Make sure you do your homework before investing
By Deborah Jeanne Sergeant
Historically, real estate has been thought of as a solid investment. It normally appreciates in value over time and offers investors reliable monthly income. Or, in the case of property flipping, a quick payout.
But is this still true?
“The real estate market has gone up significantly over the last year or so and it is very hard to predict if this trend will continue,” said Diana Apostolova, investment consultant with Rochester Investments. “This means that not only buying a property now will be expensive but the financing as well. And just like the stock market can go up and down, so can the real estate market.”
She advises clients to keep their portfolio diversified across different economic sectors.
As with any investment, Apostolova thinks that evaluating real estate begins with looking at returns.
“When we look at returns, we are interested in net returns; that is the return after taxes and expenses,” she said.
Investing in a residential or commercial rental property may bring in reliable monthly income. However, if keeping rent at a reasonable level for the market means that the investor cannot make appropriate repairs needed, that property may not be a good investment. Investors who can perform repair work themselves or develop other affordable means of maintaining properties can help mitigate their overhead.
Potential landlords must also consider that this investment is more active investing.
“If you’re comfortable doing that, it could be rewarding investment,” said Jeff Feldman, Ph.D., certified financial planner with Rochester Financial Services in Pittsford. “The rewards can be more than with passive investing. It also doesn’t depend upon the stock market. This offers an alternative.”
If it’s an investment to flip the property, the current seller’s market could offer a good deal for an investor able to renovate a run-down property. But the investor should make sure that the property and the cost of upgrades will not exceed the local market.
The cost of lumber and other renovation materials spiked, which may make the cost of an upgrade much higher than anticipated. The investor should carefully scrutinize the property before purchase to ensure that its repairs are within budget. As with a tenant building investment, the investor’s ability to complete the work can save significant money on the cost of repairs.
Feldman said that it is important to know the potential for price appreciation in the Rochester market.
“That’s probably the biggest unknown,” he said. “You can look at its cost and cashflow, but the unknown is if it will appreciate. The most recent history, prices are going up for most real estate. If you assume that will continue, there is potential for large gains. But you have to understand that you are taking a risk. Those large gains may subside and go negative. If you’re investing for the long-term, that’s OK. If part of the equation for your investment is you’re factoring in price appreciation for your property, that won’t always be the case.”
He thinks that landlords should receive 8% to 9% returns in rent based on the value of the property, minus taxes, property insurance and repairs. Those receiving less are not getting enough because of their sweat equity. Most property owners should set aside about 1% to 2% of the value of the property value annually for maintenance.
Despite taking care to analyzing the finances, “things can go wrong with real estate, like flooding, needing a new roof, electrical work you didn’t know about,” Feldman said. “You have quite a bit of extra risk and you need to be compensated for that.”
He advises that anyone investing in rental real estate should seek multiple occupant properties, rather than single occupant properties, so they can reduce their risk. Multiple units can receive closer to a 15% return. But he cautioned that some multiple occupant properties may be in a distressed area, so it pays to scrutinize the location.
“You’re not going to have to deal with crime or non-payment of rent or things like that,” Feldman said.
He believes that the worst is over regarding non-payment of rent because of the pandemic. That serves as yet another example of unforeseen events that caused many landlords to lose money.
The pandemic also affected commercial real estate.
“We’re coming out of a pandemic, so a lot of businesses closed and won’t be returning,” Feldman said. “There could be some really good bargains you could take advantage of. But, there are also some sellers trying to unload unprofitable properties. The rewards might be higher, but the risks might be higher.”
Businesses that flourished during the pandemic may need to rent larger facilities, which creates an opportunity for commercial landlords. However, new businesses started in the wake of the pandemic may not have as solid of financial footing, so landlords should screen applicants carefully.