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What to consider before investing in the real estate market

Property maintenance is expensive, and tenants can be unruly. Taxes, insurance and laws pertaining to real estate can be complex. Any investor seeking a healthy profit margin will need to prepare for these potential challenges. (Paul Sakuma/AP)
3 min

Investing in real estate — specifically, buying a property with the hope that it can be sold later at a profit — has a strong appeal for lots of investors. It seems like an understandable, accessible investment and a great way to turn a profit at a time when property values are rising dramatically. However, even with prices skyrocketing, real estate is an investment with risk.

Here are a few things to consider before you make a real estate investment:

Is now the right time?

Ultimately, investing in individual properties is a speculative endeavor — a kind of high-risk investment that can result in outsized gains, or catastrophic losses. And while there are smart ways to make these investments, this is an incredibly risky time to be entering an already risky investment.

It’s no secret that the housing market is hot right now. It’s overheated, in fact. Recent data shows that home prices are setting records, particularly in highly populated areas like Washington, and inventories of available homes are at rock-bottom levels. It can be difficult to find a primary residence to own, much less to make an investment in.

What you need to be a successful real estate investor

While low interest rates have fueled a lot of this demand, they’ve also generated a lot of competition. Real estate investors are not only competing with everyday home buyers, but also corporate investors with deep pockets. With so many dollars chasing so few properties, you’ll probably pay a premium price, which dramatically curtails your potential profit margin. If the economy takes a downturn or interest rates rise, the property could depreciate for reasons entirely out of your control.

That’s to say nothing of the usual risks and costs in real estate investing. Property maintenance is expensive, and tenants can be unruly. Taxes, insurance and laws pertaining to real estate can be complex. Any investor seeking a healthy profit margin will need to prepare for these potential challenges.

Know the trends

If you’re considering an investment in real estate, now or in the future, it pays to have a good understanding of the trends that drive real estate values. For example:

· Prices: You should be aware of the historical pricing trends for any property or location. Are they increasing, or are they depressed?

· Demand: Whom is buying in your location and is demand increasing?

· Comparative sales: Are sales of similar properties being made at a faster pace?

There are a few other questions that can help you gauge a property’s value, especially if you plan to purchase a rental property. Successful real estate investors are highly knowledgeable about these trends.

· Rental trends: How many rentals are nearby, and what are they renting for?

· Future development: Will there be changes in the building or location that could make future values rise or fall?

· Occupancy rates: Are building occupancy levels increasing or decreasing?

· Interest rates: What is the outlook for interest rates and their potential impact on demand?

Don’t risk what you can’t lose

Real estate investments typically involve large sums in single properties, and the risk of huge losses is significant. For that reason, real estate only works for investors who can tolerate the volatility — both financially and emotionally. They must understand the risks involved and, in turn, have positioned themselves to withstand the potential losses.

More Mount: Should you tap into your home equity to fund your retirement?

Perhaps even more importantly, real estate investors need to have the intestinal fortitude to look long-term and push through volatility. Keeping the right mind-set is key to not letting your emotions push you into poor investment decisions.

It may be easier said than done, but patience and planning are essential. Setting realistic expectations and managing them when it comes to the appreciation of your property can help you realize profits. Even when sales are moving quickly, don’t rush and find yourself in a bad investment.

David Mount is a director with the Wise Investor Group at Robert W. Baird & Co. in Reston, Va. Baird does not provide tax, legal or real estate advice, and does not provide or service mortgages.

Read more in Real Estate:

Building your dream house or renovating? What to know about construction loans.

Is now the right time to buy a home? Three factors to consider before making an offer.

How much can you afford to pay for a home?