Investment conversations often are limited to mutual funds and stocks, but there are complimentary investment options for these portfolios. One of the most common is real estate. Because it is important to treat real estate investment decisions with the same care as any other investment, here are some considerations to minimize the likelihood of your asset turning into a liability.
Within your research and analysis, make a point to calculate the carrying costs of owning the property. In other words, what ongoing costs will you be responsible for as the owner after the purchase? These costs directly impact both the cash flow and the investment return of the property.
Always remember that the goal of owning any investment is to make money from it. Many first time investors forfeit their profits by underestimating expenses such as maintenance and repairs and forgetting to factor in costs like homeowners’ association fees. While some expenses, like property insurance, are reasonably predictable, others can be erratic. Therefore, when it comes to estimating carrying costs, it is a good practice to overestimate the expenses to prepare for a worst case, but sometimes most likely, scenario.
Before deciding whether you can afford an additional mortgage, be sure to conduct a personal financial stress test. In layman’s terms, determine how much stress an extra mortgage payment, basic utilities, and any other ongoing carrying costs would add to your monthly budget. You should also figure out how many months you can incur these costs before you exhaust your resources.
In other words, develop the habit of deciphering between what a lender is willing to lend you and understanding what you can actually afford. The former is an indication of how much risk the bank is willing to take. The latter is the reality of the maximum risk that you can afford to take.
At a minimum, consult with your certified financial planner to determine if you can afford the property and how to pay for it; certified public accountant to address the taxation of the property; and insurance agent to buy the proper type of insurance to limit your liability. In addition, hire a real estate agent that specializes in buying, selling or managing the type of property that interests you.
Real estate investments can serve as a complement to your mutual fund portfolio, but be mindful that it comes with similar responsibilities. All investments carry risks; therefore, prudent investors conduct research, manage their risk and hire professional counsel. This process may cost more time and money in the beginning, but it often makes the difference between a desired outcome and a somber regret.
Life is a journey. Plan for it.