3 Immaculate Laws of Real Estate Investing
Across years of investing in Frederick, MD real estate, we have seen many changes. Interest rates, in-vogue strategies … fads that come in hot, then die down just as quickly.
But some things never change. Real estate has been with us for as long as people have staked claims to land and built or grown things on it. With it comes rules that have never been overturned, and it’s fair to say they never will be.
Here are three immaculate laws of real estate investing to act as guiding stars in uncertain times.
1. Buy For Cash Flow
Most people know that there are two ways to “make money” from real estate investing — appreciation in the value of the property, and cash flow from surplus rental income. (There are also tax advantages, but that’s a discussion for another time.)
Suppose you find a property for sale in a fast-growing area. You crunch the numbers and discover that, based on its rent potential and projected expenses, you will actually lose a little money every month. It may be tempting to buy the property anyway. After all, you will make your money on appreciation, right?
Here’s the problem — appreciation may happen tomorrow; maybe it won’t. Maybe you will make money in the future, but with negative cash flow you are definitely losing money in the present. The investment becomes much riskier, especially if you leverage the investment with debt. If you happen to hit a period of financial hardship, you may find yourself unable to sustain the cash drain and could wind up losing everything.
With positive cash flow, your risk is negligible. Even if you get unlucky and hit one recession after the other, you can wait as long as it takes to realize appreciation.
2. Secure Long-Term Debt
Real estate investors take on debt because it enables us to leverage our capital. In other words, we put less of our own money into the deal, and more of other peoples’ money — in this case, the bank or lender’s money.
This reduces the cash flow potential and adds some risk to the deal, but it drastically increases your exposure to appreciation and enables you to buy more property with the same nest egg.
Opting for long-term debt instead of short-term debt is important because it gives you options. The low monthly payments on a short-term interest-only hard money loan might be attractive … but when the loan comes due in two years, you’re backed into a corner. You have to either sell or refinance … whether that’s advantageous or not.
With long-term debt, you can sell or refinance at your leisure … or just sit on it for decades. The ball is in your court, which empowers you to make the most advantageous decisions possible.
3. Have Adequate Cash Reserves
Let’s not kid ourselves — it doesn’t feel good to have money just sitting there in the bank, becoming less valuable as the currency inflates. Why not buy more property, or stocks or crypto or gold or other assets?
Not so fast. Every wise real estate investor maintains substantial cash reserves attached to the investment, even though it diminishes your cash-on-cash return.
Why? Because some real estate expenses don’t happen on an orderly, predictable schedule. What if a tree falls on the roof? Or the HVAC unexpectedly dies? Or a tenant skips out on you, leaving the property trashed?
If you live on the edge, dependent on timely rent payments to cover expenses, you’re only one hiccup away from financial disaster. But with adequate cash reserves in the bank, you have the financial cushion necessary to survive any and all of these emergencies.
Don’t let the winds of change blow you off course. With these three immaculate laws as your reference points, you can invest successfully in any market condition.