Getting Started
Before you can begin there are two related questions to consider for your investment program involving structure and capitalization. Real estate investment is capital intensive and money is required upfront for the following:
- 1. Down payment on your first property acquisition. The amount required is determined by the purchase price of the property and the structure you are operating under (see “Structure” discussion below).
- 2. Closing costs associated with the transaction (title insurance, mortgage points, inspection costs, etc.)
- 3. Remodeling budget. Generally value is created in real estate via appreciation in the market area, financing conditions and, most importantly for investment properties, the rental income your property commands. An investor can only control the last value driver so generally you want to buy properties that have not been properly maintained and invest remodeling dollars that will lead to the highest possible increases in rental income.
- 4. Vacancy costs. Most quality units in Los Angeles can be rented within a few months if the rent is reasonably in line with area rents. However, our rule of thumb is that you shouldn’t buy a property if you can’t finance a 6 month vacancy period.
- 5. Reserves. We recommend clients have dedicated cash reserves equal to 3-5% of the property purchase price available for emergencies. If there is an unanticipated repair bill, you don’t want to be reaching for your personal credit card.
Successful long-term real estate investment requires a similar mindset to stock market investing. If you may need the money within the next 12 months for any reason, you should not be investing in real estate. Real estate is highly illiquid. If you’re in the middle of a 4 month remodeling project, you don’t want to have to sell the property to raise cash.
Real estate is also cyclical like the stock market. The swings just occur over years rather than days or months. As a result, if your real estate investment is enduring a downswing you need to be able to hold and get a good night’s sleep.
There are several basic structure options for your real estate investment program:
- Owner Occupant:
This option requires the least amount of capital to get started because mortgage lenders allow the highest loan to value ratio (LTV) if the borrower plans to occupy the property as their primary residence. That means less of your capital is required for the down payment. An FHA loan can require as little as 3.5% for the down payment. The downside here is that you will have to move into the property and again when you sell it. That said, if you’re willing to do this several times, you can acquire several properties in just a few years with limited upfront capital
- Individual Investor:
his option is for investors who plan to buy property without an intention to occupy it. Generally lenders will only provide a mortgage for 70-75% of the purchase price so more capital is required for the down payment.
- Investment Group:
Generally several people form an LLC or other corporate structure to make acquire properties. This structure shields the investor from potential liability and allows them to reduce their capital investment by sharing it with other investors. Keep in mind that virtually all mortgage lenders require one or all of the members of the LLC to sign the note. So the lender has recourse against your assets personally if the corporate entity defaults on the mortgage.