For the most part, real estate prices have risen over the years, making it a wise investment. Real estate has a reputation as a portfolio stabilizer because of its ability to diversify your portfolio and hedge against inflation. Of course, no investment is ever a guarantee, but real estate is as sure a bet as you can find.
Are you considering real estate as an investment option? Then you’ll need to learn about the different ways you can invest in real estate.
Option 1: Purchasing income property
Income property can be a great investment vehicle. Income property is a residential or commercial unit designed to generate income, whether through renting, leasing, or price appreciation.
Renting out your property can help pay for your mortgage, taxes, and maintenance. And once the mortgage is paid, that rent then becomes profit. Additionally, the property may have appreciated over time, leaving you with a more valuable asset.
Tips on purchasing income property
Want to own income property, but don’t want to be a landlord?
Not a problem! If you want to own rental properties without the headache of being the landlord, consider a real estate investment group. These groups build or buy properties and sell the to investors as rental properties. In exchange for a portion of the monthly rent proceeds, the real estate investment group finds tenants, manages maintenance, collects rent, and handles other responsibilities.
Worried about your budget?
It’s smart of you to get ahead of the curve! When buying an investment property, the mortgage is just the first cost. You’ll also have to cover maintenance costs, unanticipated vacancies, home repairs, and other unforeseen financial obstacles. Before buying, prepare an emergency fund and make sure you could afford your mortgage without a tenant’s rent for at least three months.
Remember that being a landlord requires more than a responsibly allocated budget. You’ll also have to to interface with your tenants (or your property manager), and deal with all the potential headaches that go along with that role. Do your research so you know what to expect, or consider finding a more experienced partner who can show you the ropes.
As with anything, planning is a big part of the process. Be sure you know what you are getting into and have a contingency plan just in case.
Setting your goals
Once you have a general understanding of real estate investing, you’ll need to identify what exactly you want to do with your property.
“When starting to invest in real estate, the first thing you have to know is your goals,” explains Brian Lauchner, full-time real estate investor. Are you looking to make money this month, or this year?
“Without a vision for what your goals are, you can end up spending lots of time and money to not get very far at all,” he adds.
On a basic level, you have two choices: you can buy a property and hold it, or you can flip it.
Chris Taylor, a broker with Advantage Real Estate, says, “It’s imperative to be aware of what your own capabilities. If you’re handy and could fix up a bathroom, kitchen, etc. Great! If you’re not, don’t go into it thinking, ‘yeah I could probably figure that out.’ Too often, you’ll find that you’ve gotten yourself in over your head.”
Identify your strengths and weaknesses as well as your preferences for involvement, and identify which route will be best for you.
Buying to hold
“If you are buying to hold, you need to make sure your cash is flowing well. In my area, I use the 1% rule—if a home is purchased for $100,000, then it needs to make at least $1,000/month in rent.
If it meets this rule, then it is worth investigating further. If not, then I look for another property,” says real estate broker and investor Jamie Crouch.
She adds, “The other quick assessment used is the 50% rule. This rule assumes that the expenses associated with the property will average about 50% of the monthly rent (maintenance, management, vacancy, etc.).
If your cash flow is still positive, then it’s worth looking into further. If not, move on to the next property.”
“Also, make sure to account for property management,” explains John Horner, Founder of John Buys Houses.
He says, “Even if you want to manage the property yourself, at some point in the future you may want to pass this off to someone else, and you’ll want to make sure the numbers still work that way as well. Property management can cost anywhere from 6%-11% of gross rents.”
Buying to flip
On the other hand, here’s what you should know if you’re buying a home to renovate and flip it.
“Most people understand that there may be real estate agent commissions and closing costs to some extent, but they discount in their mind the holding and transactional expenses associated with selling a home. There are expenses when you buy and sell,” says Brian Davis, Director of Education at SparkRental.
He explains, “Some examples would be on the sale, seller concessions, prorated taxes, who is paying the title insurance, interest paid, the closing costs at the sale, and, if selling on the retail market, you may need to account for a home warranty that the seller buys for the new buyer.”
How to get started
You’ve decided whether you’re looking to hold and rent or to flip your property. From here, how should you get started? How can you invest in real estate affordably, with as little money down as possible?
Try these six strategies to lock down an income property without breaking the bank.
Strategy 1: Wholesale properties to investors
Transactional funding lets you purchase a home at the wholesale price without any money down. All you need is an end buyer who will purchase the home from you within a short time period — typically two to five days.
In this method, you’ll serve as the middle-man between a seller looking to get rid of their property, and a buyer looking to flip it.
Be sure to consult a real estate attorney before entering into a contract with a seller or selling that property to another investor. They can help you to protect your interest and maximize your profits.
Strategy 2: Turn-key rental investments
Turn-key investments are fully renovated properties that are ready to rent out immediately after purchase. Often, the seller has bought an older property and restored it. They may also offer property management services.
