Time to Read (using avg wpm): 14.5 mins
*Press play for a read-along*
Aaaaah, real estate. The pinnacle of tangible investments.
Nothing gets me going more than real estate — except maybe general tso chicken…
When you know the principles of real estate investing and you find deals that fit your checklist, becoming wealthy in assets and cash flow starts to feel like riding a bike.
But– there are lots of factors to real estate investing, including many different types and best practices, many different players to have in your rolodex and plenty of potential but avoidable pitfalls. This, as most introductory pieces, will be just a taste. Hopefully enough of a taste to get you excited. To get you thinking of the idea of having tangible assets under your name, adding to your monthly cash flow while simultaneously increasing in equity and asset value.
So, wipe your mouth off, try to stop salivating and open your mind to the world of real estate investing.
- Making the Case
- The Types of Investing
- The Players
- Best Practices/Potential Pitfalls
- Final Words (just getting started!)
Making the Case
As I’ve mentioned, there are many different ways of real estate investing and we will get to those in the next section. What I do want to talk about is the potential pleasantries that come with stacking your portfolio with real estate. The caveat to keep in mind is that there are many different ways to do this and still call yourself a real estate investor, so not all of the pleasantries apply to each way– but we’ll go over that.
To make the case for real estate investing, I introduce the four factors:
1. Leverage. Most of your real estate deals will involve a loan, generally from the bank. With today’s standard loans, putting 20% down and having the bank finance the rest. Do one of these deals and now you have control over the investment, with only a 20% stake. Rent it out and set up your pricing to cover the mortgage costs (along with other capital expenditures, which we will see in the next section), and suddenly you have tenants paying your mortgage for you (including the interest to the bank) increasing your equity as the loan amortizes (naturally gets paid off), all without you ever having to give the bank any of your profits. That is the beauty of real estate leveraging that you seldom find elsewhere.
2. Cash Flow. This is a factor if you charge a rent to a tenant. So here’s how your rent pricing model will generally work: You’ve got to pay the mortgage, you’ve got to pay the insurance, property taxes, management fees (either to a property management company, some dude/woman you know, or just the material costs of doing it yourself), conservatively anticipated occupancy mitigation expenses (aka ain’t no peeps renting my dang property), potentially a mortgage insurance fee (depending on your financing), advertising fees, business fees or entity fees (these last few here may not apply to you until later), and then a little extra for potential maintenance bills.
Looks daunting I know. I’ve read articles where people have said that you only have to factor in your tenants paying the mortgage and keeping the rest as cash flow… that seems a little misleading to me. These are all of the factors that you may want to consider in pricing your rent. But- as is comes down to the actual profit and cash flow you get monthly, you should always price your deals to make you some money after all the expenses are gone. It’s usually not $300 profit. It’s generally $50-100.
The enticing aspect of cash flow comes after you have a few properties in your portfolio and are getting the small profits from multiple places. Suddenly, $100 a month, with 10 properties, is $1000 a month. And don’t forget, these people are increasing your equity in the property as well. When that mortgage gets paid off, you keep those tenants and don’t sell the house, then you can talk about cash flow.
p.s. I know this is a lot for just one little section, but there’s also a great strategy to assist in your cash flow called rent increases where you increase the rent by just a little bit more than the rate of inflation, call it increasing the rent for the sake of inflation and then slowly add to your net monthly cash flow. Got this from strategy from: The Weekend Millionaire’s Real Estate Investing Program, by Mike Summey and Roger Dawson. (<<< affiliate link)
3. Tax Benefits. Starting with the big one: depreciation. You can claim depreciation on your property, in real estate this is the natural loss of value and soundness that comes with the aging of your property. You can deduct this in your taxes.
Moving on the capital gains taxes. This one mostly applies to house flipping, a method which we will get to. Capital gains is the tax on assets sold, like stocks and such. This is the same tax for selling real estate and as of July 2016 is 15-20%. This may seem like a lot to you but if you didn’t notice, on average, income taxes on the wages you work for are far higher and in the 30’s percent.
Another couple tax benefits you can take advantage of, if you are smart, are wiping out paying your capital gains taxes altogether using the 1031 exchange method or having lived in the house you are selling for at least two of the last five years.
You can also deduct costs of repairs. You can deducts wages you pay to your handymen. You can deduct materials you buy for your real estate focused home office. You can deduct your insurance premiums.
These are all ways the the government has said, okay you are helping to take care of people and providing housing for them, we’ll give you a break.
4. Appreciation. And after all of that, your property is likely to appreciate. As the price of houses go up around you and inflation plays it’s part, your property appreciates. Along with the actual land below your property still existing, while the population increases (supply stays the same and demand increases), your property appreciates. That is, the perceived value of your home goes up. This happens more often than not but you should never base a real estate deal principley on appreciation, just in case it doesn’t appreciate.
And I mean really. Put it all together.
Going at it as a landlord with renters, you’ve got people paying your mortgage for you, paying off your house, paying you some profit, you’ve figured your management costs into the rent and have property managers taking care of everything for you, so no back-breaking work, you are deducting everything under the sun and getting money back from your taxes, your equity in your house is going up from both appreciation and your renters paying off your principle, and you get to put on your business card that you are a real estate investor. Awesome.
So, let’s get into the ways of the real estate game and continue the amazing journey of investing in the most tangible assets there are.
The Types of Real Estate Investing
The Landlord Way
This is my favorite way. This, generally, includes all four real estate pleasantry factors. You buy your property, whether that be a single family home, a multiplex or an apartment complex– and then you rent it out.
