Real Estate Investment 101 

The basic question in real estate and real estate investment is “Why is real estate such a popular investment tool?”  Real estate investments provide many different ways to make money, including appreciation, cash flow, development, development planning, lease options, flipping, foreclosure, and tax savings.  Any of these methods can be very lucrative.  However, we believe that the most unique aspect of buying an investment property, is leverage.  Real estate stands out as a generally appreciating, useable investment.  You can leverage to buy a vehicle, but it’s a depreciating investment.  You can leverage to buy gold, but while you own it you cannot use it.  A real estate investment gives you the benefits of leverage and use.
Let’s look over a few methods of real estate investment.  We will give you a short explanation of the plan for each method, and then encourage you to do your own research or give us a call with questions in order to understand these subjects more in depth. 

Leverage

Often buyers will put down 0-20% on property which is worth hundreds of thousands of dollars.  It is generally not necessary to purchase a piece of real estate with all of your own funds.  Banks will lend you money for real estate as long as it makes sense for them.  It is true that you will have to pay the bank back with interest, however, there is also good news!  Real estate, over time, is an appreciating asset.  When the home appreciates, you make money on the value of the home, which is substantially more than the money you put into it.  (this may be the only circumstance you are making money off the bank!)  An often used example is comparing your investment in the stock market to your investment in the real estate market.  If you put in $100,000.00 in the stock market, and in one year your stock makes 10%, you will have made $10,000.00.  On the other hand, if you put down $100,000.00 down on a piece of real estate worth $1,000,000.00 and it appreciates 10%, you have made $100,000.00.  Because of the ability to use leverage, you have made 100% on your money.  Thus, you have leveraged your $100,000.00 to make money off of $1,000,000..  Sounds good, right?  Well, this is one very realistic way to increase your net worth, but it’s not the only way. 

Appreciation

Appreciation means “an increase or rise in the value of property, goods, etc.”  This method is a very simple one…in theory.  Buy your investment or personal property at a low price, and sell at a high price.  The only problem is that we can never know for sure over what timeframe the value of the property will increase or decrease.  There are many different factors that have an affect on this.  These include the general market direction, location of the property, how strong the demand is, and how much supply is currently available.  The keys are purchase price and selling price, the first should obviously be low and the second higher than the first. 
Between the buying and selling is that big monthly payment.  There must be a goal for the investment property and there has to be a holding and exit strategy. 

Cash Flow

Cash flow on an investment property is very simply put, how are you paying for your property?  Let’s say your payment is $10,000.00 a month.  Will you be writing the check to the bank out of your own pocket?  Is there a tenant in the property paying a rent?   There are 3 different ways to categorize this.  Positive cash flow, breaking even, or negative cash flow.  
Let say in Example 1 that you have a tenant in your property.  He or his company pays you $8,000.00 a month in rent.  We call this a “Negative Cash Flow.”  This means that your tenant is paying you less than your mortgage payment. $10,000 - $8,000 = $2000.  You have a negative cashflow or $2000.00, or you have to pay $2000 out of your own pocket.
In Example 2, your tenant or his company pays you $10,000 per month.  In this scenario you’re breaking even.  You don’t make any money from your client because everything they are paying you goes towards your mortgage, but you don’t have to pay anything to the bank out of your pocket either. $10,000 -$10,000 = $0.   
In Example 3, your tenant or his company pays you $12,000 per month.  In this situation, you have positive cash flow.  You have enough money to pay your mortgage, and you have a couple of thousand dollars to put in your pocket.  $10,000 - $12,000 = +$2,000.
These are three very simple examples to help you understand cash flow properties.  However, there are many other factors that would need to be considered before purchasing a property for cash flow.  For example, how are you going to pay for your property tax?  Are you going to save up your money from the positive cash flow from the year?  Maybe the tenant should pay for the taxes on top of the rent.  (***see N, NN, and NNN lease***)  What about the utility bills, the landscaping, building upkeep, and tenant buildouts?  These are all things that should be considered before buying an investment property, and it should also be considered before signing a lease with a tenant. 

Tax Savings

There are also a few tax strategies that are great for certain investors.  Use or write-offs, depreciation and negative or positive cash flow strategies are very helpful for the upwardly mobile, sophisticated investor.  We are, however, not CPA’s and thus cannot give financial advice on investment.  Please consult your CPA for financial planning.  We can, however, give you some definitions and some stories. 
Depreciation-
Write off interest-
1031-
250k write off
Story

Development
Development could be defined as “improvement of land.”  You could be building a single family home, a set of condos, a neighborhood of homes, or a set of homes, condos, warehouses, shopping centers and parks…it’s all development. 
There are different stages of development.  Buying the land…
“Mapping” is referred to as taking a piece of land, and getting the plans engineered and approved by the city.  This includes splitting the land into separate parcels, streets, parks etc. Just taking a piece of land and getting these plans completed is worth quite a bit of money, even though you may have not literally improved the land itself, you have developed the plans for the land and you will get paid for it! 
Maybe you would rather take the land, clear it off, bring in the utilities and bring in the roads and build the ammenities.  You could sell it off to the end user with a list of approved home builders and let them build a home themselves, or as the developer you could build the final product and sell it off completed.  There are many stages of development, and depending on your experience and preference, choose any of the above methods of development. 

Lease Option
Lease options are very unique, creative ways to make money in real estate.  The lease option is a great way for some other person to borrow your credit…but in a good way.  The lease option is usually used in a situation where the Lessee has the cash, but not the credit to purchase the home they want.  As the Lessor, you would purchase the property yourself.  Let say, for example, that your payment on this property is $1000 a month and the home cost you $300,000.  The Lessee would pay you, say, $20,000 in cash up front.  They would agree to purchase the home at a price of $350,000 in 2 years.  They also would agree to pay you $1200 a month.  If the Lessee does purchase the property, the initial 20k is credited toward the purchase price.  If they do not buy the property, you keep the 20k.  You also have a positive cash flow of $200 a month, and built in appreciation of 50k over 2 years.  With the $4800 you make on your positive cash flow over 2 years, you net $54,800 over two years. (unless you credit part of the payment toward principle if the lessee purchases the property.) 
If the Lessee does not exercise their option to purchase the property, you can keep the 20k and use it to pay the mortgage until you can find another person to enter into a lease option.  If you cannot find another person, you can simply rent out the property or sell it.  Usually you can see your risk upfront…the market is appreciating and if the lessee doesn’t sell, you may be able to sell yourself and pocket the down payment, the appreciation, and the above market rents.  If the market is not appreciating, you can make sure before you get into the deal that the rents will cover the mortgage so if the lessee doesn’t buy, you can rent the home out right away and keep the 20k and not have to put any of it toward covering the mortgage in a negative cash flow situation. 

Flipping
Flipping a property is finding an undervalued piece of property, buying it, and selling it ASAP to turn a profit.  Sometime the property has very little work to be done to it before the resale, and sometimes it must be vastly improved.  The key is buying the property UNDERVALUED, and making sure your estimates are all VERY ACCURATE.  It would be very unfortunate to buy an investment property, think you are going to put in 20k to fix it up and sell to walk with 50k, and realize there is a cracked slab.  At this point, you will have to spend your entire profit, 50k, in order to fix it, sell it and get it off you hands.