My wife and I have been thinking more and more about investing in real estate, and as I was researching some stuff for us, I came across this quote from Mark Twain:
“Buy land, they’re not making any more of it.”
I feel like that quote really sums up why real estate is thought to be one of the safest and most lucrative investments you can be making right now… or ever. There really is just a finite amount of land, to the point that people are paying for air rights so that they can build up when building out is no longer an option.
The thing about real estate investing for beginners compared to investing in the stock market, is that there is a higher level of difficulty for the simple reason that it takes considerably more cash to get your foot in the door.
But, with current housing market predictions, 2019 looks like it might be a good year for you to start investing in real estate if you can. So, let’s talk about some of the most popular options.
Your guide to real estate investing for beginners
Learning to invest in real estate may feel like learning a foreign language for those who are unfamiliar with market terminology. There are also so many freaking options for types of real estate, financing options, etc. – don’t get mad if you realize I’ve left something out.
To help you get a feel for some of the most popular options, I’m going to take you through some real estate investing basics.
Before anything else, think about your financial goals and how investing in real estate will help you achieve them
Real estate investors make money in a few different ways, so the type of investing you do may affect your ability to reach your financial goals. That being said, here are a few questions you’ll want to ask yourself:
- Are you trying to increase your income monthly income?
- Are you looking for investment property, as in something that you might want to sell later on to fuel your retirement?
- Is real estate investing part of a potential business venture?
Your answers to those questions will likely determine what avenue you decide to pursue, and as with any investment option, you’ll want to do even more research to fully understand how it will benefit you.
How real estate investors make money
Figuring out what we want out of buying some property has really been the biggest thing stopping us from jumping on something. It seems like there are benefits to almost all of the options – being a landlord and having extra cash on hand for investing, buying properties and flipping them for profit, or even buying some land that might one day be developed.
Each of these options has some real appeal and drawbacks, so let’s look at the ways real estate investors make money to find out more.
M$M tip: Learn how Juan is using real estate to pay off debt and reach financial independence.
Buying and flipping homes
I’m going to say that this probably is the most popular thing for newbie investors, and not because it’s the easiest, but because it’s what we’re seeing on HGTV. I know you’ve seen the shows where a couple buys a house, fixes it up, deals with some setbacks, and then still banks a ton of money all in one deal.
Before you jump on this type of real estate investing, it’s important to understand that there is a higher level of risk because you have to be very accurate in your estimates of cost vs. benefit.
Buying a house isn’t cheap either, even rundown ones, so there are some major factors you’ll want to consider before trying to flip houses.
The initial cost of the property
Before you make any money, you’ll need to spend some, but not too much. And, because this might be the biggest investment you make while flipping, it will need to be the smartest.
The rule of thumb with flipping is that you shouldn’t pay more than 70% of the after-repair value (ARV) for the home. The ARV is what you’ll be able to sell the house for after you rehab it, and you can get an idea of the ARV by looking at market comps in the area.
The amount of work that needs to be done and the cost of that work
There is a wide range of improvements that need to be done to flip a home, from cosmetic ones to structural ones, which are probably the most costly.
If a house just needs updating – paint, modern kitchen and bathroom, new flooring, etc. – that’s going to take much less capital than one that also needs a new roof, windows, electrical and plumbing work, or even foundation repairs.
If you’ve ever done home improvements before, you know that there can be any number of unexpected costs along the way – nothing like a surprise plumbing issue when replacing a faucet in your kitchen.
The point here is to be prepared for the type of work you’re able and willing to do before purchasing because underestimating the rehab will drastically affect your ROI.
Are you going to do the work or hire a team of contractors?
Being able to do your own repairs will obviously save you money, but not everyone is a Chip Gaines. Things like painting are easy, but are you qualified to do electrical work for example?
Knowing your limitations, both financially and ability wise will help you determine how much outside help you’ll need.
Your flipping timeline
The process of finding and buying a house alone takes time, so does the rehab itself, and time is money. Knowing the work that needs to be done and how hands-on you’re able to be will affect your timeline, so figure that out before thinking you’ll turn a profit in just a few months.
What about the neighborhood?
Getting to know where you’ll be buying will mitigate your risk of losing money, so the location will need to be a consideration in nearly all investment properties.
You’ll want to pay attention to things like the school district, crime rates, historical averages, etc., before understanding what your cost vs. benefit will really look like.
Investing in rental properties
Buying a home or multi-family unit to increase your cash flow has some obvious benefits, cash flow namely, but this type of real estate investing can also be good for long-term capital appreciation, which might be something you use to boost your retirement.
The power of leverage
One of the draws to rental property is leverage. That is, you don’t need to have 100% of the purchase price up front, borrowing against your income potential to fund your investment.
Leverage also allows you to potentially purchase more rental properties to increase your earnings even more. The downside is that you’ll need to be able to find renters and really understand the area you are investing in.
