In Southern California, real estate investing seems about as commonplace as sunny days. As a young real estate attorney, it is something that I constantly hear about and therefore is constantly on my mind. With this article, I will explore some of the basic first steps in embarking on the real estate investment path. I mean Donald Bren had to start somewhere, right?
1) Identify the Right Asset
A major decision in real estate investing is determining what type of asset to buy. There are generally two options: (1) commercial or (2) residential. Within commercial or residential exists several sub-types. These include retail, office, hotel, industrial, multi-family (apartments), special purpose or development site on the commercial side and single-family, condominium, or multi-unit on the residential. For brevity sake, I won’t discuss each of these in turn, but it does reinforce the fact that there are tremendous amounts of options available to investors.
Generally, a commercial asset will cost significantly more than its residential counterpart, however, the expected gains are typically higher. A residential property may cost 10% as much, but the gain is also more limited because term length on leases are almost always shorter and the tenant typically does not pay for the expenses further outlined below in section 2. Identifying the right asset for each investor depends on both personal preference and market factors. When the chosen asset type matches up with these preferences and factors it helps lay the proper foundation for investment success in this complicated area.
2) Thoroughly Analyze Deals
Despite the fact that real estate historically increases in value, a bad real estate investment may never generate any money. Thorough analysis requires that you understand the key cost components so that the asset produces income rather than taking income. The major cost components are mortgage, property tax, insurance, property management, and capital expenditure. Properly estimating and accounting for these costs is critical to understanding whether the property can contribute positive cash flow. A commercial tenant oftentimes helps pay these costs but a residential tenant almost never does. Before investing money into a property an investor must know all of the costs, not just the purchase price. Moreover, it is key that the investor understand the market in the area that they are investing. Southern California real estate is expensive, Detroit not so much – but that does not necessarily mean the cheaper market will produce more income. It all depends on a full analysis of the contemplated asset. Some investors analyze hundreds of potential deals before actually making an offer. Whatever analysis process you use, conducting a thorough analysis can be the difference between years of positive income growth or years of added expense/loss.
3) Involve a Lawyer
Involving a lawyer in any real estate deal will improve the chances of a successful investment. From negotiating the purchase price to forming the entity that will hold title, a competent real estate lawyer should be consulted to help protect your investment. Saving $20,000 because a lawyer negotiated the deal or $500,000 because a lawyer formed a LLC that kept other investment properties safe from creditors are just two examples of what involving a lawyer early on in the process can do. Further, after the deal closes and tenants begin moving in, having had a lawyer draft a well thought out and clear lease can help ensure that the investor receives consistent monthly rental income.
The right real estate investment can be lucrative and life changing. An investor can multiply the chances of success by identifying the right asset, thoroughly analyzing the deal, and involving a lawyer. There is no shortage of real estate investors and there is no shortage of investments gone bad, but the risks can be significantly minimized by simply remembering these basics.