Investment Property Part 2 of 2: What You Need to Know Before You Buy

Welcome to second portion of a two-part series on investment property. In first installment, "How Not to Become a Slumlord", we discussed a little of what it takes to own and operate a property as well as some of do's and don'ts of property management trade. In this second segment, we will be discussing some pre-investment principles that will help you maximize your ROI.

There are three basic principles of investment property that you should know before you buy an investment property in order to avoid overpaying:

Time How long do you plan on owning investment property? As with stocks and bonds, value of your investment may change significantly during time you own it. While most real estate will appreciate in value over time, there are frequent fluctuations in short-term market. If you plan on selling your investment property after less than five years, be prepared to accept investment risk inherent in a shorter time horizon. This is especially true if you bought your property in an overheated real estate market. If this is case, you could find yourself losing money if market has taken a temporary downturn, especially if you've had to make major repairs to property.

If you plan on owning property for next twenty to twenty-five years, it's almost certain that your investment property will appreciate in value. There's also a good chance, however, that you'll have to make major repairs like replacing roof, wiring system, or major appliances like a water heater or refrigerator. Of course, these repairs will be offset by fact that you've had/will have twenty plus years to recoup cost. If on other hand, you're only planning on owning an investment property for next five years, buying a "fixer up'er" can eat up all profits you would have made during your shorter investment horizon.

How online and empowered consumers are taking charge and paying less.

Demanding consumers

“Internet buyers tend to be better informed on market conditions and better prepared to act on home they want when they start working with a realtor. Luckily for realtors, these changes don’t necessarily hurt, as long as they are able to adjust to new relationship and realize that new-style buyers value speed and efficiency over guidance when finding a home.”

– E-marketer, Internet Home Buyers Changing House Rules

Thanks to Internet and other technological innovations, more real estate information is freely available than ever before. As a result, consumers are demanding new choices, improved services, faster transactions and lower prices. According to a recent NAR survey, number of sellers stating that they didn’t want to pay a sales commission fee rose from 46 percent in 2003 to 61 percent in 2004. In 2004, 23 percent of Florida home sellers opted to sell independently without an agent, up from 14 percent in 2003 and nearly double 14 percent national average, according to Planet Realtor.

And Web-enabled consumers are demanding a high digital IQ when working with real estate professionals. In addition to being well-versed on their own industry-specific technology, real estate professionals now are expected to utilize laptops, mobile phones, digital cameras, personal digital assistants and global positioning systems to keep pace with Internet buyers and sellers. Downward pressure

“If consumers are going to do their own home-shopping online, they expect to save some money, just as they would for using self-service lane. That's why they are susceptible to online discount brokers and new affinity companies that are promoting lower commissions if only consumers will use their agents. These business models promote idea to consumers that they ought to be paying less money in commissions.”

Realty Times Columnist Blanche Evans

Traditional real estate commissions, typically around six percent of a home’s selling price, are facing downward pressure from consumers and competition. Some consumers claim traditional real estate commissions don’t reflect:

Today’s home prices. Years ago, when median-priced homes sold for $25,000, real estate commissions were typically five percent, or $1,250. Today, with South Florida median home prices around $300,000, cost of a six percent full-service real estate commission becomes $18,000. Some brokers even charge additional fees to cover administrative costs. When you consider that today’s average homeowner sells a home every five to seven years, real estate commissions can dramatically impact your personal savings and net worth.

Owner equity. When selling properties, most homeowners calculate cost of selling as a portion of sales price, though commissions are paid out of owner equity. (Equity is difference between value of your property and amount of mortgages owed.) Consider this example: You decide to sell a property for $250,000 in which you hold 10 percent equity, or $25,000. After paying a six percent commission of $15,000, you are left with $10,000 before any applicable closing costs. In this example, $15,000 commission is six percent of selling price, but 60 percent of $25,000 equity.

Services performed. Under today’s commission structure, selling a $100,000 house at six percent typically costs $6,000, while selling a $500,000 house costs $30,000. Does selling more expensive home really require five times more effort? Your cost is same whether agent spends one hour or 100 hours marketing your home. This is one reason many real estate consumers find fee-for-service real estate so appealing. Developing alternatives

“Consumers want what they want, when they want it and will gravitate to most cost-effective source to obtain it. Why? Because our "one-size-fits-all" approach to working with sellers and buyers is archaic and won't allow consumers to access various segments of help they need in a timely fashion. That's why .com Web start-ups are finding a receptive audience in real estate consumers and why for-sale-by-owners are burgeoning.”

Julie Garton-Good, Author of “Real Estate a la Carte: Selecting Services You Need, Paying What They’re Worth”