Key Insights for Those Buying Real Estate as an Income-Generating Investment

Key Insights for Those Buying Real Estate as an Income-Generating Investment

by Charles Hugh Smith, contributing editor

Monday, February 27, 2012

Executive Summary

• Determining true net cash flow from your investment
• The myth of “passive” ownership of real estate
• The criticality of finding the right tenants
• How important, really, is location?

Part I: Is Housing an Attractive Investment?

If you have not yet read Part I, available free to all readers, please click here to read it first.

Part II: Key Insights for Those Buying Real Estate as an Income-Generating Investment

In Part I, we looked at a variety of factors affecting the demand for housing, both resident-occupied homes and rental properties, because demand ultimately establishes valuation and price for both sales and rentals. In Part II, we address the many issues investors have to consider when they buy real estate for income generation (i.e., they become landlords or absentee owners).

As someone who has owned rental property for over 25 years, I have seen the pitfalls and the positives. As with all investments, it’s prudent to go in with eyes wide open and to ask, am I prepared if the future doesn’t unfold as anticipated?

Is the Net Really Positive?

One truism of income property is “you make your money when you buy, not when you sell.” In other words, if you buy a property that generates a positive net income in less-than-optimum conditions, then future value takes care of itself, as rental properties are typically valued on their income streams. An investor who buys a property with negative income, even in optimum conditions, may find future buyers aren’t interested in the “tax benefits” of an investment that loses money every month.

There are many reasons why a property that on paper should generate a positive net income does not do so once purchased.

Those selling rental properties will naturally paint a rosy portrait of high demand, rising rents, and low maintenance costs. Potential buyers will have to do their own investigations of local demand, rents, and the condition of the building. 

Sellers will naturally polish the rearview mirror, citing previous rental increases and what current tenants are paying. But these legacy rents might not reflect the current market.