Written by Alexander Biliouris
Although it’s found all over the world, there is a finite amount of real property. Second, the value of real property is typically correlated with supply and demand, and as the world’s population continues to grow, demand will outgrow the supply of it. Third, we really need it; after all living in a cave just doesn’t do it for most people these days. Last, and perhaps the most attractive feature of this investment vehicle, real estate is a tangible asset. So you can physically touch and control it, unlike many other investments that are created from fictitious market models or pie in the sky expectations/speculations.
It’s no secret that real estate has taken a significant hit over the past several years. However, upon further investigation, it is easy to see that this was a result of people losing sight of some fundamental investment principles that any investor needs to weigh and consider before placing their hard earned money at risk.
If you approach any individual who purchased their real estate at the peak of the market, now finding themselves underwater because they paid an inflated value for their investment, I’m sure they aren’t too fond of real estate at this time. However, if you really examine most real estate transactions that are now short sales, foreclosures, or Bank REO’s ( real estate owned), it is evident that the fundamentals were neglected. During the peak of the market, ignoring fundamentals gave way to momentum. Momentum buying is like playing musical chairs, as soon as the music stops someone is going to be left out in the cold.
Looking further at different real estate cycles over the years, you’ll find that most people tend to move in a given direction. Once real estate values increase, people start buying, and when real estate values drop, people will start to sell. I guess human nature requires us to emulate others and gives way to this herd mentality. I would be very cautious of this behavior, because we all know where the herds tend to end up…the slaughter house, figuratively speaking. For maximum return on your real estate, I would propose a contrarian philosophy that requires you to move in the opposite direction during any major market cycle.
So now let’s take a look at what I believe to be some of the most important fundamentals of any type of real estate transaction. These are general concepts but applicable to residential, commercial and investment properties. First, the old adage of Location, Location, Location is still relevant and probably the most important element to consider before buying.(for a more in depth discussion about location please visit the following site: (http://www.nuwireinvestor.com/articles/real-estate-investingfocus-on-the-fundamentals-51403.aspx) Second, don’t over extend yourself, make sure you can afford the property you are buying. By afford, I mean you should also have adequate savings to navigate through the unexpected (what is adequate for one person or investment may not be for another). Third, make sure you do your due diligence, including property inspections, so you can avoid any major surprises down the road. Fourth, make sure you factor in the cost of capital improvements and replacements. These costs are related to items like your roof, siding, electrical, plumbing & HVAC systems. Not planning for these improvements or replacements could have a major negative impact on the value of your investment. Fifth, you made a plan to enter the real estate market; you should also have a plan to exit the market as well. Although worse case scenarios usually don’t happen, the best laid plans can go awry. Having an exit strategy will help you prepare to minimize losses and maximize the value of your real estate investment.
I advise my clients that if you apply all of the right fundamentals to your real estate purchase, a good deal today will be a good deal 20 or 30 years from now. How do I know this to be true? Over long run, real estate in general, has always appreciated in value. Yes, there have been highs and lows in the market, but as long as you are not pressured to move in any one direction during those peaks and valleys, your investment should remain sound.
There are many external factors and unknowns that play a role in your ultimate return on investment. Keeping an eye on the fundamentals should be an intricate part of your purchase and it will help you avoid the pitfalls that plague most failed real estate investments.
So, if I still haven’t convinced you how good an investment real estate can be, here are a few other things to consider:
1. While there have been peaks and valleys, new and existing homes have appreciated in value over the last 50 years.
2. Over 40% of the wealth in this country is held in real estate.
3. More than 25% of retirees will depend on their real estate investments to fund their retirements
4. Using various IRS guidelines, such as a tax deferred exchange; real estate is one of the last investments that can grow without Uncle Sam constantly picking your pocket.
5. The mortgage interest and depreciation tax deductions make the real cost of owning real estate substantially less than most other investments.
6. You will pay fewer taxes.
7. You own it, it’s tangible and you have control over it.
8. It offers inflation protection.
9. It forces you to save.
10. It’s an investment which is an essential part of any plan to grow wealthy.