Ask Brian: Is This a Good Time to Invest in Real Estate?



Ask Brian is a weekly column by Real Estate Expert Brian Kline. If you have questions on real estate investing, DIY, home buying/selling, or other housing inquiries please email your questions to askbrian@realtybiznews.com.

real estate crowdfunding

Question from Rosemary in Northern California: Hi Brian, I think that I may have confused myself trying to decide if now is a good time to invest in real estate. I know that interest rates remain at near-record lows and that prices have stabilized compared to recent years. I’m also watching to see what happens with the pending evictions and what that might do to prices short term. On the other hand, unemployment is high, the economy is in tatters, and a lot of uncertainty exists all around. If I do decide to invest, I plan for it to be rentals generating income both today and when I hope to retire in about 20 years. I have the money to invest today but is this the right time?

Answer: Hi Rosemary. It sounds like you are paying attention to what is going on and working to develop a long-term plan. Good for you! History has shown us that there are good, better, and best times to invest in real estate but there is seldom a truly bad time. I suggest that you begin by taking inventory of your situation.

  • Can you afford to invest even if it means you might not see strong returns in the short-term?
  • Is the rental market that you are considering in good shape with a strong long-term outlook?
  • Do you expect positive cash flow from the start? It becomes a much higher risk if you think you are getting a steal when the property has negative cash flow.
  • Will the property appreciate in value over time? Most property will but there are always exceptions.
  • Are you confident that your day job will remain secure as we continue pushing through the pandemic?
  • Can you meet the stringent mortgage requirements to benefit from the low-interest rates? A good credit score and low debt-to-income ratio are at the top of the list along with job security.
  • Will you have cash reserves if not everything goes as planned or an emergency comes up?

If you’re confident that you are ready to move ahead with an investment, the next step is creating a solid property analysis process. That begins with knowing how to evaluate different property types. Most people are comfortable with the basic process for evaluating a single-family house that relies heavily on a market analysis of comparable houses in the neighborhood. Multi-unit properties, like small apartment buildings and even duplexes, should be evaluated for financial performance. That’s what we’ll take a closer look.

With multi-unit properties, you want to look at the income and profit that the property generates. Broadly, there are at least two sets of data that you want to evaluate. The current owner’s recent financial information and the financial performance you expect to achieve – Pro-Forma. The current owner’s data will provide important information such as rents collected, vacancies, property taxes, and expenses but there is a limit to how much this will apply to your specific situation. For instance, has the owner increased rents to stay aligned with the current market? Or will you be able to increase rents (although probably not all at once)? On the expense side, has the property been well maintained or are major expenses lurking in the near future? When is the last time the property was assessed for tax purposes? You need all of this information and more to conduct a thorough Pro-Forma financial analysis. For instance, is the current cash flow based on the owner taking out a mortgage 20 years ago that is almost paid off and he or she has raised the rents 18 times over the years? Your positive cash flow is going to be much less when you take out a new mortgage even if it has a low-interest rate. Rosemary, the basic information that you need to begin a financial analysis includes:

  • Overall property and individual unit details that include the number of units, bedrooms, baths, square footage, how utilities are billed, common areas, and anything else that is relevant.
  • Income (both current and Pro-Forma) from rental payments and other income such as laundry facilities.
  • Expenses that include at a minimum: maintenance, property taxes, insurance, vacancy rates, and property management.
  • Your financing details start with the mortgage amount, interest rate, down payment, closing costs, and required reserves.

Keep in mind that the current owner is going to put their finances in the best light. Don’t accept only a spreadsheet that he or she provides. Insist on seeing verifiable data that include income tax returns, property tax bills, actual rents deposited, and maintenance receipts. Of course, you need to have the property professionally inspected to make sure there aren’t seriously neglected maintenance and repairs.

Once you have all of the needed information, you begin making calculations that give you a good idea of how the property will perform financially. Without going into detail, these are the important calculation to conduct and fully understand.

  • Net operating income (NOI) expresses the total income to expect from the property after accounting for all expenses (before taxes and excluding the mortgage).
  • Capitalization rate (Cap Rate) is a ratio of NOI to property value. It helps you understand the investment risk.
  • Cash flow, which is NOI minus mortgage costs.
  • Return on investment (ROI) is a ratio of cash flow based on the total investment cost.
  • Cash on cash (COC) shows the relationship of your cash flow based on the amount of cash you have invested in the property (doesn’t include mortgage).
  • Break-even ratio (BER) shows how the property’s operating expenses and mortgage affect the gross operating income. This is critical to showing you how vacancies will affect the financial performance.

Rosemary, I hope this information is helpful. It doesn’t directly answer your question whether this is a good time to invest in real estate but it does give you the basic process to answer the question for yourself.

Please add your comments about what you think is important to consider in today’s investment environment.

Our weekly Ask Brian column welcomes questions from readers of all experience levels with residential real estate. Please email your questions or inquiries to askbrian@realtybiznews.com.

Author bio: Brian Kline has been investing in real estate for more than 35 years and writing about real estate investing for 12 years. He also draws upon 30 plus years of business experience including 12 years as a manager at Boeing Aircraft Company. Brian currently lives at Lake Cushman, Washington. A vacation destination, near a national and the Pacific Ocean.