turn a relatively quick profit, you might purchase a house, renovate it, and sell it at a price above the money you have placed into it. The basic costs of flipping consist of the purchase of the land, building, materials and labor from various contractors.
Residential and commercial leasing. Materials and improvements factor into your investment even if you’re acquiring and developing property for rentals.
Residential properties on average require less of an investment and carry less risk than commercial buildings or space. In renting commercial property, the higher risk results from dependence on the health of the business or the economy. Poor performance or economic conditions may cause business tenants to close or move operations. Finding replacements can prove more of a challenge than for residential landlords.
With the higher risks in commercial renting come greater revenues for commercial property owners. In addition to higher rent, commercial leases often have longer durations than the residential counterparts. Whereas residential tenants may even be month-to-month, commercial tenants have leases that last a specific time period.
For vacationers. Your home or condominium can afford a place for travelers and tourists. Even renting of vacation properties in peak seasons generates income comparable to year-round leasing of residential property. Investors with a knack for hospitality and lodging may turn properties into bed-and-breakfast establishments. Such places appeal to those spending a weekend or a period of a few days either as a getaway or for a nearby special event.
Investing Without Buying. Many shopping centers, lodging establishments, mortgages, apartments and offices have as owners “Real Estate Investment Trusts,” or REITs. These entities acquire real property to collect rentals and other regular income rather than to develop and sell.
As with stocks or mutual funds, you purchase shares in the REIT. Usually, all of the REIT’s earnings pass to the REIT shareholders as dividends.
What to Consider Before Investing in Real Property?
Price. When you invest through buying property, the price is naturally a major factor. To gain from such investments, you want to buy low and either sell high or fetch sufficient income to exceed the purchase price and other expenses.
Foreclosed properties traditionally cost less than similar non-distressed properties. Lenders want to rid their books of defaulting loans and wish to recoup some of what they have loaned. When banks, tax authorities and creditors foreclose, they typically do not add value to the home before the auction.
If you choose to buy foreclosed property, be sure you have funding in place. Should you place the winning bid and the court accepts it, you become legally obligated to complete the purchase. Failing to tender the final purchase price can, depending on the jurisdiction, land you in contempt of court.
Unforeseen Problems. Many house-flipping shows capture investors who discover rotten floors or walls, compromised foundations, malfunctioning plumbing or electrical systems, and numerous conditions that fail current codes. Less experienced flippers and other investors discover to their surprise that they need permits and inspections. These unforeseen circumstances lead to greater expense and delays. Often, the revelations occur after the investors have taken the leap.
Insurance. Real property is physical. It can be damaged or destroyed by a number of natural or human forces. To protect your investment, you will need property insurance.
When you acquire it, take note of the perils that the insurance does not cover. The standard homeowners’ insurance policy does not provide benefits in the event of earthquakes or floods. For these risks, you need separate earthquake or flood insurance. If you live in a flood plain and are getting a mortgage, the lender must provide flood insurance. Having this insurance, whether voluntarily or under government mandate, can add to the expenses of your investment. Without the right insurance, you may lose your investment and open yourself to other financial burdens.
Property Management. Owning a rental involves more than collecting a rental check. Inevitably, you’ll have non-paying or other troublesome tenants. Most state laws impose requirements to give the tenants some type of notice before ending the tenancy. Evicting someone without a court order, terminating utilities and failing to observe minimum habitability standards can lead you to significant legal trouble.
Consider engaging a rental property manager. The manager’s duties include filing eviction actions, responding to concerns about rental conditions, getting contracts executed, obtaining repairs and collecting rent. Property management companies or licensed realtors offer these services for landlords.
As with any type of investment, perform due diligence before you consider investing real property. Research property management companies if you plan to rent or real estate investment trusts if you don’t want to buy real property. Examine the home or other structure you propose to buy for any possible code-mandated upgrades or other improvements and determine if they are cost-prohibitive. Know whether the property may face heightened risks of damage from floods, earthquakes or storms.