How a Financial Advisor Can Help Me Evaluate a Real Estate Investment

Purchasing real estate can be an attractive investment. It can potentially generate rental income, appreciate over time, provide diversification, and offer certain tax advantages. But a property that looks like a great investment is not necessarily a great investment for you. 

Before purchasing an investment property, it's important to look beyond the purchase price and projected rental income. A financial advisor can help evaluate how the investment fits into your overall financial plan, including cash flow, taxes, financing, risk, and long-term goals. 

Here are some of the considerations a financial advisor can help with. 

1. Does the Property Actually Generate Enough Cash Flow?

A property's rent is only the beginning of the calculation. 

Your advisor can help you estimate the property's potential income after accounting for expenses such as: 

• Mortgage payments 

• Property taxes 

• Insurance 

• Property management fees 

• HOA fees (if applicable) 

• Maintenance and repairs 

• Utilities paid by the owner 

• Vacancy 

• Capital improvement expenses 

For example, a property generating $5,000 per month in rent isn't producing $60,000 of annual profit if it costs $55,000 a year to own and operate. Understanding the property's net cash flow provides a much clearer picture. 

2. What's My Expected Return?

Real estate investments can be evaluated using several measures. 

Your advisor may help you consider: 

• Capitalization rate (cap rate): Net operating income compared with the property's value. 

• Cash-on-cash return: Annual cash flow compared with the cash you invested. 

• Total return: Income plus potential appreciation. 

• Internal rate of return (IRR): A more comprehensive estimate that considers cash flows over the expected holding period. 

These calculations make it easier to compare a property with other opportunities. If a real estate investment requires $500,000 of your capital, for example, the relevant question is not simply whether the property will make money; it's also: What could that $500,000 potentially accomplish elsewhere? 

3. How Much Risk Am I Taking?

Real estate can feel safer than stocks because you can physically see the property. But that does not mean it's risk-free. 

Your advisor can help you consider risks such as: 

• A prolonged vacancy 

• An unexpected capital repair or expense like a roof or HVAC replacement 

• Rising insurance premiums 

• Higher property taxes or assessments 

• Problem tenants 

• Declining property values 

• Higher financing costs 

• Local economic changes 

• Natural disasters 

• Difficulty selling the property 

A useful exercise is to stress-test the investment. A Financial Advisor will make projections based on questions like: What happens if rent is 10% lower than expected? What if the property is vacant for several months? What if a $30,000 repair is needed shortly after closing? If one unexpected expense makes the investment financially uncomfortable, you may be taking more risk than you realize. 

4. How Should I Finance It?

The amount you borrow can dramatically change both potential returns and potential losses. Leverage allows you to control a larger asset with less of your own money. If the investment performs well, that can potentially improve your return on invested capital. But debt also creates a fixed obligation. 

A financial advisor can help you compare: 

• Larger vs. smaller down payments 

• Fixed vs. adjustable-rate financing 

• Paying cash vs. borrowing 

• Maintaining liquidity vs. putting more money into the property 

The lowest mortgage payment is not necessarily the best financial strategy. The goal is to find a financing structure that works with your broader financial picture. 

5. What Are the Tax Consequences?

Real estate can have significant tax implications. Depending on the investment and your circumstances, considerations could include: 

• Rental income 

• Deductible operating expenses 

• Depreciation 

• Capital gains 

• Depreciation recapture 

• Passive activity rules 

• State income taxes 

• 1031 exchanges 

A financial advisor shouldn't replace your CPA or tax attorney. Instead, the advisor can help coordinate with your tax professional so the investment is evaluated after taxes, not simply before them. That's particularly important when considering the eventual sale of the property. 

6. Am I Already Too Heavily Invested in Real Estate?

A property can be a good investment individually while still being a poor addition to your overall portfolio. Suppose you already own a valuable primary residence, commercial property through your business, and several rental properties, purchasing another property may leave a substantial percentage of your net worth dependent on one asset class, or even one geographic market. Your advisor can help evaluate real estate alongside your investment portfolio, retirement accounts, business ownership, cash reserves, debt, and commercial real estate. Diversification is not only about what you own in your brokerage account. 

7. What's My Exit Strategy?

Before buying a property, think about how you might eventually get out.  A good investment should make sense on the wayin and out. 

Ask Yourself: 

• How long do I expect to own it? 

• Who might eventually buy it? 

• How liquid is this type of property? 

• What happens if I need my capital sooner than expected? 

• What taxes could be triggered by a sale? 

• Will I want to manage this property when I'm retired? 

The Bottom Line

A financial advisor does not need to tell you whether a particular property is "good" or "bad." The advisor's value is helping you answer a more important question: Does this real estate investment improve my overall financial plan enough to justify the capital, risk, work, and lack of liquidity involved?

Sometimes the answer will be yes, sometimes another investment may make more sense. Either way, evaluating the property as part of your complete financial picture can help you make a more informed decision. 

This article is for general educational purposes and is not individualized investment, real estate, tax, legal, or financial advice. Real estate investments involve risk, can lose value, and may be illiquid. Consult appropriate financial, tax, legal, and real estate professionals regarding your circumstances.

This commentary reflects the personal opinions, viewpoints and analyses of the Lightcap Financial Group, LLC employees providing such comments, and should not be regarded as a description of advisory services provided by Lightcap Financial Group, LLC or performance returns of any Lightcap Financial Group, LLC client. The views reflected in the commentary are subject to change at any time without notice. Nothing in this commentary constitutes investment advice, performance data or any recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Lightcap Financial Group, LLC manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.