Residential Income Property Investing

populationMany potential investors do not think this is the right time to invest.  The economy is floundering.  There’s a brand new administration following a divisive, contentious election.  War and terrorism linger.  Tax changes are likely.  Interest rates are unpredictable.

When it comes to making important decisions involving life changes or investments, there will always be that illusory “something” to advocate a delay in action.  Maybe it’s the fluctuating stock market, maybe it’s the need for braces for your child or new brakes for your car; there’s always that mystical “something” that just doesn’t feel right. Potential investors often delay in hopes of more advantageous times.

However, in real estate, the right time, the most advantageous time, is always the present.  Real estate investing is not like stock market investing. It is not a game of chance where the investor must speculate whether it is the right time to get in or out of the market.  In fact, the only unprofitable prudent Multi-Family/Residential Income Property investments made in the last fifty years, even during times of severe economic hardship, were the ones that never closed escrow.

The truth is that profitable real estate investments have little to do with the economic climate at the time of the purchase.  Many investors are afraid to close on the first transaction because they want the economy to turn around first. They want everything to be perfect before jumping in.

This is impractical and unreasonable. Successful real estate investing requires the investor to be informed, disciplined and ready to evaluate the current and future profitability of a property. Waiting for the “right time” to buy does nothing more than delay success. Prosperity comes as one takes action, not when one sits and waits.

Make an Educated Decision!

The primary purpose of investing is to create a life-long estate for oneself and one’s family. Most people will want to eventually stop working for a living, preferring to step off the treadmill and relax, travel, enjoy life, or do nothing.  Worse yet, many will be forced to stop working — making non-fixed investments a necessity.  Even after retirement, they will not have true financial security.

There are other good reasons to consider investing in the “real business” of Residential Income Properties. According to the U.S. Census Bureau (February 2009) the population of the United States is growing, and growing fast:

  • One birth every seven seconds
  • One death every 12 seconds
  • One immigrant (net) every 33 seconds
  • Net gain of one person every 11 seconds

By the year 2035, the Census Bureau estimates that the United States population will grow by 72 million people. The current population of 306 million is expected to swell to 378 million. That amounts to a net population increase of 2.77 million each year for the next 26 years.  Based on an average of 2.5 people per household, this indicates a need for an additional 1.1 million new dwellings to meet the demand. In 2009, forecast for additional new rental units construction stands at 214,000 (Realtor.org). Even after figuring a 100% occupancy rate, that still leaves more than 2.23 million people each year, for the next 26 years, without a place to call home. So, where will these people find housing? Will they purchase an existing or newly-constructed home? Will they qualify for loans or have the down payments to purchase properties?  It seems clear that the outlook for investment in Residential Income Property is stable for many years to come.

Furthermore, according to Brookings Institute researchers, massive American construction projects will constitute a $25 trillion development market by 2030, nearly, twice the size of the entire U.S. economy today (14.58 trillion, 2008 est. source CIA Fact-Book). The majority of these funds will flow into ten metro regions called “Megapolitans.” By 2040 two of every three Americans will live in one of these regions:

  1. Seattle/Portland
  2. Phoenix/Tucson
  3. Boston/New York/Washington D.C.
  4. Chicago/Detroit/Pittsburgh
  5. Sacramento/San Francisco
  6. San Antonio/Dallas/Kansas City
  7. Raleigh-Durham/Atlanta
  8. Los Angeles/Las Vegas
  9. Houston/New Orleans
  10. Miami/Tampa

Clearly, an investment in Residential Income Property is more than an investment in real estate; it is an investment in a “real business” with a profit-loss agenda and the consequences of success or failure.

Real Estate business is not a cyclical enterprise and therefore requires the investor to be visionary, patient, and committed to success in the long term. It is not a get-rich-quick vehicle to wealth and it has nothing to do with timing the market.  It requires a hands-on investor with a proactive attitude for managing business affairs, and willingness to learn and apply that knowledge in daily operations. Over time this attitude, along with hard work and acquired experience, will guide the investor toward success using the steady processes described in this site. If followed and executed faithfully, the strategy as outlined will lead to an exponential growth of wealth.

Ninety-five percent of retirees in the United States rely on bare sustenance incomes. These retirees did not realize the importance of investing in non-fixed passive investments, such as real estate.  If investments do not produce enough to offset tax increases and inflation, they are actually losing money each year.  Investing in real estate allows one to stay ahead of taxes and, more importantly, ahead of inflation. Investing in Residential Income Properties, therefore, is a hedge against inflation.

In real estate investing, education and implementation of that knowledge is what generates wealth and ultimately, financial freedom.  The current “perfect storm” conditions provide a once-in-a-lifetime opportunity to become financially independent and wealthy, but not for investors who stay on the sidelines. Real estate investing is less beneficial and far less profitable for those who wait to buy than for those who buy and wait.

Why Invest in Residential Income Properties?

There are five main reasons why investors choose real estate investments:

  1. Cash flow.
  2. Debt reduction and equity build-up.
  3. Appreciation.
  4. Tax benefits
  5. Leverage

Consider the two most basic of human needs:  Food and shelter.

We cannot survive without food.  Yet, once we have food, our needs turn to shelter.  Being a provider and a supplier (seller) of shelter for number of people for number of years can be very profitable and thus, make the investor wealthy beyond his or her dreams.

