A Real Real Estate Investing Dilemma
September 12, 2009 – 4:14 am
I hear a lot of very excited talk about the real estate market being in a shambles that has cost many people their futures. From some points of view, it would seem that is a very true sentiment. From other points of view, especially those of the very sharpest investors, the real estate market is the hottest it has ever been: “Look at all these bargains - now is the best time to buy; I’m going to make tons of money”
So, why are these two positions so diametrically opposed?
The reason is that many people see real estate market value as the most important aspect, whilst others see real estate cash flow as the most important. Both are correct views, but for very different reasons. It really depends on the reason you are looking at buying real estate.
If you are purchasing real estate for rental income, then cash flow must be your first consideration. If the property has a good positive cash flow, then the actual market value could be less important than the market value. The reason you are renting out a property is fro the cash flow. The property has to make a good business case.
However, if you are simply looking for a bargain home to live in yourself, current and future market value are more important. Cash flow does have a bearing, but if you are not renting out, the flow is out and therefore you would tend to want the minimize it!
On the first hand, you have a house you live in that cost you $150,000 five years ago with a $120,000 mortgage. The property saw a modest increase in value over the first three years. The value then took a 5% hit, dropping to $120,000 over the last two. You are still paying the same mortgage and have the same expenses. However, you now have zero equity in the property after paying the mortgage and all the expense for a five year period. Not a good place to be in, at all.
Looking at the situation differently, it is very possible that five years ago you could have purchased a modest rental property for $25,000 with a mortgage of $22,000, including renovations. When rented, this property realized $150 profit per month after all expenses. So the property market experiences the 20% hit and the market value drops to $20,000. However, your rental income and profit stays at $150, regardless. So over the 5 year period you made a total of 5 * 12 * $150 = $9000, even with no rental rate increase.
So, you can see, to the financially illiterate masses, who are only looking at market value, any real estate currently looks like a terrible investment. The reason for this is the mindset being operating from. There are always real estate deals to be made. The outcome of these deals is completely dependent on the financial literacy of the person making them.
Have a great week!
Article by : Malcolm Guest author
