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Investing in real estate is one of the best ways to build wealth over time as it offers outstanding returns compared to other asset classes. Residential and diversified real estate investments alone have an average ROI of 10.6%. It’s commendable and a good reason to invest in real estate.
There is no doubt that real estate is a popular investment option. It’s no surprise to see that in the past year about $617,000 new houses were sold in the United States.
This guide will walk you through all the important things that are required for you to start investing in real estate.
Why Invest in Real Estate?
Here are some reasons why it may be a good idea to invest in real estate:
- Real estate is considered a stable investment as prices tend to be less volatile than other asset classes.
- It allows you to build equity for the future.
- Real estate can be a good option to generate nearly tax-free passive income. Plus, it can also provide cash flow for retirement.
- It allows you to diversify your portfolio, thus reducing your risk.
- Real estate can be a hedge against inflation since rental income also increases when prices go up. The average inflation over the last few years is around 3.5%, whereas the rental income has increased by about 6% during the same period.
- Real estate is a reliable way to build wealth as it offers tax benefits through depreciation.
- It can be a good way to save money. Instead of keeping your money in a bank account, you can invest it in a property and sell it to enjoy higher returns.
- Real estate is easy to finance compared to other options.
- Real estate appreciates in value at a rapid pace.
- Unlike stocks or bonds, real estate is backed by a tangible asset.
According to Billionaire Andrew Carnegie, about 90 percent of millionaires created their wealth by investing in properties. Why aren’t you jumping on the bandwagon?
Types of Real Estate Investments
As an investor, you will have various options to choose from when it comes to investing in real estate. Here are the pros and cons of each option:
If you’re living in a rental property then consider buying your own.
Here are some advantages of owning a home:
- Homes provide a nest egg for the future and helps you build equity.
- Property increases in value over time.
- You will have less burden since there will be no rent to take care of.
- Owning your own house is a matter of pride.
- You can live in your property and rent parts of it, for instance, your basement or one of the rooms. Because the property is “owner-occupied” you don’t need to put a large down payment. If you play it right, you can basically live for free. This is called “house hacking“.
Here are some cons of homeownership:
- It’s a long-term commitment. Plus, you will need a good amount of money to find a suitable property.
- You will be responsible for maintenance.
If you already own a home then consider investing in a property to rent it out. You can invest in single-family homes, multi-family homes or vacation rentals. It all depends on how much money you want to invest and your investment goals.
Here are some pros and cons of doing so:
- You will receive a fixed income every year.
- There are tax benefits.
- Your property will continue to gain value.
- You can sell your property to get your hands on a good amount of cash.
Here are some cons of rental properties:
- The property may not be occupied throughout the year.
- Your investment is not as liquid as other asset classes like stocks.
If you want to enter the industry only to make money then consider this option.
House flipping includes quick buying and selling of property. Some sellers sell a house after performing renovations and some prefer to sell on an as-is basis.
The first option can be beneficial if you want to enjoy good profits. However, the second option can be more suitable if you’re in a hurry or if you were able to get the property at a lower rate.
Here are some pros of house flipping:
- You can quickly make a good amount of money.
- It will allow you to learn about the industry and gain experience which you can then use to turn into a real estate agent or to start real estate business.
However, there are also some side effects of house flipping including:
- It can often take months to find a decent buyer.
- You may have to pay a lot of taxes.
Short for Real Estate Investment Trusts, REITs can be a good option if you’re interested in investing in real estate and you don’t have a lot of cash. Here are some pros of doing so:
- REITs pay a huge part of the generated income as dividends.
- Can help diversify a portfolio.
- Make it possible for everyone to invest in real estate.
- More liquid than typical real estate investments.
- Less capital required than traditional real estate investing.
While it’s a great option, there are some cons as well:
- Taxes can be very high.
- Interest rates can have a negative impact on profitability.
Real Estate Crowdfunding
Real estate crowdfunding is similar to REITs as they are generally opened to the public on the internet. It basically allows retail investors to invest in real estate without having to buy or manage the property.
