Buying real estate intelligently requires a person to separate the emotional aspect of buying a home from the business aspect required to make money immediately. You can only make money in real estate by purchasing property meeting one or all of the following conditions:

1. Purchasing the property significantly below market value (instant equity).

2. Purchasing an income producing property like a duplex (income stream).

3. Purchasing a fixer-upper property with as little out-of-pocket cash as possible, repairing it and reselling it for more than you paid for it. Or, renting the property at higher rates due to improvements made.

Many people make the mistake of buying a property at or very near the appraisal price with hopeful expectation the property will increase in value over time. With average appreciation around 5% per year it’s a slow way to make a buck and obviously a risky proposition to automatically assume a property will increase in value. This is especially true when you factor in the costs of taxes, insurance, interest charges and maintenance issues over time, which can be subtracted directly from whatever “appreciation” the property may have. For example, if you buy a $100,000.00 property, which appreciates to $105,000.00 after a year, subtract the mortgage INTEREST payments, taxes, insurance, repairs and maintenance from the bottom line and you will find that the project is not as profitable as you thought. Let’s say your taxes were $1,200.00 and first year insurance premiums were $750.00 plus $500.00 in Maintenance and repairs (a low figure), your out of pocket expenses are $2,450.00 just to hold the property. So the real net gain is $5,000.00 less $2,450.00 = $2,550.00. That’s not much money when you consider the loss of the present value of dollars used in down payments and mortgage closing costs you paid to get the home loan. In fact, the first year you will probably break even or lose money unless there is a massive upswing in value. Keep in mind we are not considering the cost of your time and hassles to buy the property, moving, etc. These cost, whether fixed or variable, mixed or hidden, all take-away-from whatever appreciation you think you gained.

Most people fail to understand that mortgage interest, insurance and taxes add no value to a home, they just suck money out of your pocket over time.

Real estate is like the stock market, your objective is to “buy low and sell high” and that is where some people miss the boat, they buy to close to the market or appraised value.

Many people spend too much money on these costs of owning real estate and don’t really understand how much they are spending to own the property. In other words, they don’t fully understand the accounting aspect of the project. They see the purchase price and the selling price but they don’t see the costs sandwiched between one event and the other. Many people are not aware how little of the monthly house payment is actually applied toward the principal. The bulk of the mortgage payments for the first 5 years are toward interest.

The best property to make money on will be a bad home in a good market that could be purchased far below market value of the surrounding homes, fixed up, and sold or rented for an income stream. Obviously, the intention when you rent is to have your tenant pay for the mortgage payment, interest, taxes and insurance with positive cash flow each month set aside for repairs.

The truth is, a residential home is a money pit for most people for many of the reasons set forth above. Things you should keep in mind before running down stupid tangents you may regret later.

That’s something a real estate agent won’t tell you!

Copyright © 2007 James W. Hart, IV All Rights Reserved