For any of those asking, "How do I get started in real estate investing?", welcome to our crash course. We're covering everything you need to know about investment real estate in order to add "successful real estate investor" to your resume and put more dollars in your pocket.
What is Investment Real Estate
Any real estate that is acquired for the sole purpose of generating income rather than primary residence is investment real estate. There are four main umbrellas of investment real estate; therefore, four avenues of untapped investing potential you need to consider.
Residential are the properties that you would be renting out to tenants. Typically this involves homes, townhouses, single-family rentals (SFRs), multi-family units, apartment buildings, vacation properties, and every other living space you can think of. Investing in residential tends to be the easiest pill for a beginning investor to swallow.
Commercial real estate encompasses all properties that will be used for business purposes including office spaces, retail storefronts, and mix-used properties (both residential and commercial). Commercial is a more expensive real estate investment than residential.
Industrial is going to be everything else: warehouses, storage facilities, and other large "special purpose structures" like breweries, campgrounds, car washes, and religious buildings.
Land for future development of subsidized and individual lots or agricultural use — growing crops, raising livestock, etc. — all fall under this umbrella of investment real estate. A lot of investors like buying land because there is no mortgage payments, utility bills, or maintenance, and low cost property insurance.
Why Invest in Real Estate?
When done right, real estate investing is hands-down one of the best ways to generate income and long-term wealth. Period. Still not convinced? Let's dive a little deeper.
Historically, real estate is one of the most dependable ways to make money due to the continued rise in population and cost of living — aside from the housing market crash of 2008. Real estate differs from other investment types in that it is the only investment asset class that can achieve income, long-term profit, and tax savings all from using someone else's money, or as our jargon nerds would call it, "leverage".
Real estate investing has the added benefit of being a physical asset that you can actually see, visit, improve, and profit from long-term appreciation and equity build. You are also protected from economic inflation because as prices rise, so does the cash flow you get from your rental.
With every opportunity, comes responsibility and risk, and getting started in real estate investing is no different. While anyone can be a real estate investor, real estate investing is not for everyone.
It requires a lot of upfront capital.
Buying property isn't budget-friendly. You'll either need plenty of savings or a mortgage from a financial institution — preferably one that invests in you, but to each their own... In addition to the property financing, you'll need a down payment, money for closing costs, and a little nest egg to cover at least six to twelve months of mortgage payments. And that is all capital required BEFORE making any repairs or renovations to make the property ready to market for tenants.
It can be time-consuming.
Researching, planning, financing, buying, selling, and fixing up real estate requires time and perseverance. Add being a landlord into the mix and it is a full-time job.
It is highly localized.
Every local real estate market is going to look different than its neighbors'. Your investment returns will vary depending on your local real estate market, which makes researching rental comps in your area that much more important.
Properties require regular maintenance and upkeep.
The risk with renting out your property is repairing anything that goes wrong, doing seasonal maintenance, and cleaning and fixing up the space between every single tenant lease. Luckily renting out the property will provide the ongoing funds needed to make these repairs, but depending on your financing decision, you will still need to make mortgage and insurance payments, and bring home a profit.
It adds liability and decreases liquidity.
Ah yes, some delicious investment real estate buzzwords. Owning a rental property increases your insurance and legal liability (fancy word for risk), while simultaneously decreasing your liquidity (fancy word for money). As the landlord, you are responsible if accidents occur in the home or if you fail to follow rental laws. The higher the liability you have, the greater the threat to your personal wealth and assets.
The opposite can be said for liquidity. The more money you put into your property — whether that be to fix it up, list it, market it, or sell it — the less money you'll have if you are in a financial bind and need quick cash.
How to Minimize Risk
With every opportunity comes risk and responsibility, but also comes ways to if not eliminate, then minimize it. Protect yourself, your property, and your money by:
Getting a thorough home inspection from a trusted individual. This could also include a walk-through with a contractor to see what repairs need to be done and how much it will cost in advance.
Consulting with a real estate attorney. They have the knowledge and experience you may lack since buying and selling homes is their passion, full-time job, and specialty.
Securing landlord insurance if you are renting out. While it may be taboo to plan for the worst, you should at least prepare for it. This type of insurance generally covers property damage, lost rental incomes, investment mistakes, and that liability piece we talked about earlier.
Having an exit strategy. (We'll touch on this more later...)
What to Know Before You Begin
Before you ask, "How do I get started in real estate investing?", you should ask, "What do I need to know before getting started in real estate investing?" It's important to realize that buying a property is not the first step in your investing journey. Not even close. There is a crazy amount of work that goes into preparation before ever signing your name on that dotted line.
