The concept of investment is simple. It involves putting aside a part of your present regular income into an income generating asset or means so that it grows with time and can assure you a better future while providing for contingencies or uncertainties of life.
But the reality is not as simple as the basic concept, which perhaps exists in some vague form in everyone’s mind. Saving a part of your present income involves sacrificing some of your immediate wants. The money saved always gets subjected to inflationary pressures whereby its future value tends to diminish. That is the reason you have to invest the money saved out of your present sacrifices into some income earning asset which not only retains its future value but also grows with time.
Real Estate as an Option of Investment
The value of real estate in the U.S. has steadily been increasing in its value for over past half a century at a much faster rate of growth than that of any other asset, thus easily offsetting value eroding power of inflation. Jeff Adams, the foremost real estate investment advisor in online columns, is enthusiastic about betting your hard-earned money on this potentially fastest race horse.
The advantage of real estate investment is the easy availability of housing loans against the mortgage of the property after making a down payment of mere 10% to 20% of its total cost. Although you should make sure of your continued ability to pay regular installments, it is still a good idea to use borrowed money as a leverage to enhance your investment capacity several times the readily available resources.
You can buy the property for self use or for renting it out. Either way you gain by putting to use the asset that you bought while it appreciates in its value. That is not the case if you choose to park your spare money into any other durable commodity of high value, which is subject to depreciation. The demand for real estate has always been increasing due to growth in population, GDP, overall affluence and increased money supply and also due to the unabated tendency towards urbanization.
Valuation of Real Estate Property
The valuation of real estate becomes tricky when there are no established guidelines for it. A comparative study of the property market in the area can be your rough guide. However, the price of a particular piece of property depends on its strategic location, the surroundings, the amenities available etc. You can obtain the data on comparative prices from real estate agents, the websites or periodic newspaper supplements on real estate which list the prevailing market rates in different parts of the city and the suburbs. However, you should think hard before deciding to pay more than 10% premium price for any property of your liking and choice.
Another method, which is more realistic, is to determine the recurring earning that you can expect over the price you pay. In stock market terms it is known as Price/Earnings Ratio (P/E Ratio). Here the earning is the monthly rent that the particular piece of property can fetch. It should be at least 1% more than the average yield from Treasury bonds. A P/E Ratio of more than 16-17 may not become sustainable for long. A high P/E ratio indicates “up” market, when you should sell the property; and you should go for buying when the ratio indicator is pretty low.
Precautions to Take
While investment in real estate has all the potential of giving you the highest returns, you should not get carried away by over-enthusiasm and turn a blind eye to the risks involved. Here are some of the precautions that you should follow:
- Do not go for speculative buying on the basis of some hear-say report that the property prices in that particular area or the price of that particular piece of property will sky-rocket very soon. Judge in a more realistic way by taking into account the P/E Ratio.
- Buy property from the perspective of your positive cash-flow position and not on the mere speculation that the property prices will always move up soon. When your cash-flow position is strong you will not get trapped in case the trend reverses for some temporary reason. The price appreciation, when it actually materializes, becomes a happy surprise like the icing on the cake.
- Start investing close to your home. Start investing with residential property first. It will be easier for you to manage.
- Do not believe all the cock-and-bull stories. Verify the financial documents, as reported to the Government agencies, stating the revenue and expenses on the property that you propose to buy.
- Do your homework well. Do not expect sudden get-rich investments plans to rain from heaven. Consider the expenses and the risks involved if someone offers you an investment plan of double-digit income.
