When and How to Start Investing
It’s never too early, or too late, to start investing. Ideally, you want to start investing (or have someone invest for you) on the day you’re born. But that’s not how the real world works, and many of us don’t start seriously investing until we hit our 20s, 30s, or even 40s. However, better is always late than never, and it’s never too late to start growing your wealth passively and taking advantage of the awesome power of compound interest.
One popular avenue for long-term wealth preservation and appreciation growth is real estate. It’s a popular misconception that real estate investments require a lot of sweat equity. In fact, with real estate crowdfunding projects, REITs, real estate company stocks, and managed turnkey rentals it is easier than ever to hold down a full-time job, have a life, and still be invested in tangible real property assets.
What percentage of your income should you save?
The percentage of your income you need to save depends on a few things, including how much you have saved right now, what your monthly income and expenses are, and the lifestyle you want to live during your golden years. If you’re late to the game, or your income isn’t as high as you might like, you’re going to want to save a larger percentage of your monthly income- if possible. While there is no set percentage of your income you need to save, a common rule is the 50/30/20 rule, which means you need to save 50% of your budget for necessities, like food or rent, 30% for discretionary spending, and 20% or more for savings. If you want to move up your retirement or simply build more security you can always reduce your expenses to dedicate more money toward your savings.
What percentage of your income should you invest in any one asset?
A diverse portfolio needs to have a wide range of different investments. Historically, financial advisors advised creating a “60/40” portfolio, which means you allocate 60% of your capital to stocks and 40% to fixed-income investments. That is not a hard and fast rule, and some in the financial world recommend that younger investors hold a higher percentage of their savings in stocks or other assets since they have a longer savings horizon.
Aside from stocks and bonds, it’s also important that investors consider holding non-correlated investments, i.e. those investments whose prices do not ebb and flow with the movements of the stock market. Common non-stock diversification investments include gold and precious metals, cryptocurrencies, bank CDs, bonds, and yes, real estate.
How to find an investment property within your budget.
Finding the right investment property can be challenging, but anything worth doing is. The right investment property will have a few universal qualities, but it will also have to fit into your individual financial situation. There are a few things you need to think about before taking the plunge, including:
Liquidity
Cash is liquid. Investment properties, not so much. While they do generate monthly cash flow if you want to receive a fair price for the sale of your rental properties you could be waiting months to receive funds.
Capital Requirements
Purchasing an investment property typically requires a significant amount of cash down, usually about 20% plus closing costs, potential rehab or repair costs, and reserves in the bank to cover unforeseen issues.
Assuming that you intend to maintain a relatively safe level of portfolio diversity, you don’t want to put more than 40% of your fixed-income allocation into real estate. For instance, if you’ve got a million-dollar portfolio, you wouldn’t want to allocate more than $400,000 to single real estate property, and ideally, you’d want to spread that money across multiple properties to reduce your risk from vacancies, evictions, tenant damage, and other issues that may come up with your rental property.
How to calculate your return on investment from an investment property.
When choosing to diversify your portfolio with real estate, it’s critical that you measure your ROI or “return on investment” to determine a particular property’s profitability. This metric measures how much profit you’ll make on an investment property and shows how effective your investment dollars will be in a given asset.
To calculate the gain or profit for an investment, take the total return on the investment and subtract the original cost.
To calculate the percentage, you would use revenue minus expenses, over capital expenses and multiply that number by 100, as demonstrated below:
Revenue – Expenses
____________________________________
Capital Expenses
= Y
You then multiply that number by 100, like so:
Y x 100 = your total percentage gain of profit from a real estate investment.
Calculating the ROI for Rental Properties
Calculating ROI seems simple enough, but remember that there are several factors that come into play when you’re dealing with real estate. These variables can affect your ROI numbers. They’ll include things like maintenance and repair costs and ways of determining leverage- the amount of money you might borrow (with interest) to make an initial investment. These financing costs will have a huge impact on the total cost of your real estate investment.
Calculating ROI for Cash Deals
If you buy a property with cash it is pretty easy to calculate your ROI. For instance, say you:
- Paid $200,000 in cash for the rental property.
- Closing costs were $2,000 and renovation costs totaled $18,000, bringing your total investment in the property to $220,000.
- Collect $2,000 in rent each month.
Fast forward a year:
- You made $24,000 in rental income over the past year.
- Your expenses included property taxes, a water bill, insurance, and totaled $4,800 per year, or $400 a month.
- This makes your annual profit $19,200 ($24,000-$4,800)
Now, you calculate the property’s Return On Investment
Divide the annual profit ($19,200) by the total investment amount, or $220,000
Annual profit
____________________________________
Total investment amount
=ROI
So
$19,200
____________________________________
$220,000
= 0.087 or 8.7%
To find the ROI, you divide $19,200 by $220,000
Your total ROI is 8.7%
How to leverage property assets to expand your property portfolio
In real estate, leverage refers to the act of using borrowed money to buy a property. To leverage a property, you will borrow funds from a lender to cover the cost of an investment property, rather than using your own funds for the purchase. It’s one of the greatest advantages of real estate as an asset class.
The concept behind leveraging real estate is to grow your returns by using lender money, and not having to risk as much of your own capital. It allows investors to purchase properties that cost more than the total amount of capital they have to spend or to spread their investment capital among several different properties.
To leverage a real estate investment to expand your property portfolio, you need to apply for financing from one of these lenders:
Banks
Credit Unions
Hard Money Lenders
Private Money Lenders
Lenders will look at the value of the property in question, the property’s potential income, as well as your personal credit score to determine whether or not they will approve the loan, and what terms and the interest rate they will offer you for said loan. They will also use this data to figure out how much of the purchase price they’re willing to finance and how much you’ll be responsible for. For instance, if you’re buying a $500,000 property and the lender offers to give you 75%, they’ll lend you $375,000 and you’ll need to come up with the additional $125,000. That would look something like this:
75% ($375,000) from lender
+
25%($125,000)
= a total purchase price of $500,000
Conclusion
Investing is an absolute necessity if you want to protect yourself from economic downturns, have a good life during your golden years, and make your money work for you. Real estate is a phenomenal, tangible option that has the potential to withstand downturns, something we saw (and are currently seeing) with real estate assets during the pandemic. Making the decision to invest is easy but choosing the right real estate investment is more challenging.
You also have to consider how much time you want to dedicate to your investment. Are you looking to jump in and take over management, basically a second job, or do you want to spend that time at work, with the family, or just taking some time for yourself? If the latter sounds more appealing, you might want to consider an investment in managed turn-key real estate. You gain all of the benefits of a real estate investment without having to put in the sweat equity that’s required of any self-managed real estate investment.
Contact the team at Spartan Invest to learn more about your turn-key options and how you can use real estate to defend and grow your wealth.