It is easy to make money from real estate. Timing and location and financing are everything, and the rest is details.

March 2009 - Probably the worst time in the past 20 years to be talking about making money in real estate, but for the beginner, this might just be the time…

First-Time Home Buyer Or Investor?

This is a discussion that can benefit both the first-time home buyer or the first-time real estate investor. In early 2009, the homebuyer’s goal is to have a residence and not to make money from the real estate or at least not to see a decline in the value of the home. For the investor, the goal are similar, but with the added goals of being able to rent out the property at al level at which substantially all costs can be covered and where a deduction can be taken for depreciation for tax purposes - depreciation being the theoretical decline in value of a physical asset such as a house or car experiences over time. Currently there can be very little hope that prices will rise significantly if at all in the next couple of years. For the homeowner this lack of increase in value is not as much of any issue as it is for the potential investor who hopes to make the bulk of the profit on a sale of the real estate in a future year.

The Basics

We will focus here on some basic principles of real estate investing, what to look for and what to avoid. Some considerations will apply more to the homeowner and some more to the investor.

Real estate can be broken down into several broad categories, commercial real estate (retail, apartment buildings, farmland) and residential real estate (houses, individual condominiums). As commercial real estate usually requires a little more sophistication, we will leave this for a later discussion.

Location, Location, Location

Whether one is dealing with residential or commercial real estate, the well-know three basic priniciples are location, location and location. One is not necessarily looking for the best deal - say a 1-bedroom apartment in Houston for $25,000 in a questionable area. Rather one is looking for the same sized apartment in Houston in a better area, where say $40,000 would buy a 1-bedroom apartment, but would be the cheapest apartment available in that area. The reasoning for this is that any increase in value would be tied to the general rising price level in the area - the better the area, the more likely it is that prices will increase. In today’s environment, the expectation is at least that prices will not go down, and the price one is paying is reasonable.

What Is A Reasonable Value?

Value is perhaps the greatest problem in real estate as I write this report. No-one really knows what anything is worth. This is not restricted to real estate. One only needs to read about the various problems in the US banking sector to realize that the value of real estate, securities, and derivatives (the notorious ‘toxic assets’) are a huge question mark.

Residential real estate is perhaps the easiest to value, because there are still people who want to buy a home and people who want to sell a home, and institutions like Fannie Mae and Freddie Mac, are still prepared to lend money to qualified home buyers to buy homes that they will live in as opposed to investors who face much more stringent lending requirements.

Buying a house: What can I afford and if I can afford it, is this a house and neighborhood which I want to live in?

An example may help explain the process.

Take a three-bedroom house in Denver, whose owner is moving and needs to sell his house. He re-financed his house when prices were high for $200,000 (a conservative number), but the house was valued at that time at $600,000 - which everyone now realized was inflated.

Lets assume that prices have gone down by 50% which would indicate a value of $300,000.

Going back to traditional conservative lending practices where a purchaser will have to have a down-payment of at least 10% to buy a house.

Based on a 30 year loan of $270,000 at say 5 1/2%, monthly payments (interest and principal - that is an amount calculated to reduce the balance to zero after 30 years) will be $1,553 per month.

In addition as the down-payment is not 20%, the lender will require a monthly payment to cover real estate taxes and insurance on the property (commonly called an escrow payment).

On a $300,000 house this might total $2,400, bringing monthly payments up to $1,753 per month.

A purchaser would therefore need a monthly gross income of $5,840 per month to afford this loan - using the traditional yardstick where a purchaser is presumed to be able to afford spend 30% of monthly income on mortgage payments, insurance and taxes - 30% of $5,840 or $1,752. The annual salary of the purchaser would therefore have to be $70,000.

Now step back a bit. Consider the purchaser and his or her circumstances. An individual or family earning $70,000 has certain expectations of where they fit in. If the house now presumed to be priced at $300,000 meets their self-image and expectations, then they can buy the house and be satisfied. The market (supply and demand) and new lending conditions will therefore have determined that housing prices in this particular neighborhood have gone down 50% and a new value system has been put in place.

If however, the seller in this case believes that a fair price is $400,000, but potential higher-income purchasers who could afford this price do not believe that this house and neighborhood fits their image, then the value is possibly too high and prices might need to come down some before this particular market can be stabilized.

Updates to this article will be published here and at Guide To Making Money From Real Estate For Beginners .

Tags: finance, mortgage