Man sitting at desk working on a calculator  Purchasing real estate is a common process. First, you use a realtor to help you find the right home, then you organize your finances, go to the attorney and finally, close the deal. We have all been there at one time or another. However, building an investment portfolio through property acquisition is a longer term proposition, so here is a little insight from our own experience that can help you build property wealth in Charleston SC.

There are a number of good real estate investment resources available on the internet. Even seasoned investors use them frequently because there are as many ways to achieve a sizable portfolio as there are investors seeking that goal. For us though, there is nothing more motivating than understanding a practical example, within our Charleston market, and something we could achieve ourselves.  

We are currently developing 3 short-term rental projects, with 9 houses in total. What you aim for here is twofold: 1) a healthy cash flow and 2) building equity.

Healthy cash flow can be defined a number of ways and is not necessarily the highest cash flow you can get. Stability has its advantages, so does tenant turnover and maintenance costs. What you seek is more hard cash steadily coming in to the project than the cost of the capital necessary to purchase it. It’s called Debt Service Coverage Ratio (DSCR) and for now all you need to know is to aim for above 1.2 preferably nearer 1.5 (that 1.5 DSCR will save you in a downturn!).

Equity is the second element in your investment arsenal. You can build that by buying carefully, having cash and good credit on hand to take advantage of opportunities, rehabbing a derelict property or new construction. All these will build wealth from sources other than your bank balance.

Now, lets assume you are going to build wealth by either a major rehab or new-build on an empty lot. Your acumen resulted in a property valued say 20% more than the cost of getting there (in a new build 10-20% is typical). Let’s assume also that your intended end use is rental and your model shows that the income will satisfy your bank’s criteria for lending. This is where the effects of time need to be used to your advantage.

Most local banks will support a construction loan on the basis of Loan to Cost (LTC). For example, you can calculate LTC as the following:

  • Cost of land + construction = Estimated $500,000
  • Final appraised value of the project = $600,000
  • Bank will lend (say) 70% LTC = $350,000
  • Your equity needed $500K – $350K = $150K (this will be spent before the bank will begin funding the remainder)

Say you build your investment over 9 months, attract the renters of whatever category you feel works (long term, monthly, short term) and operate the property for at least one full tax year (preferably 3 yrs). At this point you own a stabilized asset with an operating history. You now go back to the same bank and discuss remortgaging. In this example the bank lends on the basis of Loan to Value (LTV). You can calculate this as the following:

  • Value of the property = $600,000 x 1.05 x 1.05 X 1.05= $695,000 (assuming 5% property inflation which is conservative in the current Charleston market)
  • Bank will lend 70% LTV = $486,000
  • Your equity = $150,000 – ($486,000 – $350,000) = $14,000

So changing from a LTC basis to LTV plus inflation has returned almost all of your initial cash outlay. You own a cash flowing property where the rental income is paying your mortgage in full. In addition to that, any increase in the property value (or loss) is 100% yours. Having a sizable equity stake and a healthy DSCR will mean additional cash in-hand to cover maintenance and those little things that make life all worthwhile. The key takeaway here should be that in this model, which we believe is the right strategy for our own investment goals, the wealth is built up over time. This is not a “get rich quick ” play that can sometimes be misrepresented by others who have built wealth through real estate investing.

Note: As seasoned investors ourselves, we can help you buy, rehab, build and manage investment property in Charleston or on the surrounding barrier islands. Want to learn more when it comes to real estate investing? Download our free “Guide to Investment Terms used in Real Estate. ”  Happy reading! 

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