Real Estate 101: Things to Know Before You Invest

Real estate 28 Feb, 2019

I was speaking to a friend about investments.  His big question was "Charles - what should I invest in right now that will make me a lot of money in the long-run?"  He then said that he might have to tap into that money in about 10 years to pay for his kids college.  

Some people might think about a 529 plan for college savings.  Others might think about investing in a mutual fund.  While I'm not here to provide financial advice, I would have to say that if you have the money to invest, then consider a business or real estate.  Both have tremendous leverage and can create passive income.  I told my friend "if you want a proven, yet simple way to grow your money - check out real estate investing." Whether the  real estate investment goes up or down, you'll have an asset that you can rent out, home equity that you can tap into, or even have your kid live in while going to college.

Real Estate is a multi-billion dollar industry. Knowing the basics of real estate reduces the risks of a failed investment. Investing requires research, planning, and preparation in order for your investment to succeed. I'll try to help you understand the real estate business and the things you need to note. Here are some of the things you need to know before you start an investment.

What Is Real Estate?

Real estate is “an identified parcel or tract of land, including improvements, if any”. That is the definition according to Uniform Standards of Professional Appraisal Practice (USPAP). There are varying definitions of improvements. Improvements consists of houses, storage, fences, walls, underground cables. Stream, trees, lake and natural resources are also natural improvements.

Real estate property is also classified into four groups. Residential, commercial, industrial and open land real estate.

  • Residential real estate consists of houses for sale. The houses could be homes, condominiums, mansions and vacation homes. Residential real estate properties are either sold or rented for profit.
  • Commercial real estate consists of malls, hotels, offices, and shopping centers. Commercial real estate's purpose is to generate a flow of income. That's why apartment buildings are often classified as commercial real estate.
  • Industrial real estate consists of buildings built for manufacture and storage. They could also be properties of research and distribution of goods.
  • Open land real estate consists of wetlands and undeveloped lands. It is also used for site assembly, subdivision and farming.

Space market (PDF) is the avenue for buying and selling real estate. Space market “is the market for the usage of (or right to use) real property (land and built space). What keeps a market going is the supply and demand. Demand is the want to use space for consumption or production by individuals or groups. Supply is the real estate properties available for sale or rent by owners. Knowing the trends in market demand and supply is key to a good investment.

Space markets rely on real estate property location and the type of building. To explain this let’s take a look at a hypothetical example. A group of people wants to open up a new restaurant. They want the restaurant to be at a downtown location. They also want the building to have a restaurant design. If so, it eliminates real estate properties that are not in downtown and not a restaurant design. This narrows down the real estate market. It then raises the value of real estate property fitting the description.

Further Reading:

What Are The Types of Real Estate Investment?

Before starting an investment, you need to know what types of investments are out there. Get a grasp on how this investments generate profit for you.

There are 4 ways you can invest in the real estate market. Selling, rent or lease, Real Estate Investment Trust (REIT) and Real Estate Crowdfunding.

Selling real estate involves the selling of undeveloped property. It's also the improvement of undeveloped property and then selling it.  Developing can be a combination of aesthetics, utility and longevity . Investment in this area usually involves residential real estates or with natural resources. Investments always has risks. Such risks are the location of the property you're gonna buy. If you are planning to buy a property and sell it as residential households, consider the demand. The demand is the area's proximity to a city or a downtown area. The availability of jobs, basic needs, and recreation in a city is usually a factor to predict the rate of demand.  In regards to supply, know how many real estate competitors are in a specific range of your area. The distance relative to the city and quantity determines your competition. The type and quality of their real estate determines buyer's satisfaction. Their price range determines the competitive price. This will give you an idea on how the space market will turn out and turn it to your advantage.

Now when it comes to vacation homes the factors affecting demand differs. You would want a real estate property that focuses on aesthetics. The location of the property is also key. Views of nature increases aesthetic quality and would raise the value of a real estate.

Lease is an agreement between two parties to rent a real estate property. The agreement is set for a period of time in exchange for money. The owner of the real estate property is the lessor or landlord. the one who agreed to rent is the lessee or in common terms tenant. Both parties need to uphold the contents of the agreement. Failure to follow would result in legal implications.

A lease is set-up to give a constant flow of income to the owner. The income generated depends on the value of the real estate property. the value of the real estate property has a direct relation to the health of the space market.  

