Investment Property Basics

So you have money burning a hole in your pocket and the stock market is not behaving comfortably. Now that the real estate boom has come to an abrupt end in most of the country, it is back to basics for real estate investors. No more standing in line to get a new release condo under contract just to flip the contract on the way out the door.

Real Estate Finance:
It is all in the numbers. Real Estate can behave like a bond once it is rented long term. Look at it this way. You invest in a property, which is like buying a bond, and the monthly rental check is similar to a bond coupon. Now the ratio of the price you paid for the property and the rent you receive annually is equal to your yield. If the property cost you $200,000 and you receive a total of $12,000 in rent you would be yielding a 6.00% return.

If you could borrow the who purchase amount at an interest rate lower than your yield you would have money in your pocket at the end of the year. The property would yield a positive cash flow. Likewise if the mortgage rate was higher than the rental yield you would have to chuck in some of your own money to pay the mortgage.

It is important to understand that in this example we assumed an interest only mortgage. In real life the mortgage lender would most likely require a repayment of the principal over 15 or 30 years. As repayment is like savings it changes your cash flow but does not alter the yield.

Investment Goal:
There are two fundamental goals in real estate investing. Firstly the property you are buying should have an acceptable rental yield and secondly it should appreciate over time.

The first objective depends on the rent you can ask and the ability to keep the investment property rented. The second objective depends on external market conditions and the area and type of property you invest in.

Expected Rental Yield:
In times of falling interest rates the rental yield tends to increase making it more attractive to purchase investment property. But often falling interest rates coincide with uncertain economic conditions. So it is important to ensure a property will rent long term otherwise your investment yield is in danger. In markets with rapidly increasing real estate prices the rental rates often lag behind. This is equivalent to lower yields, which makes investing less attractive and should slow down the property price appreciation until rental rates have increased or property prices have devalued.

Picking the right area:
Think of real estate as a commodity. Would you rather own something that is rare and precious or something that is available in abundance? Look for the diamonds for your real estate investing. Find areas that are confined and do not offer much more development potential. For example beach front property has to a certain extend only limited availability. Once the front row beach homes are developed there is just no more supply. Or explore investing in mountain resort communities. Simply by their restricted valley locations they are confined to a small area.

What you want to avoid is suburban areas that offer plenty of undeveloped space. The outlet of ever-increasing inventory will greatly limit your appreciation potential.

One last tip: If you are serious about investing in real estate talk to a lot of local real estate experts. Find a knowledgeable real estate agent. Search for that person and do not blindly accept to find the right expert in the first Realtor you meet.

After a 10 year career in derivatives trading Toby Munk relocated to Colorado to pursue a career in Aspen Real Estate. Explore more on Aspen MLS search.