Real estate crowdfunding pros:
- Anyone can invest as an individual
- Less capital intensive
- Freedom to choose the property
- You can actually monitor the property
But here are the cons:
- Fairly illiquid
- Riskier if there is a recession
- Not as regulated as REITs
Residential vs Commercial Properties
Other than this, you must decide whether you want to invest in a commercial property or residential property. Here are some pros and cons of each:
Pros of Buying a Commercial Property
- Easier to finance
- Price may increase drastically if a big firm moves nearby
- Longer leases
Cons of Buying a Commercial Property
- Depending on the economy, it can be hard to find a tenant
Pros of Buying a Residential Property
- You can move to the property later on
- Stays occupied for a longer period since people always need a home
- You can upgrade to get more rent
Cons of Buying a Residential Property
- Can be difficult to maintain
How People Make Money in Real Estate
We have talked about the several benefits of investing in real estate and the many available options, but how does an investor make money? You will make money in two ways: appreciation and rental income.
According to the National Association of Realtors, the average annual appreciation rate is 3.7%. This means, a property worth $250,000 today will sell for about $259,250 in a year.
However, this is the average rate. Some places offer an appreciation rate of 8% and more. It largely depends on where your property is located, how big it is, what kind of amenities it has, and how well-maintained you’ve kept it.
This is why experts suggest to renovate a property so you can get more out of it when you decide to put it up for sale.
A swimming pool, for example, offers an average ROI of about 100%. Hence, if you spend $30,000 on building a new pool, it will add $60,000 to the value of your house.
Keeping this in mind, you will be able to sell the same property for $319,250 in a year. If we subtract the renovation costs, it will give you a profit of $39,250 in a year which is a pretty decent return.
Cash Flow ‘Rental Income’
Some investors choose to invest in real estate since it can offer a regular stream of money in the form of rental income. The average return on a rental property is about 8% but some good properties can offer up to 20%.
Let’s keep the $250,000 property in mind. You go out to find a tenant and rent it out for $1,500 per month. The house stays occupied for 10 months, earning you $15,000 in rental income.
Now, if you add this to $39,250 generated through appreciation, you will be earning a profit of $54,250 in a year from a single property. Imagine growing and investing in more properties.
Please keep in mind these are very simplified examples. We just want to illustrate the power of investing in real estate.
Is Real Estate Investing for You?
Technically speaking, real estate can be a good investment for anyone wanting to make money. However, if you’re still confused, here is a checklist that can help you find out if real estate is the right investment for you:
- You have holding power since real estate can take a few years to gain value.
- If you need a regular source of income.
- You understand the risks involved in real estate investing.
- You’re serious about diversifying your portfolio.
- You’re not on the lookout for a liquid asset since properties can take a few months to get sold.
- You’ve got enough money to make the purchase. This is important since financing may not be a suitable option.
- If you live in a developing area and the prices are expected to increase.
When is a Good Time to Invest in Real Estate
Most real estate investors believe that there is no such thing as ‘good or bad’ time when it comes to investing. It’s only about good or bad investments. However, to be on the safe side, you should consider investing in real estate when the market is expected to increase.
As Warren Buffett once said: “Be fearful when others are greedy and be greedy when others are fearful!”
But, when do people typically buy? According to experts, spring is the best time to sell a house since a large number of people go out looking for a house during this period.
On the other hand, if you’re looking at buying a house then January may be a good month as fewer people go out to buy a house in January. You can save about 1% by choosing the right time to buy a house.
And, when is the right time to stop renting? The best option is to find two similar houses – one for rent and one for sale – and divide the selling price by the annual rent. The resultant figure will be the rent ratio.
The average rent ratio is 15. If your resultant figure is less than 15 then it may be a good time to buy a house. On the other hand, if it is 16 or more, then it means that it is cheaper to rent than to own as owning a house will cost more when you take into account other costs such as maintenance and insurance.
Real Estate Funds and REITs
Real estate funds and REITs can be used to diversify an investment portfolio. A real estate fund is a type of ‘mutual fund‘ that mainly focuses on securities offered by public real estate firms. On the other hand, a REIT is a trust, association, or corporation that invests in real-estate. It’s traded just like stocks.
They are similar but with a few minor differences. Let’s find out:
Real Estate Funds
A real estate fund works like a mutual fund. It allows investors with little experience and funds to invest in real estate.
Depending on the broker you select, you will be able to know where your money is invested. Keep in mind that you will also have to pay a commission or fee the fund to manage the investment.
Since money is invested in a number of assets, your risk is greatly diversified. Plus, since you do not own the property, you do not need to spend a lot to have a share in the profit.
Something to keep in mind is that the majority of real estate funds are invested in commercial and corporate properties. Also, they don’t typically provide short term income like REITs do.