Rent is also the same as a lease but the agreement is only for a short period of time (most often 30 days). The agreement renews after the period. It ends when the tenant or landlord terminates it by giving an advance notice to the other party.

Real Estate Investment Trust (REIT) is a “a trust company that gathers a large sum of money. It's done through an initial public offering (IPO)". The money is then used to buy, develop, manage and sell real estate properties. It’s the same concept as buying stocks from a company. Instead of getting a part of the profit you're given a part of the managed real estate property. This part generates you income. It's either through renting, leasing, and selling of the real estate property.

This is a huge advantage for investors. You're given a physical property with a potential for income. It is a safety net for you as an investor for you have the rights to the property and at the same time generate income.

REIT is a great investment for small capital investors. Developing real estate involves large funds and manpower. Pooling many small capital investor creates large funds. The maintenance, development and expansion of real estate property is through this fund. Large real estate property reduces the negative effects owning small or single properties.

REIT is also required to distribute an estimate of 90% of their yearly taxable income. This comes from generated income from producing real estate properties to the shareholders. This income is generally only taxed at the personal level. The level and quality of management of the REIT contributes to the amount of income you will get.

If you want to invest in REIT you should do your research before gambling your investment. Consider the REIT’s management track record. Their real estate space market and their earnings are good indicators.

Have a look at the track record of managers’ and the teams they are running. See if they're compensated based on performance. It's a good sign that they are also looking for your best interest.

Know the REIT’s real estate space market. The location of their properties will give you an idea of their value. Their plans for expansion would also predict the success of your investment. Also take note of the REIT’s capital to fund for expansion.

Their earnings would give you an idea on their performance. It also dictates how much of the money is being given to investors. Look only at the REIT’s funds from operation and cash available for distribution.  These funds are a result of the deduction of maintenance of keeping the REIT running. It's a good predictor of the profitability of the REIT.

Real Estate Crowdfunding is a market. It's for individuals who want to engage in real estate business. Usually, they're categorized to two individuals. The one who has the funds and wants to invest and the other one is with property but lack the funds to start the business. Both the parties can engage in debt-based investments or equity investments. Debt-based is the lending of money to be repaid with interest. It can either be a fixed installment or a deadline to make the payment. Equity investments is when both the parties have a share of the income of the real estate business.

No investment is not at risk. Get to know the person you are gonna engage crowdfunding with. Have the potential investors provide their net worth or household income. Having accreditation as an investor would help erase uncertainty in an agreement.

Further Reading:

What Is The Best Real Estate Investment?

Investments come with a risk. Some will fail in investments while others gain success. There is no best investment more of what you prefer and what resource you have at your availability. What I can only give you is the optimal choice of investment according to the resource you have. Give you an overview of what’s to come to your investment.

There are 2 common reasons for investing in selling real estate property. First is you want to sell a property that is not generating you any profit and only means a one time deal. Second is you have a large real estate property but don't know how to maximize profit. If you want to start a real estate business this is the hard route. It requires a huge fund all by yourself. It requires a lot of work and research to get real estate properties with huge potential for profit. You will be competing against huge real estate companies or REITs. They have far larger funds for expansion compared to yours. This is only viable for those who want to gain profit from an unused real estate property and have the capital to do so.

Rent or lease is viable to those who have developed real estate properties. You would want to have a steady flow of income or have the amount of funds to develop one. The things to take not of when starting one is the space market your real estate property is in. Research the space market and it will give you an estimate of the value of your real estate property. Do take note that market value of your property changes overtime. It is vital to keep yourself up-to-date with the market trend. Routine maintenance of the real estate property must also be in check. It prevents the reduction of the real estate’s value.

Real Estate Investment Trust (REIT) is for those who want a safe investment and flow of income. REIT investment gives you part of the income of the operation. It also gives you the rights to a part of the real estate property (depending on the amount of investment). This is very useful as this gives you more leverage through physical asset. REIT negates you from having to compete against large market competition.

Real Estate Crowdfunding is viable to those who do not want to engage in the large real estate market. Instead, their focus is on the local market. There are also disadvantages in Real Estate Crowdfunding. This type of real estate investment is susceptible to scam. You do not want to invest before you know the other parties' legitimacy. It is best to be well-informed. Research about the other party and the real estate project they want to install.

Be wise of your investments. Have a careful calculation of the real estate market. Be well-informed and well-prepared before you make a commitment to invest. These are the things you need to make a successful investment.

Further Reading:

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