Although investing in real estate is as secure and sometimes more secure than investing in stocks or bonds, and even though real estate investments often offer larger returns, investing in real estate is always a bit of a gamble. Housing bubbles inflate, deflate, and occasionally burst.

As a real estate investor or someone who's interested in investing in real estate, you should be well aware of the risks and calculate a high enough profit into the deal when you purchase the property to protect you from any unforeseen fluctuations in the housing market.

Whenever I purchase an investment property, I use the 20% rule. I purchase the property for a price that ensures I will walk away with a 20% profit when I sell it. To calculate the maximum price I am willing to pay, I estimate a realistic sales price after repairs and renovations and then work backward:

§ Estimate a realistic sales price after repairs and renovations based on recent sales prices of comparable properties.

§ Multiply the realistic sale price by one of the following:

• .80 in a strong market.
• .70 to .75 in a steady market.
• .65 to .75 in a slow or declining market.

§ Subtract the estimated costs of repairs and renovations. Subtract another 20% for unexpected cost overruns.

§ Subtract holding costs (property tax, insurance, loan payments, and utilities). I generally subtract $100/day for 90 days ($9,000), because my crew can usually repair, renovate, and sell a home in 3 months.

§ Subtract closing costs at time of purchase and time of sale.

§ Subtract real estate agent commissions.

The result shows you how much you can afford to offer for a property to be fairly sure you will see a 20% profit when you sell it.