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The Ups And Downs Of Leverage

The seesaw swings both ways with leverage

Unlike other forms of investment, real estate investing affords property investors the innate ability to leverage their assets to obtain much greater returns over time. While this is a tried and true investing fundamental when purchasing real estate, there are also pitfalls one must be aware of before jumping headlong into the property acquisition process and obtaining any investment mortgage loan. To better protect yourself, here are the main pros and cons you’ll need to be very cognizant of when using leverage as you invest in rental property and take out investment property loans.

The main advantage of leverage

When utilizing leverage, the property investor is trying to use as little of their own investment dollars to act as a springboard to greater wealth. Return on investment (ROI) is traditionally much greater utilizing leverage than when only using one’s own

investment dollars to fund your projects. By obtaining a rental mortgage on one or all of your investment properties, you’re able to leverage the most amount of investment dollars while keeping the absolute amount of your own dollars sunk into investing to a minimum.

As an example, if a $100,000 rental property acquisition cost has a down payment of 30%, then you need only put up $30,000 of your own funds to lock up the property. If market appreciation is 4% a year, the property value in this example would increase to $104,000 on the rental real estate. But your ROI on it would be 13.3% ($4,000/30,000). And as you continue to grow your business, slowly adding properties, you can take out mortgages on each one, eventually using the equity in each prior one to help defray your new acquisition down payment costs.

The main drawback of using leverage

Traditionally, home values have remained quite stable over time. However, in periods of great flux or recession, they can decrease in value. And if you need to get out of the market at any given time, this can create a dangerous scenario for real estate investors. If, using the example from above, the $100,000 property decreases in value by the same 4% in a given year, the property would be worth only $96,000. And you, the property investor, still need to make interest and principal payments on the loaned amount (in this case, $70,000), regardless of the current market valuation. If you have leverage multiple properties, and we hit a bad real estate market all of a sudden, well…you can see the potential for financial destruction that could ensue.

Beware the dangerous housing “bubbles”

Luckily, these periods of “correction” or housing bubbles come few and far between.

But nevertheless, it is imperative when buying rental property that any prospective property investor understand the conceptual financial risks inherent when taking on investment property mortgages, thereby increasing their leverage. While leverage is one of the fundamentals of real estate investing, if you’re willing to take moderate risks, you’ll be able to manage using leverage to your advantage. However, always weigh the illiquidity of property investments, as well as the lack of diversification if you only acquire properties in, say, residential real estate and/or in one geographic area.

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Best Tenant-Choosing Tips

Maximizing profits

Attracting good tenants is the lifeblood of any successful rental property investment. And there are some essential rules for attracting these tenants to your units. Keep these tips in mind as you continue buying rental property. These tips will also help keep you maximizing your cash flows when investing in real estate. Remember that you can always be learning new and better ways to maximize your profits in investment properties by becoming an even better landlord.

If you want good tenants, be a good landlord

Any landlord worth his salt will ensure he performs proper maintenance on his rental property. As a landlord, you should not only make repairs in a timely manner on all defects you can see – but also on those you can’t. Remember, that when investing in rental property, since you’re not going to want to disturb your tenants constantly, make sure to ask them on a periodic basis what physical property issues are arising in their units. Is there a new small leak in the kitchen drain? Is their toilet working properly? Any gas or oil odors suddenly present? You need to ask to find out.

And you should be asking these questions about your investment properties on a regular basis. When you keep up with repairs to your investment property, you make your tenants feel more secure about you, as well as making them feel good about staying in your unit. This will aid in future retention. Obviously, the more tenants you can retain year to year, the less work you’ll have to do – since you won’t need to look for new tenants to replace them. Proper maintenance also keeps your overall repair costs down over the entire term of your ownership of the rental property.

Hire a good property manager

If you’ll be using the services of a property management company, make sure you are stringent in your due diligence prior to hiring them. Check out their references, talk to their current landlord roster, and obtain referrals from local real estate pros like real estate agents in your area. Good property managers always stay in regular contact with all tenants. They don’t simply collect rent. It’s their job to maintain good relationships with all tenants. They are proactive at performing property inspections, and will take care of maintenance and emergency repairs as needed. And they will screen prospective new tenants for you as well.

Set realistic market rents for your units

If you set a rent that’s too high, you may profit from the incremental amount above market rent for a short time…but you’ll end up paying for it later when that tenant decides to move because his rent is too high. Again, looking for new tenants is always a costly endeavor. Not only time-wise, but also due to the increased vacancy that occurs every time a tenant moves out. On average, expect at least a month of lost rent due to any tenant moving out. Always make sure you know what current market rents for your area are. Check out your competition for like units. Go visit them. Talk to local real estate agents to get more information as to what constitutes market rents for comparable units at any given point in time. Check out Craigslist listings for rentals in your area. Become an expert on market rents. Know what other real estate investors in your area are charging at any given time.

Likewise, setting rent too low does you no good either. While you may get more takers for your unit, you’re not optimizing your cash flow, as you are giving up the differential between market rent and what you’re charging each month. Remember too that tenants that pay rents under market rate tend to not be so careful about keeping up the look of the unit. Ultimately, they may end up doing more harm to the physical space due to increased wear and tear, and lack of care. Basically, they’ll take much less pride in their living environment when they know they are paying a discounted rate for it.

