REAL ESTATE INVESTING

The Basics Of Real Estate Investing

Whether you are investing for retirement or just trying to build wealth, choosing the right investment can be daunting. Stock and bond prices can be volatile as well as risky, and deposit accounts can be low on return.

Some investors are choosing to invest in real estate with a measure of success. If you are considering this avenue, it is wise to be cognizant of some of the negative aspects of this type of investment as well as the rewards that may make this the optimal choice for a solid return.

While real estate almost always appreciates in value with time, it is interesting to note that only a small segment of investors include it in their portfolios. There are a number of reasons that may contribute to this lack of choice in real estate. One possible reason may be the fact that purchasing real estate can be much more complicated than buying shares of corporate stock.

Real Estate Investment Types

There are four basic types of real estate investments that can be entered into, but they are not all good choices for everyone. It is very easy to get in over your head or lose a fortune if you aren't aware of the risks and disadvantages of each type relative to your particular financial situation. Conversely, it is just as important to be familiar with each type in order to maximize your potential for a good return on your investment.

Purchasing Your Home

While the purchase of a home may seem like a big investment, it really shouldn't be considered as an investment on the level of other assets in your portfolio. Of course, you hope that if you need to sell your home someday, you will be able to sell it for more than you paid for it or, at the very least, for more than you owe on it. But homeownership should never be confused with investing in real estate for the purpose of increasing cash flow or boosting wealth.

Rental Property

Buying property for rental purposes is a popular type of real estate investment. It allows you to begin receiving a return very quickly in the form of rental payments. This can greatly boost your monthly cash flow with a regular income while allowing you to maintain ownership of the asset. In other words, you don't have to sell the property in order to realize a profit.

There are disadvantages and risks to purchasing property for rental purposes. For example, some renters are not dependable in making their rent payments. They are also often not inclined to take good care of property they do not own. Maintenance costs, repairs, taxes, and insurance can also eat into your rental profits if you do not exercise care in establishing the rental rates.

Flipping

Flipping has become a popular method for turning a profit in real estate. Simply put, flipping real estate consists of purchasing real estate at a bargain price and then making improvements to the property that will allow you to sell the property at a net profit.

House flipping can be a relatively quick way to turn a profit on a piece of property, but it is not for amateurs. Before purchasing a property to flip, it is imperative that you do your homework. Check with realtors or land title companies to determine how the housing market is performing in that particular area.

It is also a good idea to have the home inspected by a professional before making the purchase to make sure that hidden or unexpected costs are kept to a minimum. For example, termites can completely undermine the foundation of a home while remaining hidden from the untrained eye.

Flipping a house can be time-consuming and physically exhausting, but the rewards may be worth it.

Investing in REITs

REITs, or real estate investment trusts, are not as commonplace as other methods of real estate investing, but they are attractive to some because they are usually less complicated than flat-out buying real estate.

REITs function in a similar fashion as purchasing shares of stock in a corporation. With REITs, the real estate is actually owned by a corporation or trust that sells shares of the real estate to investors who hope to receive a portion of the profits that are earned when the real estate is sold.

There are disadvantages to this type of investing as well, mainly that you are relinquishing control of your money and how it is handled. All of the decision-making is handled by the owners of the trusts and may or may not be in accordance with your preferences.

What About Income Taxes?

Just as is the case with anything else that boosts your income, revenue earned from real estate investing is taxable as capital gains tax if you own the property for at least a year before you sell it. The amount that you will owe depends on a number of factors including your tax bracket and the net profit derived from the sale.

For example, let's assume you purchase a house for $100,000 and spend $60,000 in renovations before selling the property for $200,000. The cost of the property was actually $160,000 for you, so you gained $40,000 from the sale of the home. Because you purchased this property as an investment property, you are allowed to deduct the real estate commission you paid as well. For this example, let's say the commission was $10,000 so now your profit is $30,000.

So how much will you owe in capital gains tax? The answer lies in your tax bracket for ordinary income. For 2018, if you are within the 10% to 12% bracket, you will pay no capital gains tax. If your tax bracket is 22%, 24%, 32% or 35%, your tax liability will be 15% and if you fall in the brackets of 35% or 37%, you will be taxed 20%. So, in our example, if you are in the 24% tax bracket, your tax will be 15% of $30,000 or $4,500.

Short Term Capital Gains

Since the capital gains tax outlined above pertains to property owned for at least a year before it is sold, you may be wondering about a property that is owned for less than a year, such as may occur with a house that you flipped.

In this case, the capital gains tax is much simpler. The money that you make from the sale of the property is simply added to and taxed together with your other income for the year

What About Rental Income?

Just as with short-term capital gains, rental income is reported on your tax return as a part of your income for the year. You are allowed to deduct expenses that you incur for maintenance and repairs of the property but you cannot deduct expenses for improvements.

For example, suppose you purchase a house for $100,000 for the purpose of renting it out. The house has a leaky roof that needs to be repaired in the amount of $8,000 and you also decide to add shutters to the windows for $5,000. The roof was a necessary expense but the shutters were cosmetic. You were able to rent the home for $700 monthly for the year, bringing your total rental income to $8,400.

To figure your taxes, you would deduct the cost of the roof replacement from the rental income. $8,400 minus $8,000 leaves $400 taxable rental income. Other costs for maintenance and repairs would also be deducted, further lowering your taxable rental income.

Six Steps to Get Started in Real Estate Investing

There are six basic steps for successful investing in real estate:

Pay in cash: It is never a good idea to borrow money in order to invest in anything, and this goes for real estate too. Interest costs can erode your profits and the risk of loss through a foreclosure is not worth taking.

Spread it around: Don't tie up too much of your investment portfolio in real estate. Most experts agree that 5% is the maximum percentage of total portfolio investments that should be allocated to real estate. 

Keep it local: It is always wise to invest in real estate that is within a reasonable distance from where you live. It is difficult to properly maintain and manage property that is located too far away for you to monitor. 

Be prepared for problems: Even the best renters can suffer job losses or other problems that can interrupt their ability to pay rent on time. It is a good idea to be prepared with a cash reserve for these types of problems.

Start conservatively: Do your research before jumping in. Maybe rent out a room of your home or a garage apartment before shelling out money to purchase a rental property. This would give you experience in dealing with renters before taking the plunge.

Don't undertake the investment alone: Always hire a reputable real estate agent to assist you with the purchase of a rental property.

Is Investing in Real Estate a Good Fit For You?

By doing your research and following the guidelines outlined above, you should be able to decide if real estate is an investment you wish to explore. If you enjoy the challenge of buying a property and taking your own steps to make it profitable, then real estate investing may be a great fit for you!