1.0 Income Property


Income property is an investment. You attempt to derive an income from the asset for a certain period of time prior to capitalizing on a sale. Although income may be derived immediately, the final return on the project may not be known until it is sold in the distant future. In fact, in many projects the bulk of the investment return is tied to the future sales value. Until the project is sold, you technically haven't made a profit.

"I don't make a profit until the sale? What do you mean? If I make more income than expenses - it's a profit." Technically, you have not made a profit. Your project has positive cash flow. Although it seems like splitting hairs right now, this technicality will become apparent when you put your pro forma together. For now just accept that positive cash flow is great, and your profit is unrealized until sale.

Although you have a longer exposure to the market, income property has some advantages over flipping. First, you have considered the income potential of the area and bought a project that is supported by the local rents. Second, because the project is cash flowing, you have a high probability of being able to wait out economic down times. You may need to adjust your rental rates, but your chances of defaulting on the property are much lower than somebody needing to sell in three months. Finally, there are tax advantages to owning income property. You are able to depreciate the project and keep more of the income. Just bear in mind, all of those tax depreciations are recaptured at sale; albeit at a further reduced price when considering the time value of money.


1.1 How do I get started in real estate investing?

There are some good books out there on many different types of income property. Believe it or not, almost all real property (there are a few exceptions) is income property. You just need to understand the ins, outs, and whys regarding income and expenses - not always a simple task. For instance, a residential project has different revenue and expenses than say a hotel or retail project. Needless to say supply and demand are also significant factors on your projects viability, not to mention market forces.

If you are just getting started, it is probably best to stick with smaller projects. One reason for this is that it is difficult to get financing in a project type that you have no experience, and we're talking about in good times. Also, any mistakes you may make on a smaller project will probably not wipe you out financially. On this site, we are going to concentrate on fundamentals of income property and focus on a single unit residential property; a house. Using what you learn here as a basis, you will be able to expand your knowledge in other building types as you do further research. The Urban Land Institute has a diverse selection of books on virtually every type of property. Unfortunately in the real estate category, there are as many inferior references as there are good ones. Avoid any materials promising instant riches or huge riskless returns.

"So how do I get started" First, you need to learn some fundamentals. Before you can run, you have to learn to crawl and then to walk.


1.2 Real estate fundamentals, the beginning

Both speculative and income property investment consider the sale of the property in their profit calculations. A speculator though, is attempting to cash in quickly on a bump in the projects capital value. In laymen's terms, they are trying to take advantage of the market mispricing an asset; an arbitrage of sorts. For income property, the primary concern is that the income generated is sufficient to cover the expenses and provide some profit. Here you need to speculate on future values, but you have the ability to wait out negative market swings.

" So why do you consider income property an investment instead of speculation?" In all honesty, any investment in real estate is speculation of one degree or another. When investing in income property, you are speculating that your assumptions regarding demand are correct and that income will actually exceed expenses. If you are way off in your projections, you could incur heavy losses and potentially face foreclosure. What makes us consider the deal an investment is the project time line. With income property it is generally assumed that you'll hold it for at least a year or more. In the investment analysis the holding period is modeled at five years. In fact, many lenders would prefer that the project is modeled at least five years. So by most definitions, a long term hold is considered an investment, whilst a quick turnaround requirement is speculation. Perhaps it really is just semantics.

"How do I avoid a disaster?" Unfortunately, there are no guarantees of success in any investment. What you can do is reduce your risk of failure by analyzing each deal and choosing the one with the least known risk. If nothing else, you will be able to eliminate many projects that were doomed from the start. You see, many major problems with income property are made at the purchase due to a miscalculation of the future market. One could say there were unrealistic expectations, but in most cases those expectations were supported by independent (and expensive) experts. So our goal is to review the fundamental of how to adequately analyze an income property.

The following sections are mostly concerned with the "upfront" work and analysis to select an income property. While management of the property is very important, there are plenty of other books out there on how to manage the property. Our focus is on helping you choose the right property to manage. If you read the Flipping material you will notice much of the information is relatively similar. In fact, the process of choosing either a flip or income property is similar, but with a few important differences. By the end of the material, you should have a reasonable understanding of basic modeling of income properties. Also, you will have drastically improved your odds of success - for free (the best things in life are free - so they say).

Don't sweat the concept of modeling. You only need a simple spreadsheet. You can do this - let's get started.



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