Know Your Financing Options
Investing in real estate, especially for beginning investors, requires money. Lots of it. From finding to fixing, securing hefty down payments, unstable interest rates, unexpected operating costs, and monthly mortgages, knowing what your financing options are is crucial to your investing success. Choosing the wrong one could mean owing more over time, and less personal profit, or losing decision power on YOUR investment property. Talking to a lender helps narrow down those options and determining which financing option is best suited for your needs.
Pay Down Personal Debt
It is a wise decision to pay off what you owe — student loans, medical bills, credit card debt, etc. — before jumping into another venture that has those high upfront costs. Unless the return from your real estate is greater than the cost of your debt, have a margin of safety so that you don't put yourself in a situation where the cash you need to pay off debt is tied up in real estate.
Calculate Cash Flow
Knowing what money you could make off of a property before buying it is a good indicator on whether or not you should purchase that property. A way to calculate what the property's net cash flow would be is following either the 1% rule or the 50% rule. If the resulting cash flow of that property is not enough to sustain both the property itself and your livelihood, it may not be the right fit for you. Remember that cash flow can fluctuate throughout a property's lifetime and can be used as a rule of thumb AFTER purchase of the property as well, though not preferred. If you're not making positive cash flow, then the investment is not worth it.
Determine an Exit Strategy
An exit strategy influences the type of properties you seek and guides every single investment decision you make about that property. It also allows you to have a plan in place for when you need quick cash following a market turnover.
Decide What Type of Investor You'll Be: Active vs. Passive
The type of investor you choose to be will also greatly influence the type of investments you seek. If you are ready to take on the additional responsibility that comes with being a landlord (an active investor), go for it. If not (a passive investor), then hiring a property manager may be right for you. Hiring a property manager will take over those time-consuming day-to-day operations and bring in someone that has industry experience, but will cost you more than if you managed the property yourself. According to Investopedia, "Property managers typically charge between 8% and 12% of collected rents, which can really eat into profits." Ask yourself the following to decide if hiring a property manager makes financial sense for you:
- Do I have time to manage the property myself?
- How close is the rental property to my home?
- Am I willing to deal with tenants, including the unreasonable ones?
- Is my rental property for short-term or long-term tenants?
- Do you need to be in control?
Properties to Look for as a First-Time Investor
A good way to dip your toe in the water of investment real estate is to start with buying real estate investment trusts (REITs). REITs are what you get if you want to invest in commercial real estate, but not in the physical building. Operating similarly to investing in a stock, you give your money to a trust or corporation that purchases a property. And as the property appreciates, you get a proportion of the high dividends. REITs provide potentially higher total returns with lower overall risk because instead of needing an exit strategy, you can cash out and sell your shares at any time without having to worry about selling the property. REITs are also required to pay out 90% of taxable income to shareholders. One of the cons of REITs however is that they are long-term investments, so you'll need to hold on to your shares for years — a.k.a. no quick profit return.
Similar to REITs, crowdfunding platforms are passive investments popular for small-time real estate investors where you don't individually purchase the property. Instead of going through a trust or corporation, however, investors pool their assets and match with real estate developers or sponsors. Crowdfunding can be riskier than REITs since you cannot sell as easily and your ROI is more dependent on local real estate market variables.
Single-Family Homes Near An Elementary School
Families are always looking for houses in good school districts, making this a reliable property type for long-term investing. There is less tenant turnover since families with school-age children want to stay in one place longer, making them more likely to renew leases every year, even if that means rent increases. You will also make a large return down the road if you want to sell the property all together instead of renting out for that same reason: Homes in good school districts are always in demand.
Apartment Buildings Near Universities
Another property type always in demand is housing for students on or near campus. Nearly all property types: studio, one-bedroom, two-bedroom, etc., do well when within walking distance of a campus. Though you'll have higher tenant turnover, lower-income tenants, and greater reliance on referrals, finding new tenants and generating monthly cash flow will never be a problem.
Properties with Two Separate Entrances
Properties with two separate entrances have the potential to turn a smaller property into two leases. What that can look like is mother-in-law-suites, single-family homes with additional dwelling units (ADUs), or a furnished garage or basement. As long as the property meets legal building and zoning requirements, having two steady sources of income is better than one.
Hopefully, you are leaving this blog with more answers than questions, and a strong understanding that matches that strong desire to expand your investing horizons. If not, download our Investment Real Estate Guide or check out another one of Flagship's many resources:
- 7 Podcasts Commercial Real Estate Professionals are Listening To
- The Best Commercial Real Estate Investing Books
- Talk to a Lending Expert