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Following your gut and not your head
Many Investors fall into the trap of buying an investment property the same way they'd buy their home, using emotion instead of relying on numbers. It is important for investors to remember that every home is the right home for somebody, even if it isn't them. The difference between investing and speculating is that investing relies on research and number crunching; speculation relies on gut fellings.
While leverage is a highly valuable tool in real estate investment, not knowing the difference between positive leverage and negative leverage can mean making payments on an investment rather than getting paid by an investment. Calculating the Debt Service Coverage Ration (DSCR) for an investment is an important method of determining whether or not an investment will earn money or cost money.
Thinking real estate is an easy to get rich quick
From 2002-2006, the residential real estate market experienced a period of rapid appreciation, which was subsequently lost in the years following. Real estate appreciation over time has been slow but steady, and offers great rewards to the patient investor who does the research and works to ensure property appreciation. In fact, real estate investment beat the S&P 500 in appreciation over the past 30 years - and that even factors in the recent crisis. Wise real estate investors know there are no short cuts, and are willing to put in the time and work to ensure good returns on properties. "Get Rich Quick" schemes are just that: schemes.
Not understanding tax benefits and liabilities
Among the key advantages of real estate as an investment are the tax benefits. Understanding how to deduct for depreciation and passive activity loss can greatly increase the cash flow from a property. There are also ways to defer capital gains that are unique to real estate, such as the 1031 exchange. But benefits are only part of the story. Wise investors understand deperciation recapture and how to minimize taxes upon sale of a property. Be sure to seek a qualified accountant for tax advice regarding real estate investment.
Investing without a clear goal
Simply buying a property because it's a good deal can be dangerous. Shifts in market conditions, unexpected vacancy or extended holding costs can quickly turn a profitable property into a money pit. Investors should always have a clear goal for a property, one that includes an understanding of a specific cap rate, cash flow, and expected return on investment, as well as exit strategies should you need to take action.
For a free glossary of Real Estate Investing contact me @ firstname.lastname@example.org and enter Glossary in the subject line.
"If I could have only one investment, it would be real estate"......Donald Trump