While this route maximizes convenience and shortens the time it will take to find a tenant, the price of entry will be higher as well.
Strategy 3: Buy as an owner-occupant
“If you are looking to flip a house, you can live in the property for two years and usually pay no taxes on the profits. This is a great strategy for those with little money,” says Mark Ferguson, real estate agent, real estate investor, and creator of Investfourmore.com.
Jeff Miller, a real estate agent at AE Home Group, adds, “Starting out in real estate investing can be expensive. If you’re looking for a way to get in with little money, consider buying a primary residence and renting out rooms.
These owner-occupant loans require very little cash down, and your tenants will pay the mortgage.”
He adds, “You can use the money you save living mortgage-free as the down payment for your next investment. If you decide that being a landlord is not for you, then you can sell the property after two years tax-free.”
This strategy works because of the federal government’s home-sale tax exemption for principal residences.
Strategy 4: Seller-financing
Seller-financing is another little-known option. Instead of getting a loan through a bank, you can make monthly payments directly to the seller.
“I wish I would have known that there are owner-financing deals out there. My partner picked up a condo with only 10% down and seller financing in place. I recently was approached on a deal where the seller would carry financing for only $5,000 down,” says Brook.
This could be a great option if you are struggling to get approved by a bank. Further, sellers may offer you a good deal to sell their property quickly. Be sure to ask your prospective seller if they’re interested in financing your purchase directly.
Strategy 5: Rent out your primary home and take out a HELOC
A HELOC is a home equity line of credit — a credit line secured by the equity in your home. If you already own property, this is a great way to make regular payments if you don’t have a lot of cash on hand. Just be sure to make your payments, or you’ll risk losing your home.
“It’s hard to get started without much money, but it can be done. One of the easiest ways to start is by leasing your current home instead of selling it when you’re ready to move. You will have to qualify for both mortgages, but that’s how many investors get started,” says Crouch.
She adds, “Most investor loans require at least 20% down, which is hard to come up with for a lot of people. As a result, many investors open a home equity line of credit (HELOC) on their personal home.
You can use this for the down payment. Just make sure you have a plan to pay it off or refi the investment home to get your money back out.”
Strategy 6: Hard money lenders
A hard money lender is a private company or investor that issues a specific type of asset-based loan financing. The borrower receives the money, and the loan is secured by the property in question.
The terms are usually steeper than those of conventional loans, offering shorter periods of time with higher interest. However, they’re also easier to get — lenders will care more about the value of the property than about your credit score.
Jen Nash of the Chief Money Instigator says, “If you want to invest quickly, go find hard money lenders. The right kind of hard money partners will review your deals. They won’t do them if they don’t think it will work, so it’s almost like having a helping hand.”
Option 2: Invest in a real estate investment trust (REIT)
If you want to invest in real estate but don’t want to be the sole owner of a property, consider investing in an REIT.
Though real estate prices have bounced around over the course of the last few years, many feel that because of its tangible nature, it is still a worthwhile investment. For this reason, one real estate investment vehicle – known as a REIT – has increased in popularity recently.
A real estate investment trust (REIT) is a corporation or trust that uses a pool of capital from investors to purchase and manage income property or mortgage loans. REITs generate returns from lease and mortgage revenue, or by selling properties that have appreciated in value. They are traded like stocks on the major exchanges and are granted special tax considerations.
There are two types of REITs: equity and mortgage.
Equity REITs earn from the rent on properties they own, as well as the capital gains for the sale of those properties. Mortgage REITs lend money to developers, earning interest on the loan. Hybrid REITs invest in property and mortgages; they earn from rent, capital gains, and interest.
The benefits of an REIT over property ownership include:
- Liquidity. They are bought and sold as easily as stock, whereas, it takes time and patience to buy and sell real estate.
- Breadth. Instead of just owning a home, you have a chance to invest in hotels, malls, and other commercial and industrial properties.
- Flexibility. You can invest as little or as much capital as you want. You won’t be tied to a specific property, and you’ll be free of landlord duties.
A REIT is a fairly safe investment because they pay dividends regardless of how the shares perform.
Option 3: Invest in a real estate operating company
Similar to REITs, real estate operating companies (REOCs) invest in real estate. However, instead of passing dividends along to investors, they reinvest their earnings into the business.
You may be asking yourself why you would want to invest and not receive a financial return. Investors in REOCs are after capital gains, not passive cash flow.
If an REOC is your real estate investment of choice, look for a high return on investment, return on equity, and return on assets, as well as a good valuation. These are strong indicators of how well a company uses its invested capital, equity, and assets to generate profit.
No matter how you’re looking to invest in real estate, the first step is to do your research. Would you rather own your own property, or invest in an REIC or an REOC? If you want your own property, are you looking to flip it or to rent it? Do you want to save money by living on the property while renting out rooms? Or would you rather take the hands-off approach and use a turn-key seller as a property manager? Once your plan is set, you’re ready to embark on real estate investment.