Buying an investment property: why and how?
BY LISA SCONTRAS
According to the National Association of Realtors®, investment/vacation home-buyers make up nearly 20 percent of the market. While the most frequently cited motivation for purchasing a second home or investment property is to diversify their investment portfolios, 42 percent of investment buyers also expect to generate rental income.
Locally, long-term appreciation conditions are ripe for those who are considering investing in a rental, which also creates a niche for real estate agents who specialize in buying investment properties.
“Historically, at least dating back a half century, real estate in Hawaii has demonstrated strong 10-year appreciation performance with only a handful of 10 year spans exhibiting negative appreciation,” said Chad M. Takesue, Realtor and partner at Locations. He points out how a good investment portfolio should include a mix of stocks and real estate.
“Stocks have greater liquidity than real estate. Real estate is a more tangible investment and you can enhance its value with improvements to the property,” Takesue added. “A good portfolio has investments that complement one another — provide some liquid investment in the event an infusion of cash is needed and some investments that can outperform the stock market or are less volatile on a year-over-year perspective.”
Diversification is a part of the equation to supplement retirement income, though it is not without pitfalls. There is more to investing in real estate than simply taking the rent to pay the mortgage. Responsible investors know long-term success requires planning for vacancies, maintenance, taxes, insurance, and the business of being a landlord.
Lurline Johnson, broker-in-charge at Property Profiles, recommends setting aside four to six months of expenses, not only to cover vacancies, but also to deal with unexpected repairs and maintenance.
“For example, just because you purchased a single-family home that doesn’t have a maintenance fee, doesn’t mean there will be no need to set aside money for future expenses,” Johnson explained. “You should project the number of years remaining until you need to re-roof, paint, replace appliances, flooring, etc., and factor that into your monthly or yearly amount needed to set aside for those future expenses.
“This is probably one of the most overlooked business decisions landlords make,” Johnson said. “They think all rental income over and above their expenses are their personal spending money, so when they need to repair or replace things, they have no reserve to fall back on, and feel the investment and tenant are taking away money from their personal spending.”
Cash flow is an important part of the making the numbers work when evaluating a property.
Johnson suggests “Ideally, you’d like to put enough money down to break even or come out with a positive cash flow. If the property cash flows, then fluctuations in the market are less relevant and you can hold on to the property regardless of market fluctuations and interest rate cycles.”
However, she added, there are circumstances when a negative cash flow may be worth the outlay because of the projected return on investment. For example, if you had a negative $200 per month, that would be $2,400 a year — or $12,000 over five years. If you’re able to handle that additional $12,000 and project that your return will be substantial enough to recover that and more — let’s say the property goes up by $80,000 — then that’s a great return on the invested cash.”
Investment properties can be a significant boost to your retirement bottom line, but do the math first and consult an expert before jumping in.