A common mistake that many investors make begins with the misconception that all real estate can be a smart investment.  In truth, the only real estate investment that is good is the one that achieves the goals that you define.

Before you purchase your first property, you need to understand what you are trying to achieve with this investment.  Typically an investment goal is defined as “I want to make x percent on the money I have invested in y period of time.” 

It’s Not all about Cash
Many people mistake the word “investor” with the word “wealthy”.  Actually, being a residential real estate investor has very little to do with how much cash you have on hand.  Being an investor has to do with setting realistic strategic goals and actually achieving those goals.  The cash part comes after a few successes. 

Often, you can overcome a lack of cash with time. For example, some of the best investors start with the properties they live in.  When they buy a house to live in, they consider what the future rental market will be for that property.  Then they live in that house for a period of time and eventually convert it over to a rental property and buy another house.  After enough years, they have had renters in their homes paying off the mortgage (which is fixed over the 30 years) but slowly generating more and more income each month based on the increases in rental income.  By the time they are ready to retire, they are exceedingly wealthy.  They can either keep the homes and enjoy the monthly rental income, or sell of the properties at a significant profit.

Start with Timing
Let’s say you invested $100,000 into a property, had all of your costs covered during the holding period, and then sold it for $500,000.  That’s a $400,000 profit which is great, right?  Well, that really depends on how long you had the property.  If you bought the property when you were 20 and sold it when you were 80 years old, that would be $400,000 divided by 60 years, for a net annual return of $6,666,67.  That translates into an annual profit of 6.67%.  That’s still not bad, but it a far cry from the initial wow factor that just talking about the purchase and sales price gave you.

Before you can determine a good investment strategy, you first need to understand when you intend to exit from your investments.  This will help narrow down your investment strategy choices, and define whether the strategies you select really can achieve the goals you need from your real estate investments.

Calculating the Percentages
Let’s say last year you made $100,000 in total income from your real estate investments.  Seems like a high number, right?  Well, if you started with $100,000, you would have effectively doubled your money which is truly an excellent percentage return.  However, if you started with $10 million, your return is very low at only 1%.

Calculating your return needs to be measured by the amount of money you invested (cash) relative to the amount of money you earn (profit). In an average market, typical returns on stocks range from 5 – 10 percent.  For residential real estate, calculating your profit is a little trickier.  Your profit on a rental home, for example, includes monthly cash earned above the cost of maintaining the home, tax benefits (including depreciation), and net equity growth over the period of time that you hold the property.

So let’s say you invested $50,000 in a property and you get the following:

• $400 per month positive cash flow
• $7,000 total tax savings based on depreciation, mortgage interest, and property taxes
• $10,000 per year net equity growth

Your total annual percentage return is (($400 x 12) + $7,000 + $10,000) / $50,000 = 43.6%.  That’s a great return.

Setting Your Short and Long Term Goals
Typically with real estate investments you get two periods that you calculate your return from – the short term (monthly or annually) and the long term (usually achieved at the sale of the property through equity growth).  However, these two goals can sometimes be mutually exclusive.  If you are looking for a short term that maximizes your monthly income, typically you will not be able to increase your volume of holdings significantly enough to generate a lot of long term growth.  On the other side, if you are more interested in the long term growth and are willing to have a break even for the short term goals, you can maximize your volume and achieve significantly higher equity positions. 

For most investors, it is some combination of the short and long term gains that ultimately provides the best strategy.

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