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Investing in Real Estate Series
Why Invest in Real Estate?
Real estate—land and anything permanently attached to it--is something we’ve all had experience with. Everyone needs a place to live, work, and play. The land in which we do these things is a limited commodity. Common economic theory supports the idea that as demand increases for a commodity with limited supply the value will increase.
If you were trying to buy or sell a home, land, or rental property in Helena, Bozeman, or Missoula in the past couple of years you probably had firsthand experience with this concept. In recent years some neighborhoods in Helena have seen appreciation of 8 to 10 percent or more per year. Missoula and Bozeman have seen much greater appreciation of values. Water-front and view properties throughout Montana have increased in value as the demand has increased. And, with the high-tech securities sector slowing down from the high-flying 1990s, the long-term outlook for investment properties is strong. As a consequence, values of income-producing real estate have climbed as demand has increased.
If you own or are buying a home or condo, you are already in the game of real estate investing. If you are renting, you may want to consider buying a residence and becoming a player. Current tax law allows owners of a primary residence to sell after 2 years and pay no capital gains tax on the appreciation (capital) gain up to $250,000 as an individual and up to $500,000 as a married couple.
A distinct characteristic of real estate is that unlike a stock certificate or a mutual fund share, the owner of real estate can manage the investment—influencing value by increasing revenue and decreasing expenses or improving appearance and function of the property. We can add sweat equity to the property by investing personal time in the upkeep and management of a property. General remodeling tasks, minor interior and exterior maintenance, general accounting and other related chores often can be completed by the investor. This helps reduce overhead costs while letting the investor be more of a “hands-on” property owner. An owner of real estate can directly influence how their investment performs. Few of us have the ability to do that with our stock and mutual fund portfolios.
An investment is an expenditure of money in exchange for income or profit. There are a myriad of investment types and examples. Some investments produce guaranteed income while others fluctuate with market conditions. With all the investment opportunities offered in our society, why would you invest in real estate?
Most of us know someone who has made money being a landlord or from selling real estate for more money than they paid for it. But buying and owning real estate as an investment is different than many other types of investments. We need to know our investment objectives, know the distinctions of the various types of investments, and understand how they work.
Speculative investments that have future profit potential depend on appreciation of value between the time the investment was purchased and sold. Examples include artwork, collectables and antiques. In real estate we think of these as non-income producing properties such as our homes and raw land. Speculation is risky and difficult to predict.
Income produced by investments can be from interest, dividends, or rents. For example banks loan money and charge interest; conversely when you put money in a certificate of deposit—loaning the bank your money--they pay you interest; you may receive dividend payments from stocks or bonds or receive rents from real estate. Examples of income producing real estate are residential rental property or commercial real estate. Residential rentals can be single-family homes to multi-family apartment buildings. Commercial properties include several classes such as: office, retail, manufacturing, industrial, etc. These properties have predictable revenue streams and expenses that allow detailed analysis of the cash flow in their evaluation.
Investing in real estate may require a great deal more time than investing in stocks. That’s why first-time commercial investors are advised to purchase smaller properties. Also, these properties require less initial capital outlay. More experienced investors may opt for larger properties and spread out their risk and capital outlay with partnerships and syndication. Commercial properties with large cash flows may allow owners to hire a property manager, creating a more passive-type of investment.
Commercial investment real estate may be an option for the individual willing to take on a little work and research. Investors making a first-time foray into investment real estate should keep the following in mind before closing on a commercial property. Commercial properties offer a wide range of alternatives, from single-family residential rentals and small multi-family apartment buildings to strip malls and shopping centers to self-storage warehouses. There’s a tremendous range of commercial properties available for the real estate investor to consider. Each type of property presents its own potential for returns, management responsibilities and, of course, levels of risk. However, a property that is well-managed and properly financed can yield significant returns over the long term.
Commercial real estate, like any long-term investment, presents great opportunity and inherent risks. A commercial real estate specialist experienced in valuation, cash-flow analysis, brokerage, lease work, asset management, and other related areas can prove to be invaluable. A qualified professional can help minimize your risks and chart a long-term path to success. Select a real estate professional who has been educated in dealing with these and other issues that may surface during the anticipated length of time the property will be held.
Also, find an experienced tax advisor who can help you understand the tax advantages of owning real estate. A good tax advisor can explain liabilities and strategies involving the capital cost allowance and cost recovery (depreciation calculation).
There’s plenty of capital available in the marketplace right now, and opportunities are available in the commercial sector for investors willing to take some risks. Like any investment venture, real estate may not always perform up to short-term expectations. Over the long haul, however, a well-managed and properly financed piece of commercial property unquestionably can prove to be a solid investment.
Randall Green
Real Estate Broker
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