Smart investing rule: Work less, make more
Why invest in real estate? Why does real estate investing provide safer and better returns? Why not consider other options like stocks or bonds?
I often hear these questions from family and friends who are curious to know why many people, especially beginners, are starting to set aside extra money to invest in real estate.
First off, the benefits of investing in real estate are enormous. With research and ocular inspection of a handpicked asset, a beginner investor can slowly see his or her investment grow. On top of the sheer joy of watching one’s wealth increase, the investor can simultaneously enjoy passive income, predictable cash flow, fairly good returns and even avail of tax breaks.
With its low risk nature and high return potential, real estate falls under the category as one of the best investment options available. That is why many savvy investors, young and old, seasoned and beginners, are leveraging real estate to build their personal wealth.
When you are convinced that real estate is a good investment option, the next challenge is where and how a new investor should begin.
Rule No. 1: Define your investment objectives
Is it cash flow? Will it be passive income as you are still gainfully employed? Is it to grow your net worth? Is it to make money while you’re asleep? Is it to accumulate wealth over the long term? Is it to invest in an old single-family dwelling located in a prime location then fix (renovate) and flip to an end-user family for a decent margin? Or do you just want to invest in a regular property stock or a real estate investment trust (REIT) stock so you don’t have to be burdened by the usual tenant management issues like leasing, maintenance and other operational issues?
Whatever your plans are, it is important that you are clear with your objectives from the onset.
Real estate investing is all about cash flow
For starters, real estate investing is synonymous to making money through leasing and value appreciation.
In business parlance, it is often referred to as cash flow. For beginners, it is plainly rental income. The latter can be classified as short stays like getting daily guests through the app Airbnb, or securing longer term tenants. Whatever route you prefer, you will need to invest on basic fit-outs, furnishings and appliances that will make any move-in seamless. You can always factor the cost of your additional investment in the unit when you make your lease offer.
Rule No. 2: Manage your finances using two important rules of thumb
One of the most important tools in real estate investing is the 1 percent rule. It is quick and easy to apply, and allows a beginner to evaluate the price of a home or condo unit if it qualifies as a good investment. It is also a strategy to determine your threshold rate and allows an investor to watch out for certain metrics when evaluating assets for sale.
1 percent rule
In this formula, investors should benchmark rent to be at least 1 percent of the total purchase price.
As a rule of thumb, if the asset rents for at least 1 percent of the acquisition cost, it can qualify as a good investment.
Acquisition cost takes into account renovation or other costs related to getting the house ready for occupancy. An example would be buying a house for P4 million and renovating it for P1 million. The total acquisition cost is P5 million.
Applying the 1 percent rule, the rent should be at least P50,000 a month (1 percent of P5 million) to be considered a good investment. This rule is not cast in stone though. There are many conditions like location, demand and supply of homes in the area, rental index (if any), and the livable condition of the house or condo.
In short, there are other factors that may not necessarily provide the asset with a 1 percent rental value. But just the same, applying the 1 percent will allow you to focus on targeting a mortgage payment under P50,000 a month. This ensures that you can meet your monthly amortization and still earn extra money on the side.
80 percent rule
I used to apply the 75 percent rule but markets have changed considerably especially in emerging economies and thus, I have shifted my sights to a more realistic 80 percent rule.
The latter is my personal yardstick in acquiring secondary real estate. It is a pricing benchmark to ascertain whether the price of the property is viable and worth pursuing. For example, if you stumble upon a residential property described as fairly livable, the 80 percent rule of thumb calculation will make you decide right away whether the amount proposed is worth investing in.
Here’s how to calculate: multiply the offer price by 80 percent, and the resulting value will be the maximum amount you should be willing to pay for the property.
Rule No. 3: Understand the real estate market
Now that you have some basic knowledge in real estate investing, it is time to further educate yourself.
Be part of real estate organizations, read up on books about real estate investing, seek out property experts and investors so you can further enlarge your network of expert advisors. The key is to deep dive for a few more months to learn other variables like taxes, financing models, renovation costs, homeowners association issues, property insurance, etc.
When you are ready to make your first investment, I strongly suggest you shortlist desirable locations where you can jumpstart your investment plan.
In closing, it is very important for a first time investor to be mindful of the fact that in any investment upside, there are real risks involved. Every investor I know has his or her own set of peculiarities and biases and therefore every individual investment must be thoroughly studied before making the important decision to invest in an asset. In the end, it will all boil down to a financial decision.
The author is an executive director of W+B Advisory Group
