How to Assess a Real Estate Investment

We should start by defining success. Our general understanding of business gives us an idea of what we should expect over time. Amateurs invest with expectations that they will generate massive returns overnight. A better understanding of business helps us appreciate that we should assess investments over a longer-time frame. Think of the hockey-stick approach to investing!

I started with a five-year plan, and by clearly defining success: I set a goal of building $1 million in assets.

Logic: If I could accumulate $1 million in assets, I could build equity as the investment grew in value.

• If the asset appreciated 10% over time, I would build $100,000 in equity.
• If the asset appreciated 15% over time, I would build $150,000 in equity.
• If the asset appreciated 20% over time, I would build $200,000 in equity.
• If the asset appreciated 25% over time, I would build $250,000 in equity.

You get the idea. If we build a pool of appreciating assets, the assets build equity over time. We don’t have to do anything but maintain the asset.

If we invest in performing assets, meaning the assets generate income, we can use the income to reduce debt. Performing assets build equity by reducing debt while simultaneously rising in value.

When you assess a potential real estate investment, consider the asset’s potential to rise in value. Also, considered its potential to generate income. Can you use the income to reduce debt?

If the asset does not generate income, assess your ability to generate resources to pay down the debt.

CAPITAL NEEDS: AN OVERVIEW

When investing in real estate, think about all of your capital needs. Where will you go for capital?

My website offers a free tool for you to measure the cost of capital. Click the following link:

• Amortization Table

This tool will help you assess the cost of capital. When you invest in real estate, you may need to raise capital. That capital may come from several sources, including:

• You may have built a savings account that you can tap for a down payment.
• You may pursue capital through conventional sources that include mortgage companies or banks.
• You may pursue capital through unconventional sources that include partners, investors, or private equity funds.

The Amortization Table will help you determine how much you should expect to pay for the use of that capital. Consider the following when investing in real estate:

• Acquisition price of the asset
• Amount of down payment necessary to acquire the asset
• Amount of monthly payment to maintain the asset
• Amount of income the asset will generate on annual basis, allowing for potential vacancies.
• Amount of carrying costs to cover while you wait for the asset to generate income.
• Amount of income you can generate and apply to maintaining the asset.
• Amount of capital (if any) you will need to improve the asset.
• Amount of anticipated gain over a five-year time horizon.

ASSESSING CASH FLOW

If you acquire a single-family house as an investment property, consider whether generating cash flow is part of your investment plan. It doesn’t have to be. As a beginning investor, I’ve invested for cash flow as well as for capital gain. With some investments, I counted on the asset to generate income to pay down debt. With other investments, I improved the property with an intention to sell the property and realize a profit.

Always begin with a strategy of how you will make the investment perform for you, in accordance with your plan.

To assess cash flow from the investment, use tools that are freely available on the Internet. Some tools include:

• Zillow.com
• Redfin.com
• Trulia.com

Those websites provide information you can use to assess the value of the investment. Consider the following:

• What price will you pay for the acquisition?
• What is the price per square foot of the property?
• Find comparable properties in the neighborhood and calculate their price per square foot. Compare their price to the property you’re buying.
• What is the cost of repairs to the property?
• What is the estimated rental income from properties in the neighborhood after repairs?
• What is the cost of capital to purchase and maintain the property?
• What plan do you have for the asset?
  • How long will you own the asset?
  • How much will you spend to maintain the asset?
  • How much income do you anticipate the asset will generate?
  • How will the asset influence your time?
  • What is the tenant pool like for the asset?
  • What is the exit strategy for the asset?
  • What do you anticipate the asset will be worth in five years?
  • What will be your return on investment over five years?

CASE STUDY: ASSESSING MARKETS

Financial reports show that in 2012 I set an investment strategy of acquiring real estate assets. To acquire that real estate, I used a variety of tactics. I raised capital in both conventional and unconventional ways.

I invested with a goal of generating income and also with a goal of building equity.

By keeping abreast of the market, I could assess the performance of my investments regularly. When the real estate market changed, I adjusted.

From my perspective, in 2018, it made more sense to begin investing in other markets. The following facts guided my decision:

• Real Estate values in California rose to a level that would make it difficult for me to replicate similar returns on investment that I built previously.
• From my perspective, stock market valuations seemed too high. A market correction could slow growth in the U.S. economy, hurting real estate values in the U.S.
• Yields from fixed income instruments were too low.

Those factors influenced me to begin searching elsewhere for investment opportunities.

When you consider the overall market, determine whether it makes sense to adjust your investment strategy. Understand that “what got you here won’t get you there,” as a well-known business book advises. We must assess markets continuously and make adjustments as necessary.

• Sometimes it makes sense to invest in stocks.
• Sometimes it makes sense to invest in bonds or fixed-income instruments.
• Sometimes it makes sense to start businesses.
• Sometimes it makes sense to invest in domestic real estate.
• Sometimes it makes sense to invest in international real estate.

As the captain of your ship, you must decide what type of investment will work best for you. Your understanding of general business will help you make better decisions. It will also help for you to learn strategies from others.

Take in as much information as you’re able. Use that information as part of your guide to build wealth through investments.

In the following chapters I’ll offer insight into the investments I’ve been making since I assessed market changes in California. The investment strategies work for me at this stage in my life. Use them as a guide. They may help you make decisions with regard to setting a strategy to create wealth by investing.