For many, real estate investing is unchartered territory. There are so many ways to invest in today’s world, and real estate investments is one of the best ways to diversify. People will always need a space to live, a place to rest their head, and to call home. There is a huge opportunity for real estate investors to provide that space and see financial gains in the process. There is also a potential for loss with real estate investment, IF you are not working with the right realtor, contractors, property manager, etc.
When approached smartly, real estate can be a lucrative and reliable way to generate substantial returns. Real estate investing can provide consistent income, with the opportunity to appreciate rapidly in comparison to other investing models. There are also a host of tax advantages that can be seen from real estate – (talk with your your CPA to find out how this could help you).
REAL ESTATE INVESTING -WHAT IS IT?
Purchase, ownership, lease, or sale of land and/or structures on it for the purpose of earning wealth. Real estate can be categorized as:
- Residential Real Estate: Single family homes, townhomes, condos, and multi-family homes. Multi-family homes that are larger than four units are commercial properties.
- Commercial Real Estate: Property used for a business purpose, such as office, retail, land, or multi-family (over 4-units). Examples include business offices (office), restaurants (retail), farmland (land), and large apartment buildings (multi-family).
- Industrial Real Estate: Serve an insdutrial business purpose such as warehousing, factory, power plants, or shipping.
HOW TO BUILD WEALTH THROUGH REAL ESTATE INVESTING?
1. CASH FLOW: When an investor owns a property they can create a monthly cash flow by leasing that property out for an amount greater than the mortgage. Cash flow is the reason we seek passive income-producing assets. Without cash flow, you don’t have income… meaning: you can’t quit your job without it. Here’s a look at where cash flow comes from:
- Rental amounts – (mortgage and management costs) = monthly cash flow
- Management costs –
- Mortgage Payment – principal, interest, taxes, insurance + any association dues- if applicable
- Utilities if paid by landlord
- Property management fees – if applicable
2. EQUITY CAPTURE – Equity capture is when you buy a property for less than it’s worth. For example, you buy a home in a $200K neighborhood, for $100K and put $40K into it, so you’re all in at: $140K. You just captured $60K in equity. This goes directly toward your net worth. Now, this situation is the DREAM, but there are few other investments that can create wealth so quick.
3. APPRECIATION: When you purchase a property and put money down an/or start making mortgage payments, you are building equity. By the time you decide to sell that property it will probably have appreciated quite a bit. When you sell, you will be receiving a liquid form of the equity you have built up, plus the appreciation the property has seen over the time you have owned it. The appreciation, or increase in property value over time, is essentially your profit seen when selling the property. This is one long term return, versus rents being a short term cash flow from the investment property.
4. PRINCIPAL PAY DOWN- We naturally accumulate equity in our houses as we pay off our mortgage. Even if you aren’t cash-flowing much or anything in a property, you tenants are still paying down your mortgage a bit each month, therefore adding to your equity.
5. TAX ADVANTAGES- Real estate investors pay the lowest taxes of any for-profit group in the United States. The IRS allows us to reduce our earned income tax on cash flow by taking a depreciation deduction against the house. Ask a CPA how to avoid capital gains tax when selling by using a 1031 tax exchange.
KNOW YOUR NUMBERS + INVESTMENT GOALS – Each type of real estate investment carries potential for both risk and reward. Regardless of how you decide to invest it is important to choose your investments wisely. This starts with choosing the right realtor that will help you with your due diligence- making sure it is financially sound and will meet YOUR real estate goals.
- CAP RATE – most investors want to look at a property’s cap rate to see if it is a worthwhile investment. The cap rate is essential the rate of return on the property based off sale price, monthly income, and monthly expenses. For many properties, the cap rate is higher than the going stock market rate. This makes real estate investing even more attractive (besides the opportunity to diversify investments).
WAYS TO INVEST IN REAL ESTATE:
1. RENT OUT YOUR OLD HOME
- Many start the process of real estate investing by moving into a new home, and keeping the old home to rent out. You want to be smart about this and choose a property that will rent well when you buy your first home. (Make sure that the rents are higher than the mortgage payments so that you have ‘cash flow’ or monthly income). Be aware of what is going to happen to the area up until the time you want to rent out the property and that it will still be a desirable area when that time comes.
2. ACQUIRE RENTAL PROPERTIES
- Single family, duplexes, multi-family, commercial, etc. There are many ways to buy real estate to rent or lease. When you do so, the goal is to buy a desirable property in a desirable area, so that the people/businesses renting your property, are not only paying your mortgage (if you have one), but also helping you make passive income each month. Your passive income will be what is left over from the monthly rent after your mortgage, landlord expenses, repairs, etc are covered.
- Expenses – Many don’t realize that you get to spell out what is your expense and what is the tenants. Don’t want to pay utilities, water, trash, mow, snow removal, etc? Write them into the lease as a tenant expense/responsibility. Lost keys? Maintenance needed? Write in a protocol in the lease and make sure that tenants understand it. Building these into the lease and modifying the rent price can help you take on more properties or just lessen the responsibility/time.
- Who you should know when getting into rental properties? –
- Vendors- ask your realtor for a list of good vendors, should you need maintenance work, painting, snow removal, etc.
- Property Management – If you plan to take on multiple properties or have a hectic schedule, hiring a property manager may be a smart plan. Ask your realtor for resources.
3. LIVE IN FLIP
- This option is not for the faint of heart, you have to be willing to put in some major sweat equity – and maybe be more stress-tolerant than many! 🙂 But the idea is to buy a home that is livable (able to be financed), but that would require a lot of work. Updates could be of any variety, including, updating new flooring (hardwood/carpet), painting, updating kitchens/baths, finishing a basement, building an addition, etc. Be ready to live in a construction zone for some time!
- Before choosing a property – estimate the ARV (after repair value), then a budget for remodeling. If you are handy and can do the work yourself, you will stand to make a larger profit. If you aren’t the most skilled in renovations, you will want to find a RELIABLE contractor, that will do the work on time, and well. That is not an easy feat, if you are looking to get into flips, finding the right contractors to do the work is going to be a large of your due diligence prior to buying.
- Low-risk – the main benefit of a live in flip is that it is fairly low-rick. If the numbers don’t work and you can’t sell for a profit, simply stay in the home. If you can sell for a nice profit, sell it and buy your next live in flip or a more move-in ready home.
4. FULL FLIP
- The same idea here as the live in flip, but there is more risk, since you are taking on another mortgage besides your primary residence. Just make sure to get the property for a reasonable price based on the ARV you expectations and the renovation budget you have in mind.
- Reliable contractors are even more important for flip homes, because if they are not progressing your project you are incurring holding costs while the project gets delayed.
- Having a great realtor is also imperative, they will help you find good properties (pocket listings that have yet to hit the market in many cases) as well as help you sell quickly once the flip is complete.
WHAT TO DO WITH YOUR PROCEEDS?
- Use them for a downpayment on another property, or keep as liquid cash for this purpose in the future
- Save for repairs/maintenance need should they arise in the future
- Pay down the mortgage on a property
- Put them into the stock market or some other investment
Real estate investing can be confusing at first. If you’re ready to get started, we are here to help. Contact us!