Unlike in any other businesses, Residential Income Property investments offer profit in multiple ways:

1) Appreciation of the property.
2) Rent payments that generate a steady stream of income that overtime becomes residual income. Simply put, this is like an actor receiving residual income from television show reruns.

These investments work for the investor 24 hours a day, seven days, 365 days a year, with no vacations, no holidays and no sick days. A good economy versus a bad economy does not affect rent due dates. Alternatively, in other businesses there’s only one way to profit — from the sale of a product or a service. Moreover, in a weak economy or recession, selling these products and services becomes more difficult.
The top ten reasons why investing properly in Residential Income Properties is a smart way to increase one’s financial wealth are as follows:

  1. The population is increasing at an exponential rate.
  2. The supply of land for residential real estate construction is limited.
  3. Inflation causes a rise in land value.
  4. Inflation causes a rise in rent.
  5. As rents increase, property values increase.
  6. The average annual price increase of real estate in the United States from 1968 through 2004 has been 6.4% (Realtor.org).
  7. Residential Income Property investments have led all other commercial real estate asset types, for total return over the past twenty years (National Council of Real Estate Investment Fiduciaries, NCREIF).
  8. Real estate investing offers unique tax shelter benefits unrealized in other industries.
  9. Real estate offers the highest leveraged use of all types of investments.
  10. Real estate investing is relatively easy and highly lucrative.

What is a Residential Income Property?

The Real Estate industry is divided primarily into two separate categories, residential and commercial. Each category is further divided into sub categories:

Residential real Estate:

  1. Single Family Residence (SFR).
  2. Condominium.
  3. Mobile Residence.

Commercial Real Estate:

  1. Multi-Family (Residential Income Properties).
  2. Office.
  3. Industrial.
  4. Retail.
  5. Land.

The term commercial property (also called investment property or income property) refers to buildings or land intended to generate profit. The profits can be generated through capital gains, rental income, or both.

Residential Income Properties are properties occupied by tenants from all social groups who pay rent and in the process generate income for their owners. The income generated through rents and other auxiliary amenities in the property qualifies it as an income- producing asset and thus a Residential Income Property. In many instances Residential Income Properties are also referred to as Multi-Family Income Properties. Apartment buildings, six-plexes etc., all fall into this category.

Purchasing a single family residence or a single condominium unit and renting it out to a tenant does not make the property a Residential Income Property or Multi-Family Income Property, even though it may produce an income. These properties should be considered somewhat speculative for investment purposes because they are tied directly to, and affected by, real estate housing market trends, both when purchased or when sold.

Investing in Residential Income Properties is less complicated than investing in other sub-categories of commercial real estate. It is easy to comprehend and easy to manage because it is based on economies of scale. Everything is available to the investor in one package. Most importantly, investing in Residential Income Properties is a recession proof proposition. Regardless of economic conditions, people need a place to live. Consequently, rent payments take priority over any other expenditure, which may explain why Residential Income Properties hardly, if ever, become distressed properties.

Furthermore, sub-prime loan origination is not practiced in Residential Income Properties’ financing because obtaining a loan is based on the property’s net operating income (NOI), cash-on-cash return (COC) and on the CAP rate (Capitalization rate) thus, reducing the chances of defaults on loans. The owners and investors of Residential Income Properties also benefit significantly when mortgage rates rise because it creates more demand and makes renting more attractive than buying to the public.

There are two different kinds of Residential Income Properties — buildings with up to four units and buildings with five or more units. Buildings with up to four units can be purchased with conventional residential loans and thus, are not considered as being commercial properties. Buildings with five or more units are considered commercial properties requiring commercial loans. As such, the loan on commercial properties (five units or more) is based on the cash flow of the property and not on the investor’s personal credit score, as is the case with a conventional loan. Banks treat these properties as businesses, and analyze and evaluate them from their P&L (Profit/Loss) perspective when deciding what amount to lend, or whether to lend at all.

Residential Income Property investments are different from other real estate investments, such as Single Family Residences (SFR) or condominiums. Therefore, they cannot be analyzed or evaluated using the common approach or formula of conventional real estate purchase.  In the conventional sale model, the home or condominium is bought for a seller-based price.  The seller sets his price based on the cost of the home and, to a certain extent, improvements, overhead, profit, and sales of similar properties in the neighborhood – in other words, what the market will bear.  This market data approach to value is simply a “feel good” approach to other comparable properties.  The more someone likes the property, the more the seller can ask for it, and the more the buyer is likely to pay.  In this equation, the buyer’s satisfaction is generally emotionally motivated.  The buyer, after all, is seeking a shelter, not an investment.  Although a home may become a good investment one day, the primary purpose of buying is shelter rather than investment.  Equity, preservation of equity, yield on equity, and risk are secondary considerations.

Investing in Residential Income Properties, on the other hand, is a money-preserving and moneymaking enterprise.  It is a business. The emotional value should be zero; its sole purpose is equity preservation and the expected yield on capital.  Risk is an essential element of this equation and it includes both the possibility of failure to obtain the required minimum yield (return) and the possibility of loss of the entire equity.  These potential risks are much more certain to occur if one doesn’t have a proper understanding of the market or of the value-return paradigm, or if one pays too much for a property in the first place.

Photo Credit: woodleywonderworks

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