Real Estate Investment Trusts ‘REITs‘
REITs operate slightly differently. Investors come together to buy a share of commercial real estate and earn a profit from their shares. The income is taxable and is paid in the form of dividends.
You can choose from three main types of REITs:
- Hybrid REITs: Are a mix of mortgage and equity REITs.
- Mortgage REITs: Trade residential and commercial mortgages. A majority of income comes in the form of interest.
- Equity REITs: Own, trade and operate hard assets. A majority of income comes in the form of rent.
REITs are popular due to little to no entry barriers and ease of management. However, you will have to pay a brokerage fee. Plus, you will not be able to sell your shares in the open market.
10 Steps to Invest in Real Estate
We have broken the guide into ten steps to make it easier for you to understand the process of investing in real estate:
- What’s Your Financial Position?
- Selecting a Particular Real Estate Investing Strategy
- Choosing a Target Market
- Understanding the Investment Criteria
- Creating a Team
- Lining Up Financing
- Increasing Cash Stream For Reserves And Down Payments
- Strategizing To Find Deals
- Time Scheduling And Prioritizing Future Actions
- Selling a Property
Step 1 — What’s Your Financial Position?
The very first thing you need to figure out is where you stand financially. Consider real estate investing as a mountain and the ultimate goal to reach the peak because that’s where the real rewards are. However, you can’t magically end up on the peak even if you are financially sound. There’s a bit of grinding and strategizing involved.
So, ask yourself these questions:
- What is my financial position?
- How much am I saving?
- Do I have enough money to invest in real estate?
- How can I save more?
The more you save, the more you will be able to invest. If you aren’t financially sound right now then work on a strategy and start by:
Paying Off Your Debt First
It’s best to avoid high interest debt, but if you’re already in debt then take steps to pay it off as soon as possible.
Getting rid of your debt will take the burden off your shoulders and allow you to concentrate on your savings and investing goals.
If you are low on money then consider finding a way to increase your income, cut on expenses or both.
Try to find ways to save money so you can start putting cash aside for your real estate venture. The more money you save, the faster you will be able to start investing in real estate.
In addition to this, you should also take steps to earn more money so you can easily get rid of debt and save more to invest in real estate.
Knowing Your Investment Horizon
As stated earlier, real estate is not the most liquid asset out there. Plus, it can take years for it to gain value. If you are financially weak then real estate may not be the best option for you since you may not be able to sell it right away at a good price.
Consider your overall financial standing. Invest in real estate only if you can invest and forget about it until things change. It’s not a short-term investment strategy.
Step 2 — Selecting a Particular Real Estate Investing Strategy
We talked about the different types of real estate investments earlier in this guide. It’s important to pick one according to your financial goals.
If you want to purchase with the intent to sell: Opt for a property that has scope for improvement so you can perform upgrades and sell it at a higher price. A property that requires upgrades will ideally be cheaper to buy, hence you will get a good deal.
If you want to purchase with the intent to live: Go for a property that is ready to move to so that you do not have to spend more before you shift.
If you want to purchase with the intent to rent out: We suggest that you go for a property that has a history of being occupied. This is very important because it is not uncommon for both residential and commercial properties to stay unoccupied. Residential properties, however, are better in this regard as people will need a house no matter what.
If you want to purchase with the intent to flip: It’s best to choose a property that’s available at a discount price so you can quickly sell it at a higher price.
You’ll need to be in constant touch with agents and keep an eye on real estate ads to ensure you never miss out on a good opportunity.
Most people sell at a discounted price when they are in a financial mess. You can move to sell it on an as-is basis at the actual market rate or perform upgrades before putting it up for sale.
We should also mention that you can use a single property for multiple purposes. For example, you can buy a house, live in it for a few months, rent it out, and then sell it when you find a good buyer.
Other than this, decide between residential and commercial properties:
- Residential Properties: Include houses, condos, villas, vacation homes, etc.
- Commercial Properties: Include warehouses, offices, stores, malls, and industrial parks.
Step 3 — Choosing a Target Market
One of the biggest dilemmas faced by investors is to choose a target market. Some think of investing locally, close to their homes while some think of investing abroad.
Local vs International — Should I Invest In My Own Country Or Abroad: This depends on how much money you have and how easy it is to buy a property abroad.