Purchasing rental property
Because buying a rental property is seen as a riskier investment for banks than if you were owner occupying, expect to take out a loan with an interest rate that is around 1% higher, plus expect a down payment of 20-30%.
All of that will depend on the lender you use and whether or not you will owner occupy, like in the instance of a purchasing a multi-family unit that you also live in – which can lower some of your costs.
Cash flow on rental properties
Like I said, one of the biggest draws of rental property is cash flow, which is the money going in and out of your rental, calculated by subtracting your expenses from your income. This means taking things like mortgage, taxes, insurance, repairs, reserves, etc. into consideration before seeing that cash.
Your cash flow will also depend on your ability to find and retain renters, and you’ll need to have some reserves on hand if there is a lapse in renters and also for regular and unexpected repairs. That being said, you’ll want to put some of the money you’re making on your rental property aside for those expenses.
An upside for those interested in real estate investing with a rental property is that even though interest rates are going up, buying a rental property now means you can lock in a lower rate and payment while increasing rent at renewal time to reflect overall inflation rates.
Here’s a cash flow breakdown from BiggerPockets to learn more.
Tax considerations for rental properties
Because the money you make from your rental is considered income, you will need to not just claim that income, you will also need to know what deductions you can take to lower your tax burden.
With rental properties, you can deduct your mortgage interest, property taxes, operating expenses, depreciation, and repairs. The IRS has a lot to say about taxes on rental properties, which you can read about here.
Location, location, location
I mentioned this with flipping homes, but it’s just as important to think about with rental properties. The location of your rental will affect your cash flow, property appreciation and depreciation, etc.
With any type of real estate investing, you need to know the neighborhood to understand whether or not this investment will be good for you.
Maybe the biggest consideration, do you really want to be a landlord?
I think about this one a lot when my wife and I have talked about real estate investing. I’m just not sure that I want to be a landlord. There are managerial tasks that come with being a landlord that can be time consuming, like finding renters, collecting rent, and making repairs. If that doesn’t sound like your idea of fun, then hiring a property manager might be something to consider, and it’s honestly probably what we would do.
The thing about hiring a property manager is that it lowers your rental income, but they may also make that income feel a little more passive, which would allow you to invest your time, and potentially money, into more real estate investing opportunities.
M$M tip: Want more about passive income? Read How to Make Passive Income: A Guide for Real People.
Investing in commercial real estate
I’m not going to devote too much space to this one because it probably isn’t where newbie real estate investors will start. Still, I’d be be ignoring a huge market if I left it out altogether.
The benefits to investing in commercial real estate are:
- Higher income potential than residential real estate.
- More professional rental relationships because you are dealing with businesses rather than individuals.
- You and your renters would have a similar goal – increasing the value of your investment.
- With a business having limited hours of operation, you will be less likely to get calls in the middle of the night about repairs or other issues.
- More objective pricing because dealing with businesses can alleviate emotional appeals.
The drawbacks of investing in commercial real estate are:
- If you own a larger building with more than one tenant, there will be more to manage in terms of leases and other managerial tasks.
- There is a higher level of professionalism expected, meaning you’ll want to have professionals handling emergencies and repairs, then increasing your costs.
- Because commercial rentals may be larger than residential properties, it will likely take a larger investment commitment to get started, and larger properties can also mean more costly repairs, think industrial sized HVAC systems.
- There are just more risks when you have a property that sees lots of visitors on a regular basis.
Final thoughts
What I just wrote was a very, very broad and surface look at real estate investing. I know there were some things that I left out, like real estate investment trusts (REITs), but my goal was to just scratch the surface… so don’t yell at me in the comments.
I do plan on expanding more on this, and I’m looking forward to hearing from you about your experience in real estate investing and what you’d like to learn more about.
Question for you:
Have you started investing in real estate?
Nice post. I’ve started with Reits ETF and now I am looking to got with REITs. Liquidity is something I want and doesn’t want to manage propertie on my own so REiTs are good for that but you can’t use the leverage you have with mortgage and property.
Great summary. I invested in real estate and it funds my retirement today. It took about 12 years before my real estate profits could support my lifestyle as a physician. You speak of needing a bank, but of the 5 apartment complexes I purchase, I only used a bank on one of them. I think it is the best investment available. It’s correct for you to leave out REITs in this discussion as they are not really real estate investing. REITs are stock market investing in the particular sector of real estate. The two should not be confused. They both track the same market, but they are not the same investment and they do not have similar returns. REITs are helping someone else be a real estate investor with your money and in return they will share some of the profits with you. You should be the real estate investor yourself and keep all the profits and tax advantages. I’m going to list this article on my Fawcett’s Favorites on Monday’s blog post. Thanks for providing good information.
Dr. Cory S. Fawcett
Prescription for Financial Success
Nice summary. My wife and I have also been talking a lot about this as of late.
We currently invest quite a bit into REITs now as a way to dip our toes in it.
We are currently in the same dilemma about wanting to be a landlord or not. Guess we will see.
-Chris