If you think that when you retire your pension will allow you to continue to live in the manner to which you have become accustomed during your working life, think again! These days most people know the importance of taking things into their own hands when planning for their future. When it comes to investing your money there are a lot critical decisions to make and unless you have special training you’re going to need some guidelines written in plain English.
First off, you'll probably want to know what the "perfect investment" is. Ask around, you'll quickly discover this is not a straightforward question. Everyone you talk to will have a different idea on what makes the "perfect investment". Who's right?? Nobody!
Nothing is perfect! - There is no such thing as the perfect investment! If an investment has a high rate of return (profit), chances are there will also be a high degree of risk and if an investment has a low degree of risk, it will probably offer a lower rate of return. The rule of thumb in investing is that all investments are a trade-off between risk and return.
Since every investment is a compromise where you must weigh the levels of risk and return it is important that you tailor your investments to suit your personality and financial situation. For example, one investor may be willing to accept a higher risk in exchange for the chance of higher returns while another investor is more comfortable with safer, less risky investments, which usually means a lower rate of return (but allows for a good nights sleep). Since everyone is different, there is no one “perfect” investment for everyone.
Getting ready to invest. - You need more than a good idea to start investing for your future. In order to have the money to invest you may first have to take some steps to pay off existing debt and build up a cash reserve. Don’t forget to fund your retirement accounts, they should always be considered your retirement safety net.
OK, you've got your debt load under control and you have some cash to play with, what next? You need to pick an investment. Where do you start? We've said there's no such think as the "perfect investment" but what we didn't tell you is that real estate is as close to perfect as you can get!
Why choose real estate? - Why is real estate such an enticing investment? Because more millionaires have made their fortunes in real estate than anything else! Marshall Fields is quoted as saying “Buying real estate is the best, safest way to become wealthy.” And if that’s not enough for you, Theodore Roosevelt said, “Real estate is the basis for all wealth.” What did these millionaires know that you should know? They know that over the past 80 years real estate values have consistently increased. In fact in periods of high inflation, real estate values actually go up. Finally you can get some benefit out of inflation! Of course there has been the odd jog in the upward spiral but the overall trend has been up, up, up!
Real estate is one of the few big-ticket items you can purchase with just 10% down, which makes it accessible for many “regular Joe” investors. If you use $10,000 to put a down payment on a $100,000 house and your house appreciates 10% in a year, your $10,000 investment has just doubled, that’s a 100% return on your money. Now that’s wise investing!
As well as providing a regular source of income, you may also find that there are tax advantages to be had when you own property as an investment. Check with your accountant for the availability of investment interest write offs and depreciation write offs.
Why invest in single-family homes? – It may make sense to invest in real estate but why choose single-family homes? Why not invest in some of the big-ticket real estate items like restaurants, malls, apartment buildings or raw land? Because success with these pricier real estate investments requires lots more time and experience so why not start with something more “user friendly”.
Single-family homes have lots of advantages over other forms of real estate:
- You need less money to start with – If you have enough money to go out and buy a mall or 50 acres of prime real estate you probably also have an investment broker who does much of the work for you. Single-family homes are an investment you can manage yourself if you are careful and willing to do a little legwork. Plus for only $20,000 down you can buy a $100,000 house.
- Start with what you know – You probably spend some of your time shopping in malls but chances are you have lived in a single family home (or know people who do) and are familiar with many of the issues you will face when you own one. Plus, if you already own your own home you will have seen it appreciate in value over the years; that makes for a good nights sleep if you decide to buy a second home as an investment.
- Don’t tie up all your capital - If you could either have 5 houses or 1 apartment building for the same amount of money, which offers you more flexibility? Think about it, if you suddenly needed to access some of your capital you could sell one of your 5 houses or refinance one or bring in a partner on just one of them. With the apartment you would either have to sell the whole thing, refinance the whole thing or bring in a partner on, you guessed it, the whole thing. And if you decide to sell your property, what do you think sells faster, a single family home or an apartment building?
- Divide and conquer – If you take over an apartment building you are going into a situation where the tenants probably know each other and chances are pretty good that they also know what everyone else pays in rent. This makes it difficult to start raising rents one at a time. Houses can be managed individually and you can adjust each rent to suit yourself, including lower rents to keep excellent tenants happy and staying put.
- Build more equity - There is usually more appreciation in single-family homes than in a larger investment like an apartment building. Apartment buildings are valued based on how much money they bring in and single family homes are valued based on sales of comparable homes in the area. Remember, a home is a psychological desire; most people are working towards getting out of an apartment and into owning their own homes so there is usually more demand for houses than apartment buildings.
- No rent control -Rent control is where the government tells you how much you can charge for renting out your apartments. Sometimes the rent the government allows you to charge does not cover your costs; this does not make for a good investment strategy! As a property owner you will quickly find that rent control is a very bad thing so it is fortunate that most rent control laws only apply to buildings with 4 or more units. Check this out thoroughly before buying any rental property.
- Less risk, better sleep – Why put all your eggs in one basket? Single-family homes (imagine that you will own more than one) are usually scattered around an area and if one part of town starts to get seedy it doesn’t affect the rest of your investments. When you own an apartment building, if the area goes bad for some reason (rendering factory goes in next door, for example) you, and your investment, are sunk.
- More stable renters - As a rule, single family homes usually tend to attract a better, more stable class of tenants than apartments (like families with kids in school who are less apt to move frequently). Apartment dwellers are often more transient, single people or young couples that will soon outgrow an apartment and want to move to a house. Most people who live in apartments won’t do minor repairs and maintenance but people living in a house often will.
What’s the downside?
Every investment has some drawbacks; nothing is perfect. Here are some things you need to know about owing investment homes:
- Your investment will need to be managed - All real estate acquisitions require management, either by you or a professional management company. Obviously there are more headaches involved with a “hands on” investment like real estate than with simply putting your money in mutual funds.
- Takes more time - An investment portfolio of several single-family homes is more difficult in some respects because the homes are spread out. This makes showing the homes to prospective renters more time consuming versus an apartment where all the units are in one location. Repairs and maintenance to several houses spread throughout the city will also require more of your time. There is more paperwork involved in owning several homes because each house has its own mortgage, property taxes, insurance, etc. Management takes some time, but if you develop a system and stay on top of it, it is not all that hard.
- Vacancy packs more of a punch - All real estate can suffer from vacancy from time to time but with a single family home, if it’s vacant there is NO rental income coming in. With an apartment you can have one or two vacancies but you still have the other rental income from the other units. But by doing your homework and purchasing the right properties in the right areas (and charging fair rents), you can minimize the vacancy rate so it isn’t a big problem.
- Repairs can be pricey – It’s true that any real estate is going to require repairs occasionally but there are some major differences between apartments and single-family homes. Single-family homes each have their own furnaces, air conditioners, roofs, etc., unlike an apartment building that may have just one furnace and one roof.
Houses may have more repairs in the long run but they will generally be less expensive repairs than for a larger building. Apartments also require services such as landscape maintenance and snow removal. A tenant in a single family home usually performs those tasks themselves along with lots of minor repairs.
How do you find a single-family home that is suitable as an investment? To be continued...
Diane Walker is with CENTURY 21 Platinum Realty in Edmonton, AB.