Many Americans are choosing to invest in houses, condos, and commercial properties, above and beyond their homes. They are purchasing property to balance their wealth against other types of investments such as stocks, bonds, and annuities. They have seen how their homes have appreciated over the past 5 or more years, and have wished that their other assets were booming like their real estate. This is as true in Hawaii as it is elsewhere.
Speaking of booms, Baby Boomers are dominating this market, according to a 2006 study by the National Association of Realtors, which includes second homes and vacation properties in the category studied. It’s only logical: as they approach retirement, many people consider real estate to be an ideal place to put their hard-earned savings for the future. The most recent figures show that 36% of properties purchased are vacation/investment properties. Real estate is unlike other types of investments. It is tangible, visible, and has enduring value. You can rent it out for income, keep it for future appreciation, or you and your friends and business associates use it as a perk. The chances of a well-researched real estate investment becoming worthless are practically nil. Besides being a solid place to stash your cash, investment property can be a status symbol. Who wouldn’t want to casually mention to an acquaintance that you are spending a week at your place on the North shore…or in Maui…or at your cabin in Oregon?
Sound intriguing? Buying investment real estate is not for everyone, but it might be right for you, and what better place than Hawaii? To make the right decision, you will need to examine your goal in purchasing.
Keep Your Eye on the Prize Some investors are looking for a small condo that they can hold onto for future value; create a home for a relative if the need arises, or use as a second home. Perhaps you are thinking of retirement, a smaller place with minimal maintenance so you can spend your time on the golf course. Until you truly examine what you want out of your investment, there is no point in selecting properties.
One of the mistakes investors make is to choose an investment form an emotional basis if they never intend to use it personally. You may love the place, but if it pencils out like a Black Hole, you will eventually fall in. So much depends on what your expectations and needs are, and your overall financial planning.
Your tax accountant or CPA needs to be consulted before you make this decision, as with all real estate decisions. Depending on your income and your financial profile, you may benefit from creating the desired cash flow: negative, even, or positive. Be sure you understand what works best for you before you finalize the financing.
Does the Cash Flow?
If you are looking for immediate and positive cash flow, you will probably need a substantial down payment into the purchase. You may be able tailor your down payment to achieve the income level you desire. Most Hawaii homes and condos do not generate positive cash flow without substantial down payment, but they are great for secure future appreciation over the long term. Houses on Oahu for example have appreciated about 400% in the past 20 years, from median prices of about $165,000 in 1987 to $665,000 as of mid-2007. Condos have gone up in the same period of time from a median around $100,000 to $325,000. Commercial properties – warehouses, office buildings, and retail centers – are also popular investments, but in short supply. They are often grabbed by big-time investors as they are generally much higher priced.
If Hawaii cash flow is not up to your standards, your other you may also want to consider purchasing a property in an area where the ratio of cost to the rent realized is more favorable. Positive cash flow is much easier to attain in locations away form the high-priced costal states and urban centers. The flip side: most of those areas do not have a history of property values appreciating like they have historically done in Hawaii! I’ll be happy to refer you to a Realtor in Texas or elsewhere if you want details!
Many people purchase investment property to replace other investments they are selling, through an Internal Revenue Code 1031 Exchange. They may be able to defer profits on the sale by repurchasing according to specific rules and a tight schedule.
How do you determine the Cash Flow for a property you are considering? It takes some research so here is a summary of the steps.
Rental Income is Crucial You will need to get a realistic idea of the income that the property can generate. Past history is the best guide, second best is finding out the income derived from similar properties. Many long-term tenants are paying rent below the current market rate, so you may need to look at average rents to come up with a reasonable figure. Your Realtor should be able to get the opinion of a professional Property Manager on what typical rents would be for a similar property. That professional will also be able to tell you what the management overhead will be to handle your property.
Sharpen Your Pencil Spend some time with your calculator, and make sure you are being realistic about the monthly cost of ownership of the property. I suggest a good way to start is by example, if you are new to this.
Ask your Realtor to help you pick out a condo that is for sale and a good buy. What have similar units been selling for in the past 6 months? Use that figure to estimate your purchase price. With the help of your mortgage lender, come up with a real-life financing figures after you deduct your desired down payment. Remember that you may need at least 20% down payment as a financing requirement, depending on the property and your credit score. Buildings with low owner-occupancy ratios, co-ops, and condotels (condos with a hotel desk in the lobby) will probably require more. Ditto studios less than 300 square feet and “lodging units” with no full kitchen (hotel rooms, in other words). Then obtain details on some of the other costs of ownership:
Typical monthly expenses:
Mortgage payment- principal and interest
Monthly maintenance fees
Property taxes, which can vary widely from unit to unit in the same building and change annually
Property management – commonly from 7 – 12% depending on services provided
Insurance - property and liability
Utilities paid by owner
Gross Excise Tax on rents collected, and Transient Occupancy Tax (for short term rentals) – unless passed on to the tenant
By deducting your monthly expenses from your rental income, you will get an estimate of your monthly cash flow.
Owning property involves other expenses which may vary, so you will need to keep reserve funds for:
Furnishings, kitchen wares, linens etc if appropriate
Cleaning – a big factor in vacation rentals
Renovations if and when needed
Advertising for tenants
Allowance for vacancies
Cap Rate- How Important Is It? Cap Rate is commonly used to value commercial and multi-family properties, but is not the definitive way to compare other types of investments. This term, short for Capitalization Rate, is merely another way to analyze your investment. It is calculated like this:
Capitalization Rate = Annual net operating income Value of property
For example, if your property nets $12,000 income annually after expenses (but before deducting your mortgage payment), and it costs $240,000, the cap rate would be 5%.
This sort of analysis rarely results in an exciting rate of return for Hawaii properties, but will make Kansas homes look like an investor’s dream. That is, until the time comes to sell and you discover that property values have declined!
If you are financing the property, as most people are, Cap Rate does not tell you what your actual return will be. Low interest rates plus other factors make real estate purchases more attractive than the cap rate may reveal. Perhaps a more important question is: What property at what value will help you attain your investment goal?
Simple Tips on Investing in Real Estate
Decide what you want out of your investment.
Don’t make an emotional decision about a property, unless you plan to live there.
Bring your calculator, notepad, and a sharp pencil, and do your homework.
Always talk to your tax specialist and financial advisor first.
Don’t buy sight-unseen unless you are a very experienced investor. Many novices fall for scams that seem too good to be true.
Short term gains or “flipping” properties is always risky. Don’t do it unless you can afford to lose.
Make sure you understand the legal rental use of the property. Many condos have a minimum rental terms, and many Bed and Breakfast operations are illegal.
Be realistic about the rent you can expect.
Hawaii law requires that you or a representative reside on the island where the property is located. Plan on hiring a professional property manager – unless you live nearby and have the time and energy for the job.
Don’t underestimate what is involved in managing your property: It’s more than just collecting the rent. There are Federal and State laws to follow, tenants to screen, rental agreements to draft, repairs to arrange, and records to keep.
Choose your tenants wisely. They are much easier to get in than pry out of your valuable property!
If you need help deciding about purchasing investment property, you may email me at firstname.lastname@example.org. or on my direct line at the office at (808) 951-3215. Whether it is for cash flow, vacation use, retirement, or future value, the right property can achieve your investment goal. Since 1986 I have assisted dozens of investors realize their Hawaii property investment dreams.
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