It is best to find properties locally if you are working alone and it is your first time investing in real estate. You can, however, move to different cities or states within your country. Different states have different appreciation rates and prices.
On the other hand, foreign properties can be beneficial as well but they can be hard to manage. You will have to take care of the paperwork and hire an agent to represent you.
There are some growing markets with a lot of potential. If you think you can handle the process then go ahead and invest in foreign countries but make sure to remember the impact on taxes.
Step 4 — Understanding The Investment Criteria
Next up is creating a written investment profile to outline your criteria. The idea is to share it with potential buyers, investors, partners, and real estate agents and ask for input.
It should be written with two things in mind.
- Target Property
- Target Terms
Target Property: It involves choosing a niche within the market. Highlight which property you want to invest in and why.
For example, if you want to buy an office then highlight that you’re investing in a commercial property with the intent to rent.
Target Terms: It involves running the numbers and figuring out if a certain deal works for you or not. If it does, then you can send a proposal to get the property under contract.
For example, the 1% rule can help you calculate if a property is worth buying.
The 1% Rule: It says the monthly rent must greater than or equal to 1% of the total purchase price of an investment property
Moreover, this section should highlight what you’re aiming for. For example, your target can be to earn $50,000 in a year. The person you present your idea to, will evaluate and analyze the property and conclude if it’s worth investing in it or not.
Some popular methods to evaluate a real estate investment are:
- Net Operating Income
- Net Rental Yield
- Gross Rent Multiplier
- Cash Flow of a Rental Property
- Gross Potential Income
- Gross Operating Income
- Depreciation in the Value of a Rental Property
- Breakeven Ratio of Rental Property
Different agents use different techniques to determine the expected income. You can also perform these calculations on your own if you do not want to get a professional involved.
Step 5 — Creating a Team
You cannot possibly handle real estate investment matters on your own, you’ll need a team. A team of viable advisors and contractors. Here’s a list of the people that can make up for a great team:
Close Team Members:
This can include your spouse, business partner and personal advisors. These people are the ones who get to know everything about your investment plans.
This involves taking the support of a property manager, real estate attorney, CPA, lenders, etc.
The point is to create a team that could support and advise you on deals before you finalize them.
The supporting members play a vital role in this because they are the bearers of technical information.
Step 6 — Lining Up Financing
Now’s the time to ready your finances and take the first step but what if you’re low on capital? In that case, you can turn to financing options such as:
- FHA (Federal Housing Administration) Loans: While it’s not the best idea to go for a loan, it may work for you. FHA loans are government-insured loans that are easy to apply for thanks to simple terms. It involves a small down payment and a fixed interest rate. It’s a long-term loan which can easily be paid off.
- VA (Veterans Administration) Loans: This loan is for veterans and is given at 0% down payment, fixed interest rate.
- Conforming Loans: This loan can include a 5% — 20% down payment and a fixed interest rate.
- Seller Financing: One of the best financing options out there. It involves a seller that has equity and is willing to allow you to buy a real estate property and pay in regular installments.
Make sure to take input of your advisors and mentors before choosing an option.
Step 7 — Increasing Cash Stream For Reserves And Down Payments
The cash you require depends on how expensive the property is.
Ways To Increase Cash: There are a few effective ways that can help increase your cash stream such as:
- Selling: Raise funds by selling things and valuables that are not in your use anymore.
- Borrow: You can turn to a friend or a person who can lend you money to purchase a property. This option is far better than taking personal bank loans because of the collateral and huge interest rates involved.
- Partnership: It’s about seeking a trustworthy partner who can partner up with you and divide the expenses on an agreed ratio. However, you will have to divide the profits as well.
Step 8 — Strategize To Find Deals
This is the most important part because here’s where the real work begins. You won’t get to come across good deals while sitting idle. In fact, you will need to go on a treasure hunt to find the best deals possible.
Work With Agents: Work with agents who have access to a lot of properties. Let the agent know your budget and goals and he or she will find you deals. Keep in mind that real estate agents charge a commission (i.e. between 1% to 5%) to help you find and close a deal.
Check Online: There are various websites like Realtor and Zoocasa where you can feed your requirements and choose from available options.
Use Mobile Apps: Mobile apps like Realtor allow you to get quick access to available deals.
Other than this, you can find deals through social media, personal contacts, and listings.
