Whether investors own one-family rental homes or multi-unit store, office, and apartment complexes, they are operating a business. Most business experts, including the Small Business Administration (SBA), emphasize that a business plan is an essential prerequisite to the launching of any type of business. For real estate investors, the investment plan functions as their business plan.
Write a Real Estate Investment Plan
Having financial goals in writing makes real estate investing more concrete and attainable and less pie-in-the-sky. This is because organizing the relevant facts and figures helps tame the fear and reckless risk-taking that defeat individuals who fail to prepare.
To create a real estate investment plan:
- Establish personal financial goals, such as desired net worth, the amount needed for a comfortable retirement, and the amount to bequeath to loved ones.
- Set a schedule for achieving those goals, such as five years, ten years, or retirement age.
- Calculate various ways to achieve those goals – including different down-payment amounts to offer and the corresponding amounts to finance through mortgages, and making research-based estimates of the operating expenses of the properties and the rents needed to cover the expenses; this results in target cash flow amounts.
- Understand the types and quantities of property to seek based on those calculations.
- Determine how and when to dispose of the properties.
Tax professionals can suggest strategies for reaching financial goals and minimizing taxes. Investors will get more out of those consultations if they know in advance their net worth goals and cash flow needs.
Cash Flow Projection
A good real estate investment plan hinges on the determination of whether an investor wants to take out cash regularly from a property. How much cash is used to buy a property and how the debt and operating expenses are managed after the purchase affect the cash flow. The larger the down payment on a property, the smaller the mortgage payments will be and, by extention, less of the monthly rent will be devoted to the mortgage paydown.
The cash flow calculation will differ if an investor will not need to draw money from a property and instead wants to see both a good return on the initial cash outlay — the down payment — and growth in equity. In such a case, the investor may want to make a small down payment and finance as much of the purchase price as possible. This often means a small cash flow amount, which can be applied to paying down the principle on the mortgage loan. At the same time, the equity in the property will be growing because of the debt paydown, inflation, and appreciation.
Develop an Exit Strategy for Maximum Wealth Protection
The SBA advises small business owners to plan their exits from their businesses. The SBA notes that an exit involves several steps and can take several years, depending on the size of the business and the reasons for leaving it.
Similarly, real estate investors must decide when and how to dispose of properties in their portfolios, all in keeping with their investment goals. Outright sales, taking back mortgages, and 1031 property exchanges under the U.S. tax laws are some of the disposal methods, and each method triggers its own tax consequences.
The form of ownership in which property is held also must be considered. State laws have specific requirements for the dissolution of partnerships and corporations, and the appropriate tax returns must be filed. These procedures usually require sound guidance from attorneys and tax professionals.