Investment property can be a sound investment that provides cash flow and tax benefits. Information is the key to incorporating real estate investment into your financial plan. However, real estate investment is not for everyone. It isn't a passive strategy that allows you to buy a few houses and sit by while money pours into your pockets.
You should thoroughly research the pros and cons of owning real estate before taking the leap, and carefully consider the points below.
Be prepared to run a business on the side
Owning rental property is equivalent to starting a small business. Realize you will be an investor second and a business owner first. It requires time, energy and cash to keep the property in good repair, manage the finances, and find and manage reliable tenants. Expect to receive phone calls at all hours. You will be expected to handle emergency repairs immediately, regardless of your other commitments. If several tenants move out at once, you will have to locate new tenants quickly or forego income on each uninhabited property, thereby reducing your profits.
Capital is king
Buying and maintaining property requires substantial working capital. In addition to having a significant down payment, you need cash for repairs and improvements plus cash flow to hire any accountants, contractors or property managers. Yes, you can DIY many of these tasks, but are you qualified and will you have the time in addition to your day job? If you hire a management company, be prepared to oversee their operations closely.
Know the “before you buy” criterion
- Ideally, you own directly or have an ownership interest in specific properties.
- The property should produce a regular income that exceeds your expenses.
- You should be able to provide some level of labor or management necessary to run this as a business rather than as a pure investment.
While the first point seems obvious, many people do not achieve ownership interest. For example, investing in a REIT (Real Estate Investment Trust) means you will have no control over the kind of property you are investing in, no say in decisions about the property and no guarantee of a return. These factors could make this a risky option for many investors.
Know when it's time to get out or sell
Experts advise that there are generally two reasons to sell a property: 1) when the depreciation runs out and/or 2) you are losing money on the property. Have your accountant run the numbers if you suspect you are losing money. Also, ask your accountant if you can take advantage of section 1031 of the tax code which lets you roll the profits of the sale into the purchase of another similar property and defer taxes.
For some people who are able to invest time and hard work, real estate investment properties can be an important part of their overall financial plan. Investment property can provide many tax benefits, positive cash flow during a tough economy, passive income and an asset you can pass to your children.