Real Estate is a Hard Asset that Doesn’t Vanish

If you’re in the market to buy a new residence this advice may come in quite handy for you. If you’re thinking about it but you’re scared, there may be some gains awaiting for you if you do your homework first. Even if you’re not versed in the real estate market there are many good reasons to diversify your investment portfolio with some income producing properties. I like Real Estate as part of my retirement portfolio for more than one reason. First of all Real Estate is a hard asset, it’s real and it does not vanish like the paper assets manufactured by Wall Street. If bought at the right price and with the right terms it can generate substantially better returns than money kept in the bank. Why many Americans found it to not be a good investment is because most of them bought during the peak of the real estate boom, they over-leveraged themselves, and they did not have the right professional to help them make good decisions.

Not long ago a friend of mine asked me for advise. My friend is smart. He knows that buying real estate today is less risky than buying during the real estate boom. He wants a property in which he can move. But he doesn’t just look for a personal residence, he wants something that he can also call investment. A condo he thought would not be a bad idea yet I found other ways that could potentially be better than this type of real estate.

The first property I owned as a personal residence was a duplex. The experience I gained while owning it helped me feel more comfortable investing in other properties. That’s one of the reasons I am fond of real estate. Statistics reveal that most of the owner occupant buyers in the U.S. go for the single family homes. Indeed there may be some benefits to it with one being the privacy issue. When buying a townhouse or a condo the element of privacy is eliminated since neighbors are “attached” to you. Other than that when you own a house there is still responsibility that comes with it. When it comes to your mortgage and money matters however, here are some thoughts worth considering.

Let’s just say for the sake of proving my point we use a hypothetical example where we compare a house to a duplex. This is not geared towards anyone looking to move into a million dollar mansion. It’s for average folks like many of us out there. Buying a $100,000 house and getting a mortgage with a 10% down payment would result in an estimated $700 per month payment (at today’s low fixed rates), that includes property taxes, insurance, and mortgage insurance. You may say that’s not bad considering you’re probably spending that much in rent. But what if you spend only $425 or less on your mortgage and turn your residence into a real estate investment? If you find a duplex (2 attached units in a building) chances are it won’t cost you double in purchase price, taxes, insurance, etc. At $140,000 price with a 10% down payment the total house payment should be at an estimated $975. Of course, you must have a tenant next door from which to collect rent every month. In our example if the rent you charge for the other unit is $550 you end up paying $425, almost $300 per month less than if you paid the mortgage on a house. You can use this example and modify it based on real estate prices and rental market in your area…you may have a very nice surprise.

You can also use this idea and calculate the figures based on buying up to 4 attached units (fourplex). You may end up having all your tenants pay for your mortgage and in some cases – if bought at the right price – you may benefit from a nice little cash flow. If you don’t need to get financing – and you pay cash – your cash flow would be much higher. One other thing worth mentioning is that if you use financing to purchase a duplex you can qualify just as you would for a single family mortgage; that’s because 1-4 units are classified as residential loans. FHA may even be the right program for the smart and qualified first time home buyer.

Before you start dreaming of buying a duplex let me explain the challenges. Your investment comes with responsibility. You must determine however how much of that are you willing and/or able to handle. You can take on full responsibility or you can hire a reliable property manager. When managing on your own you should know how to pre-screen potential tenants, how to handle plumbing leaks or hire the right plumber that will do a good job charging you a reasonable fee, how to make your tenants responsible for the units they occupy, how to write up lease agreements, and other tasks that require your time and effort. If this is not for you hiring a competent property manager is highly recommended. For a charge of about 10% of the gross monthly rents a professional can handle most of the issues. In addition, you are next door so if you see something that a tenant does – that does not comply with his responsibility under the lease agreement – you can immediately notify the property manager to take action.

You may – and there’s a high likelihood that you will – have times when one or two units will become vacant and there may be a month or two until other qualified tenants move in. In the meantime your mortgage payment is due every month. The lender doesn’t care how many units you have vacant. But that’s why it’s even more important to know what to do with the savings that you get during the times when the property is fully occupied. The savings must be turned into liquid reserves. Those reserves will help you when you have vacancies and they will also help you when repairs in the other units must be completed. The savings I am referring to should be calculated based on how much you’d spend on a mortgage for a single family house – in the above example being $700 – and what you end up paying for the mortgage after receiving the rents from the other units on a multi-units property. In the above example the monthly savings are $275 but they could be more or less depending on each individual case. Spending the money instead of saving it in a separate account will end up with a tragic outcome. Being disciplined with your money will help you turn your residence into a successful investment.

As time goes by more of the loan balance will be paid down and more equity will be gained. If you have to move in another city or another country it may actually become one of the best investments in your life. With a great property manager your once primary residence can become part of your retirement portfolio. Sure, it would have to be well maintained and placed in the hands of a competent professional but it will not vanish like the Wall Street manufactured securities.

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