- The Washington Times - Friday, July 13, 2007

Q:I have bought two investment properties and have a five-year, interest-only loan.

Since the market is now favoring buyers, I would like to buy another one. I am a little concerned because my rates will increase in about four years.

My aunt was a real estate investor and had 10 properties at one time. The bottom fell out of the market and all the properties ended up in foreclosure.

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I don’t want this to happen to me. Any general advice?

A: I can certainly give you my thoughts on how to invest in real estate safely. Here are some tips.

m Understand that real estate will generally appreciate over time, but not without periods of value stagnation and even depreciation.

Folks who believe that real estate values only increase are wrong. All real estate investors should have the ability to hold the property in the event of a market downturn.

m Understand that properties don’t all appreciate at the same time and by the same amount.

New homes in the outer suburbs are more susceptible to market downturns because there is more developable land, increasing the chances of an overabundant supply.

On the other hand, purchasing a home in a “gentrifying” neighborhood carries its own risk. Gentrifying neighborhoods often take longer than anticipated to reach a point where they become highly desirable.

m Understand the myth of a “no-money-down” purchase.

Forget about those late-night infomercials touting these investment strategies that require no cash. The fact is that the larger the mortgage, the higher the financing costs and the higher the carrying costs.

There are very few, if any, properties that are able to command rental income that will cover the monthly “nut” of a 100-percent-financed deal.

Writing a check each month to cover the imbalance between the carrying costs and the rental income is what kills many investors. A positive cash flow is pretty important.

m Understand the rental market.

A property that remains vacant for long periods of time means that the asset is generating no revenue.

m Understand all costs associated with investment properties.

These costs include maintenance, taxes, insurance and repairs, among other things. These expenses need to be factored into the analysis.

Calculating a capitalization rate is a quick and dirty method of determining whether a property is well-priced.

Let’s say a property is on the market for $200,000. A buyer pays all cash. He then rents the property out for $1,200 per month, or $14,400 per year. In the first year, he spends $4,500 in taxes, insurance and maintenance. This nets him $9,900.

Divide his net income of $9,900 by his cash investment of $200,000 and we find that his “cap rate” is 4.95 percent.

Some investors might find this acceptable, especially if the property naturally appreciates. However, if the investor decides to put only 5 percent down, his invested cash is only $10,000.

But he then must carry a hefty mortgage payment. At 8 percent, for example, the monthly mortgage payment might be close to $1,400 per month or $16,800 annually.

Add the $4,500 in expenses and we have a cash outlay of $21,300 in the first year with revenues of only $14,400. Our investor must write a check of $6,900 to keep up.

This amounts to $575 per month.

Real estate investing can be very lucrative over the long run. Remaining in the game usually requires low financing costs, healthy rental revenues and a reasonable equity investment.

Henry Savage is president of PMC Mortgage in Alexandria. Reach him by e-mail (henrysavage@ pmcmortgage.com).

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