Real Estate Investing: The Lottery Backup Plan – just in case you didn’t win!
I know we were all a little surprised last week when we didn’t win the billion dollar lottery. The great news is we have other options for building our wealth that don’t have to include luck and unachievable odds. Since I get to talk a lot about real estate investing I thought I could share a few of those ideas with you…
If we could all win the lottery the reality is we probably would not be in the market for investment real estate. However, since the odds of winning the lottery are incredibly low, it would be good to have a backup plan if you are not planning on working your day job for the rest of your life. But before you get started, you need to realize that being a landlord can be financially rewarding, but you will need to invest time, money and energy to get the results you are looking for.
Asking the right Questions
- Why do you want to be a landlord?
- What type of landlord do you want to be?
- Why do you want to make more cash?
- What are you going to do with the cash?
- Do you want more cash now or in the future?
- Do you want monthly income or a large future payout?
- How does your real estate investment compliment your larger investment portfolio?
- How do you plan to create a balanced investment portfolio?
- How long do you plan on being a landlord?
- How much time can you routinely dedicate to your rental properties?
- What geographic area do you want to be in and why?
- What type of properties do you want to buy and why?
- Would you be interested in living in the same property as your rental?
- Do you have a backup plan if you move away from your rental?
- How much of your cash savings are you willing to invest?
- How much of your other investments are you interested in transitioning?
- What type of rental return are you looking for?
- What is your risk tolerance?
- Can you afford to loose money in the short or long term?
- Is your spouse /partner in agreement with this investment?
- Have you considered investing with a partner?
- What is your exit plan?
Cash is ultimately king and whether you are trying to make the money today or tomorrow everyone enters an investment to make cash in the end. When you buy a stock it is easier to calculate how much cash you made on your investment because you know exactly what you bought it for and what you sold it for and there really aren’t variables in the middle that make a difference. The opposite is true when you invest in real estate because there are lots of ways to count cash, profit and expenses and the way you calculate cash may also be different from the way Uncle Sam will want to count cash at the end of the year for taxes or capital gains.
When life gets complicated it is always best to go back to the basics so lets take a minute to talk about the P & L or the Profit and Loss Statement.
LINGO A Profit and Loss Statement is an important tool used by appraisers and other real estate professionals who are interested in determining value of property used for income purposes.
Again, keeping it simple, to figure out how much cash you are going to make you need a simple formula based on cash flow.
Total Income (Gross Income) – Total Expenses = $$ Profit (or Loss)
Yes, we told you the math was going to be simple, but understanding how to find all the income and all the expenses can be a challenge if you don’t own the property and haven’t been paying the bills. If you start with a general Profit and Loss form and fill in all the blanks for each of the investment property your are looking at, you will be able to best compare each investment property to another. By examining the numerous costs connected with the property and understanding the dollar value of each expense, you will be able to calculate the total expenses. And once you understand the income and expenses connected with a property you can better understand what you are willing to pay to buy the property.
TIP Take advantage of your accounting software to develop a budget for your investment property and create a sample Profit and Loss statement.
LINGO Net income is what the property will earn in a given year. It is calculated before adding accounting items like depreciation.
Gross Income = Total Income.
Net Income = Total Income – Expenses
When setting up and reviewing your profit and loss statement both monthly and annually you will need to know the following:
- Gross income is the total amount of rent collected.
- Gross expense is the total of all monthly expenses associated with the property
- Gross debt service is the amount you will on mortgage payments associated with the purchase price of the property.
- Gain or loss is how much cash you can expect from the property.
Leverage When thinking about leverage the idea is you are using the bank’s money to make money, yeah. But you need to understand what the bank’s money will actually cost you so make sure you don’t end up just making the bank money. When starting to look at financing your rental investment take a minute to ask the following questions:
- How much of a first mortgage can I take and should take to ensure my investment produces the cash I expect.
- Should I take a second mortgage?
- How much money should I put down?
The bottom line is will the property make you successful and are there ways to manage the money you get from the bank to make you more successful. For example you may want to keep your first mortgage under a certain value to get a lower interest rate or you may want to utilize a second mortgage to minimize the amount of cash you will need to put down. There are lots of different ways people choose to finance their investments and you will need to think about what works best for you and this specific investment. Often investors will choose to finance multiple investments in different ways based on a number of factors including how long they plan on keeping the property and what they believe the economic outlook is for the next few years. Ask your accountant, your CPA, your real estate agent and even your friends to find out what they suggest.
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