Real estate investing

Buying, managing, and selling real estate for a profit are all part of real estate investing. An individual who makes real estate investments, whether actively or passively, is referred to as a real estate investor or entrepreneur. To increase their profits from properties, some investors actively develop, upgrade, or renovate them.

History

International real estate development saw a rise in the involvement of real estate investment funds during the 1980s. Real estate became a global asset class as a result of this change. Having specific understanding of the real estate market in a foreign country is typically necessary when investing in real estate there. The availability and caliber of information about foreign real estate markets expanded in the early 21st century as foreign real estate investing grew in popularity. In China, where real estate accounts for an estimated 70% of household wealth, real estate is one of the main investment categories.

Types of real estate investments

Residential, commercial, and industrial property are the three main categories into which real estate is separated.
Assessment

Valuation

Most countries’ real estate markets are not as well-organized or effective as those for other, more liquid financial products. Because individual properties are distinct from one another and cannot be easily substituted, assessing investments is less certain. Real estate, in contrast to other assets, is fixed in a particular location and primarily derives its value from that location. Commercial property When it comes to residential real estate, a property’s perceived safety as well as the quantity of services and amenities in the area can raise its value. Because of this, the social and economic climate of a place frequently has a significant impact on how much its real estate is worth.

Often, the first action made in a real estate investment is property valuation. In real estate markets, there is frequently information asymmetry, where one party may know more precise information about the property’s true value than the other. To ascertain a property’s value prior to acquisition, real estate investors generally employ a range of real estate assessment methodologies. This usually entails obtaining records and data regarding the property, examining the actual asset, and contrasting its market worth with that of comparable assets. Dividing the net operating income of real estate by the capitalization rate, or CAP rate, is a popular way to value real estate.

To standardize property valuation, there are numerous national and international real estate appraisal associations. The International Valuation Standards Council, the Royal Institute of Chartered Surveyors, and the Appraisal Institute are a few of the bigger ones.

A multitude of sources, such as market listings, real estate brokers or agents, banks, government agencies like Fannie Mae, public auctions, owner sales, and real estate investment trusts, are frequently used to acquire investment properties.

Financing

Since most real estate assets are pricey, investors usually do not want to pay the full acquisition price in cash. Typically, a sizable amount of the purchase price will be financed using debt or another financial instrument, like a mortgage loan secured by the real estate. Leverage is the portion of the purchase price that is funded by debt. Equity is the amount that is funded by the investor’s own funds, either in the form of cash or other asset transfers. Leverage to total appraised value, often known as loan to value for a conventional mortgage, or “LTV,” is a ratio that represents the risk an investor assumes while financing the purchase of a property. In order to optimize their return on investment, investors typically look to reduce their equity needs and raise their leverage. When asked to finance real estate investments, lenders and other financial institutions normally have minimum equity requirements in place. These requirements are typically in the range of 20% of the appraised value. When buying a property, investors looking for lower equity needs can investigate several financing options (such as seller financing, seller subordination, private equity sources, etc.).

Traditional lenders, such as banks, frequently won’t finance on a property if it needs significant repairs. Instead, the investor could have to borrow money from a private lender using a short-term bridge loan, similar to a hard money loan from a hard money lender. Due to the increased risk involved in the transaction, hard money lenders typically charge substantially higher interest rates on short-term loans. Compared to traditional mortgages, hard money loans usually have a substantially lower loan-to-value ratio.

Certain real estate investment firms, such hedge funds, pension funds, and real estate investment trusts (REITs), have substantial financial reserves and investment plans that permit them to own 100% of the properties they buy. This reduces the risk associated with leverage but also lowers the possible return on investment.

Leveraging the purchase of an investment property results in recurring (and occasionally significant) negative cash flow from the time of purchase due to the needed periodic payments to service the debt. This is sometimes known as the investment’s “carry” cost or carry. Real estate investors need to control their cash flows in order to generate enough positive rental revenue from their properties to cover their carry expenses and then some.

President Obama loosened the rules on investment solicitations when he signed the JOBS Act in April 2012. Real estate crowdfunding is a more recent way to raise equity in smaller amounts. It allows accredited and/or non-accredited investors to join forces in a special purpose entity to provide all or part of the equity capital required for the acquisition. In the US, Fundrise was the first startup to crowdfund a real estate venture.

Sources of investment returns

There are several ways that real estate properties might make money: through capital appreciation, tax shelter offsets, net operational income, and equity build-up. The total of all proceeds from rent and other regular sources of income that a property generates less the total of recurring costs like upkeep, utilities, fees, taxes, and other costs is known as net operational income. One of the primary revenue streams from investments in commercial real estate is rent. In addition to paying a percentage of the property’s maintenance or operating costs, tenants provide landlords an agreed-upon amount in exchange for the use of real estate.

Three methods can be used to counteract tax shelters: tax credits, depreciation (which can be accelerated in some cases), and carryover losses, which lower the tax burden applied to other sources of income over a 25-year period. Depending on the rules controlling tax obligation in the jurisdiction where the property is located, some tax shelter benefits may be transferable. These can be sold to third parties in exchange for money or other advantages.

The rise in the investor’s equity ratio as the amount of principal paid on debt service accumulates over time is known as equity build-up. When debt service is paid off with income from the property rather than from other sources of income, equity build-up is measured as positive cash flow from the asset.

When an asset is sold, the growth in its market value over time is known as capital appreciation and is recognized as a cash flow. If capital appreciation is not included in a plan for growth and progress, it can be highly erratic. Buying a property for which capital appreciation (price increases) is expected to provide the majority of the forecasted cash flows instead of coming from other sources is regarded as speculation as opposed to investment.

Foreclosure investment

Buying properties that are in some sort of foreclosure process is the main focus of investment strategies for some people and businesses. When a homeowner misses payments on their mortgage, the property is deemed to be in pre-foreclosure. State-specific formal foreclosure procedures might be judicial or non-judicial, which has an impact on how long the property is in the pre-foreclosure stage. These homes may be bought at a public auction, often known as a sheriff’s sale or foreclosure auction, once the official foreclosure procedures are initiated. Ownership of the property is reverted to the lender if it is not sold at the public auction. Real Estate Owned, or REO, properties are those that are in this stage.

When a property is sold at a foreclosure auction or as a REO, the lender may retain the money to pay off their mortgage, associated legal fees, and any unpaid taxes, less the costs of the sale.

During the REO stage, the foreclosing bank or lending institution is permitted to uphold tenant leases (should there be occupants in the property); although, often, the bank prefers for the property to be empty to facilitate a quicker sale.
Rehab, buy, rent, and refinance

A real estate investor with prior experience rehabilitating or renovating properties will employ the buy, rehab, rent, and refinance (BRRR) method to “flip” residences. BRRR is not the same as “flipping” properties. Buying a property and swiftly selling it for a profit, whether or not repairs are necessary, is known as flipping houses. BRRR is a long-term investment strategy in which a property is rented out and allowed to increase in value before being sold. While home prices rise and prospective capital gains are increased, renting out a BRRR property offers a reliable passive income stream that is used to pay the mortgage.

In a Bloomberg News story from 2022, the term was somewhat modified to “BRRRR” to refer to the real estate investing strategy of “Buy, Rehab, Rent, Refinance, Repeat,” when BiggerPockets added “Repeat” at the end.

 

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