Step 9 — Time Scheduling And Prioritizing Future Actions
Stay organized at all times. Here’s what you need to focus on:
- Future actions
Most people who love to invest are knee-deep busy in their jobs or businesses. Investing is not a full-time business. Most of us do it to make quick cash and change our fortune, which is also why you should only invest the money you can afford to lose.
Investing may sound like an easy thing to do, it requires a lot of time. Searching for properties, visiting the property can take a lot of time.
You may even lose some good deals if you do not plan properly. This is why it is important to plan. Here are some good solutions:
- Work with a partner and divide the duties. This will reduce your burden and ensure you do not miss out on good deals.
- Hire a manager to help you manage things but it may be profitable only after your business starts to give returns.
- Trust the experiences of your real estate agent.
- Work on the weekends.
Do Not Forget the Importance of an Emergency Fund
Build an emergency fund and count on it to bring you out of trouble if you ever need money for your investment property.
Professional property managers suggest putting aside 10% of your monthly rental income in an emergency fund.
Step 10 — Selling a Property
Selling is a huge part of investing. You will not make a decent profit until you have sold the property.
The most important thing is timing. Know when to sell a property. It’s best to start with a goal. For example, you can invest in a property with the goal to sell it at a 10% profit.
The goal should depend on market conditions and other such factors. Get rid of the property once it gives you the required returns, and invest the money elsewhere to start the circle one more time.
Other than timing, think if you want to sell the property as-is or after repairs. Both options have their own benefits as certain repairs and changes may offer you very high returns.
Important FAQs Related To Real Estate Investing
We have found some of the most important questions with regards to investing in real estate. Here are our answers.
How Much Money Do I Need to Invest in Real Estate?
The idea is to start slow if you’re a beginner. Look for smaller projects if you are doubtful. This is important even if you have a lot of money at your disposal. Understand how the business works before you go big.
Of course, the more money you invest, the more profit you will make but the key lies in not being greedy.
If you are willing to invest in a big project then consider seeking professional help. As a beginner, it may be a good idea to invest in real estate through real estate funds and REITs.
Can I Lose My Money?
You can if you are not careful. You expect the prices to go up but that may not always happen. Prices may go down due to a variety of reasons including changing market conditions, political changes, etc.
These are the factors that you cannot control, hence you cannot always predict where the market will be. However, the good thing about real estate is the fact that it always bounces back.
If you can hold on to a property when it’s down, you will eventually make a profit but it may be a while before that happens.
What Kind of Fees do Brokerage Charge?
Some charge a flat fee while some will charge a commission. It is best to go through the policies before you sign on the dotted line as there might be miscellaneous charges as well.
What is the Best Way to Find a Good Deal?
You can turn to real estate buying/selling apps. They make your life much easier. There are several apps that show properties “For sale”. These apps can show you condos, apartments, schools, etc.
The apps will allow you to find multiple photos, maps, and a way to contact the real estate agent dealing with the property.
Are Real Estate Funds a Good Investment?
Real estate funds can be a great idea if you do not know much about real estate. You don’t need to be a professional or have a lot of capital to get started.
Should I Sell a Property or Rent it Out?
It depends on your goals. We suggest you to rent out a property until it increases in value so you can then sell it to make a good profit.
Renting can be a good option if you want a reliable running source of income. You will receive a fixed amount of money every month which you can use to pay bills.
How Much Commission Do Agents Charge?
It depends on the Agent, some will charge as low as 0.5% and some as high as 5%. It might be a good idea to negotiate the commission as many agents are willing to accept a lower fee, especially if you are interested in both buying and selling a property at the same time.
What Kind of Property Should I Buy?
It depends on your needs. Think about why you want to buy a property. If you want to live in it then you will have fewer options, however, if you want to sell it later then you may have a bigger pool of options to choose from.
All types of properties have their own pros and cons. Study the market and see what works for you.
We hope that this guide will help you make the right investment decision. Real estate is the right investment option for everyone. While you need a big amount of money to invest in properties, the availability of funds makes it possible for all people to benefit from the growing market.
Be careful and take all buying and selling decisions after much deliberation and you will have reasons to rejoice.
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Ricardo is an entrepreneur, investor and personal finance nerd who enjoys spending time with his family and friends, travelling and helping others achieve their financial goals. Ricardo has been quoted as a personal finance expert in several online publications including Healthline, Bankrate, GOBankingRates, MSN Money, Yahoo Finance, U.S. News & World Report, Forbes and USA Today.