Is real estate right for your investment portfolio?
“There’s only so much land and God isn’t making any more of it.”
“It can never go to zero.”
“I like an investment that I can see and touch.”
“I don’t trust the stock market.”
If you’ve had thoughts like these, you may have debated if real estate investing is right for you. We have heard it said that more millionaires have been created from real estate than any other source. That’s probably true. It might also be true that real estate has caused more business-related bankruptcies than any other source.
So how do you know if it’s right for you?
Real estate is a broad term. Our focus here is on directly owned, single-family housing. Generally, this is a good starting point for many new investors with the following foundations:
- Real estate investing differs from home ownership. Your home is where you live, not an investment in the purest sense. An investment must be free from emotional attachment.
- An ideal rental property isn’t a smaller version of your own personal dream home. You must view properties through a tenant’s lens.
Shopping tips – Choosing the right property
- Get some help. Consider hiring a savvy real estate agent (preferably one that works with investors), a CPA and an attorney. You cannot Google and Zillow search your way to becoming an expert.
- Don’t overpay. An old real estate adage is that you make your money on the front end. Never be afraid to walk away from an unfavorable deal.
- Understand local market rents. Build a net operating income model that incorporates realistic rents minus the costs of operating, maintaining and insuring the property.
- Decide about leverage. Given historically low interest rates, a mortgage can be an attractive tool. Before you lever up a property, however, have a plan for handling debt payments if things don’t go as projected.
- Explore a protective entity like an LLC. An LLC may provide additional liability protection, keeping rental problems from threatening your personal net worth. The more you have to lose, the more attractive this becomes.
- Be realistic about the time commitment required to manage a property well. If you cannot commit the time, consider hiring a property manager – these can be costly, will lower returns, but can provide a needed service.
- Don’t do anything without good tax advice. If you partner with someone other than family, you can potentially open yourself up to some additional Tennessee state taxes.
Tenant tips – Choosing the right renter
- Run a background check.
- Run a credit check.
- Understand tenant law. As a landlord, you must be fair in your tenant selection. If your unit is in Davidson County, you must comply with the Landlord and Tenant Act.
- Have a real estate attorney draft the lease.
Life as a landlord
Many new investors follow these tips and still achieve poor results. Why? By far, the most common mistake is a lack of ongoing scrutiny of their investment property. They simply conclude that a positive cash flow means they have a “good investment.” This isn’t always the case. You must do the math and keep your investment models up to date.
The following formulas provide a true test for measuring an investment property’s returns. The first computes a “cash on cash” return – the pre-tax yield your equity in the property is producing for you. The second measures the property’s price appreciation over time. After studying these returns, you must ask yourself if property ownership is still the best use of your capital.
- Return on investment: rents received – (operating + maintenance + insurance costs) divided by (current market value – debt balance).
- Average annual price appreciation: (current market value – purchase price) divided by (purchase price x years held).
As a final exam, if you can make it through the movie “Pacific Heights” and not curl up into a quivering ball, you probably have what it takes. Residential real estate investing is hard work, but it can be a great source of investment income for a well-balanced portfolio.
Let one of TrustCore’s financial advisors help you decide if real estate is right for you. To get started, contact us.
TrustCore is one of the largest independent wealth management firms in the U.S. From its offices in Brentwood, a suburb of Nashville, TrustCore advises on client assets of $1.8 billion for clients in 34 states across the nation.
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