Beware the professional bad tenants

Tenants that know how to work the system are the ones you’ll need to be most careful installing in your units. While tenants that don’t pay their rent on time need to be evicted as quickly as possible, some states allow the eviction process to last for months. All the while you’re losing revenue due to non-payment. And don’t forget the legal fees involved as well for retaining the services of a good eviction attorney. The best advice here for all real estate investors is simple: make sure you carefully check all references for any prospective tenant. This includes speaking with their previous landlords, running credit checks on them, as well as criminal background checks too. Do this, and you should properly protect yourself from those professional tenants who are gaming the system.

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The Best Property Investing Advice

Creating The Buffer Zone

All start-up businesses are plagued by the same problem: a lack of sufficient capital to get through the initial rough period where cash flow is crucial, and tends to be almost non-existent until the business hits a critical mass of revenue. The same applies for any beginning foray into the property investing field. The best advice I can impart is that you set aside an adequate amount for reserves to get you through your first couple of years of operation. This means, you’ll need self-restraint in order to not want to tie up all your available capital in the most expensive, or the biggest projected money-making endeavor. If you leave 15%, 20% or a bit more in adequate cash reserves, you will be able to deal much better with the obstacles that are sure to befall you as any beginning property investor would encounter.

Holding back

Sure, you’ll want to use up your full capital reserves to maximize your return. But don’t. Hold back. Keep that extra amount in the bank for the proverbial rainy day. It may appear so attractive to utilize the maximum amount of your investments to gain an even better deal, an even better (or greater) mortgage amount – but don’t do it. Restraint, restraint, restraint. This will ensure you create a safety net for yourself. Until you know how the business will go, and you’ve acquired sufficient knowledge to be able to predict better how each succeeding property acquisition will perform, lay back, and keep that certain rainy day amount in reserves.

Sleeping better

When interest rates go up, or the market tanks, or your tenants don’t pay on time, or your taxes skyrocket suddenly, you’ll be able to sleep better knowing you’ve planned for emergencies. The last thing you’ll want to do is go back into the borrowing pool to finance an already-extended property. That’s where things get disastrous fast. Especially when you can’t make your mortgage payment (see financial crisis of 2008 – 2011), and are forced to either go through a short sale , or worse, a foreclosure on your property. Or possibly worse – being forced to place your investment property on the market at a fire sale price in order to unload it quickly. Very, very hazardous, and not for the faint of heart.

Socking cash reserves away

So play it safe. Put those cash reserves away, and know it’s OK to make mistakes. Mistakes that I can guarantee, you will definitely make as a beginner property investor. You’ll certainly be best prepared for entering the property investing arena in this fashion. Finally, always take your time crunching your numbers on each potential property acquisition. The more conservative the numbers for rent and expense items you plug in, the better equipped you’ll be to handle any market downturns and surprises that will hit you financially.

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A New Year’s Property Investing Tips

Time for review…

The beginning of a new year makes for a perfect time to go over your property investing strategy. There are several key elements in any good property investing plan that should be reviewed at regular intervals…so why not now? It shouldn’t take very long to do this review, so let’s get started!

Annual rent roll review

A solid property investing strategy is to review your annual rent roll to ensure you are maximizing market rents from all your units. If you don’t already have tenants under leases, consider creating set leases with small yearly bumps included in them. If you have current leases coming due this year at different intervals, make sure you have a good idea of what bump-ups you want to ask for. Market research is critical here. Go out and check your competition. See what the going rate is for similar units as the ones you have coming available, or that will be up for renewal. Never leave rent roll money on the table. Always be maximizing your cash flow in this way.

Maintenance review time

Have you deferred any needed repairs to your units and/or buildings from last year? Make sure you create a schedule for the needed repairs, lest they become even bigger problems that could cost you exponentially the longer you put off the fixes. Budget for the repairs, and include them in your pro forma cash flow expenses for this year to get a more accurate picture of exactly how much you will net from your property investing.

Debt structure review

If you have long term mortgage notes in place from a long time ago, consider refinancing while rate s are still relatively low. This could end up saving you greatly in the long run. If you paid all cash for a property recently, consider whether this would be a good time to increase your leverage by taking out a mortgage on the property now. If you’ve added improvements to it in the past year, this would also help free up your cash. Crunch your numbers first, and see if the extra debt load from the new mortgage will still allow you a positive cash flow. If so, then a new mortgage may be a great way to help free up your cash for more property investing.

Pre-tax time review

Prior to April 15^th, the beginning of the year gets you to focus early on whether you are maximizing your depreciation on your buildings. It’s also an excellent time to get in to see your accountant to go over these matters – before they are snowed under with work come tax time in April. Maybe they will have some new suggestions about how best to maximize your day to day expenses, as well as your capital expenses to help offset your cash flow income, realizing a smaller tax bite come tax time.

Insurance review time

Consider the beginning of the year as the perfect time to review your current building insurance policies. Yu should already be working with one dedicated insurance agent for all your property investing needs. Go over with him any adjustments he would recommend to make sure you are adequately covered in the event disaster strikes – or you have a negligent tenant. Also remember to review your current liability insurance policy on each of your buildings. This may the most critical insurance item to review. Make sure your insurance agent feels you are properly covered in the event of a tenant accidentally hurting themselves on your property, and suing you.

To sum up…

Utilizing this time of year as a great time to review all these key elements of any good property investor will help you substantially. You’ll end up maximizing your cash flows, as well as reducing taxes, and making sure you’re adequately covered in the case of emergencies or disasters.

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