Real estate has become an important part of my family’s investment planning. I have been a licensed real estate agent at True North Realty for over 15 years, and my wife and I own our primary home and three investment properties. As a result, I am often asked for advice on home purchasing for both primary residential use and for investment. Both types of purchases come with inherent levels of risk that should be at least minimized but are often not even noted before making the purchase.
Here are the TOP THREE things I consider to mitigate risk before purchasing a family home or an investment property:
1. Time in the Market and the Seven-Year Rule
Much like the stock market in general, real estate increases in value over time. Yes, there have been times when it has decreased, but on average real estate is an appreciating asset. Therefore, if I am going to make a real estate purchase for my own use or for an investment, I put a seven-year time horizon on it. If I cannot see myself owning the property for seven or more years, I do not buy it. Seven years allows for market fluctuations and for you to weather any storms that could come in the market.
Chances are pretty good that if you own the property longer than seven years, you will be in pretty good shape from an equity perspective, especially if you follow rule #2…
2. Down Payment and the Proper Use of Leverage
I am not a huge fan of buying real estate with small down payments. It typically costs someone 5-7% of a home’s value to sell a home. Therefore, if you purchase a home with 0%, 3%, or 5% down, that leaves you no margin if an emergency arises and you must sell the home. (God forbid the emergency is compounded thanks to Murphy’s Law and you are hit with a real estate market downturn as well!) Having to sell a home with little to no equity is going to be emotionally and financially taxing. It results in having to bring money to the closing table, short selling the property, or potentially facing foreclosure.
My personal risk tolerance will not allow me to purchase a home with less than 20% down for a primary residence and no less than 25% down for investment properties. Anyone looking to purchase a property or multiple properties for investment purposes needs to decide what percent leveraged/mortgaged they are willing to risk.
My current situation: across the four properties we personally own we are 67% leveraged but no individual property is more than 75% leveraged. Therefore, if I needed to sell any of the properties in a pinch, we could without having to come out of pocket to do so. If the housing market were to decrease in the short-term, we have a significant buffer if we needed to sell.
3. Location, Location, Location and the Importance of Resale Value
When purchasing a property – as with many endeavors – you always want to start with the end in mind. At some point, you or your heirs will sell the property, so you want to pay close attention to the potential resale value when considering its location. Outside of a home’s own characteristics, resale value is most heavily impacted by the opportunities available for work, proximity to quality schools, and the comparable sold properties around it.
Our primary residence checks the boxes on all of these resale value qualities, but for our investments, we took it one step further. To help decrease risk we have purchased our investment properties near a military base and have been able to rent them to solid tenants whose employment is somehow linked to the base or government work. These types of renters have safe employment and generally solid credit, and thus far our investments have been unharmed by world events (coronavirus, market downturns, etc.).
- Own property already? Do you know at what percent you are leveraged? If not, grab your mortgage statement and note the principal amount owed, then get with a licensed real estate professional in your area to have a quick market analysis done to determine your home’s market value.
Percent Leveraged = principal amount owed / market value x 100
- Research real estate as an investment before jumping in. Avoid low downpayment gimmicks/training/books and instead, focus on buy and hold methods. Example: The BRRR Method.
- Seek mentors. Talk to people who have a lot of experience with real estate. They can share words of wisdom and lessons learned that will help you avoid mistakes and pitfalls.**