- You always buy with all those factors in mind from above (in the cash flow section) with the rent you will have to charge in mind. If the rent you will have to charge is absurdly higher than the rents in the area, you may decide that buying that property is not the best idea.
You can also build a home and go this route (what I’m currently working towards, will post on that if this project becomes viable.)
You will typically keep this property in your portfolio forever and wait for the mortgage to be paid off, where it becomes a large cash flow asset.
Or, you would 1031 exchange it for another property or borrow against it, tax-free, for another property or go live in it for 2 years with the intent to sell it tax-free.
Now this small, small section on being a land lord does not do justice to all the different options and minutia and innards and I can barely even call it a taste. There will be further, more niched posts on the different styles of land lording — so have no fear.
Now into the most popular way of real estate investing:
Being a Flipper
This way requires a bit more work but is still a totally fine way to make money with real estate.
You’ve probably seen house flippers on TV and pretty much know what all of this entails. You would need to buy a beat up, broken down house, or at least one that has a vastly lower value than it could have, and then fix it up and sell it for a profit.
If you hold on to these for at least a year you can get the good capital gains tax of 15-20%, otherwise it will be taxed as regular income. You generally want to do these as quick as possible to avoid paying the mortgage (or whatever financing fee there is) and the property taxes and insurance and what not, for any longer than you have to. So generally you will be taxed on your profits at the normal income rate, unless you hold onto it for a year.
I don’t think I would ever go this route because this is more of a full-time job rather than a long term investment and you can’t really take advantage of all of the pleasantries of real estate investing, like cash flow and appreciation.
But you say, “Hey, I don’t like things that exist. I’d prefer never seeing what invest in and just worrying about it one-dimensionally.” That’s good. I know just the way for you:
Paper Real Estate
Call yourself a real estate investor without ever owning a property.
Note Buying- You can buy mortgages. Check out this article to learn more.
REITs- You can jump into a real estate investment trust, something I talked about in the stock market post here.
Wholesaling- This is pretty cool and is often used to get people who don’t have much money into the real estate market. In essence a wholesaler finds deals and gets them under contract, and then sells these deals to other investors, usually flippers. This is a great way to get started because you learn how to evaluate properties and do deals, all without ever risking too much.
You can make anywhere from $500-5000 per deal. Check out the Bigger Pockets article on wholesaling here.
Oh, and I forgot about the other way:
This particular kind of real estate investing brings in rent from businesses that are renting from you.
You would own a warehouse or a floor or a building and have a company rent it from you and pay you. There are goods and bads to this way in the form of vacancies.
If a business is renting your space then you can usually rely on them to stay in their space and make their payments — but if they leave/go out of business or you buy an empty one to begin with; you usually are going to have a long vacancy if there are no businesses moving or forming in your area.
Okay cool, that all good and nice– the pleasantries and the different ways, but how do I get into it… how do I finance?
*Press play if you are not listening to the read-along*
I’m a doggy dog real estate G
All the cats and dogs coming to me
They tell me they need a place to be
I say okay just know it ain’t free
Business is booming and everything is great
So many opportunities no need to complicate
Suddenly the the crash and that changes the state
No more easy money since 2008
Flames died down no more need for flame douses
Ain’t no market any more for any dog houses
Alright, found a niche renting condos to mouses
Now I’m thanking real estate for all my penthouses
A Real Estate G, a Rap by Doug
Thanks to The Passion Hifi for the free rap beat
End of Intermission.
Now, to financing…
There are many traditional ways of financing and there are a few creative ways. How you finance makes a huge impact on your deals, whether you keep all the money, 10%, or maybe just a lump sum.
Here are a few ways that I know of, plus some that I’ve scrounged up from all over the internet (including references of course):
Wholesaling to build up the capital
Here you use the wholesaling method, mentioned above, to start building up your nest egg while practicing and developing your real estate deal experience and skill.
For investments, the bank will usually require a 20% down payment and then loan you the rest over a 10, 15 or 30 year period at a fixed interest rate.
Short for “subject to existing financing.” This is when you make a deal with the seller to keep the loan in their name but take the title and make the payments on the loan until you can work out your own financing. Usually good for seller if they need to sell the house and good for buyer if they are unable to make a down payment.
Get a partner to help you finance! Work out some equity deal with them and share the risk and the rewards
The Lease Option
aka rent-to-own. You would lease the house/rent it for a high-ish rent for a period defined by the contract, after which you will have to buy and finance it
Borrow from IRA or whole life policy
Take from another one of your investments which could be in your individual retirement account or your whole life insurance policy
FHA loans and “house hacking”
Get a 3.5% down payment with a federal housing agency loan for a house you are planning on living in. Then live in it and share with renters. This is a popular way to finance duplexes and multiplexes, as they qualify for FHA loans and have separate housing for renters (as long as you live in them).
This is another kind of FHA loan and is usually referred to as a renovation loan. This loan you would use on a house you were planning on living in (or house hacking) that needed some renovations. Then you would get the cost of the renovation confirmed by a licensed contractor and roll those costs into the 3.5% down FHA loan.
If you are a veteran, you can get a 0% down VA loan.
Another 0% down loan, you will need to be between a certain income, on the lower side, and your property will have to be in a rural area.
Home Equity Loans and Using Collateral
You can use some of the equity in your home you have build up, using a cash-out equity loan or a home equity loan/second mortgage. You can also put up your car or a house or some property as collateral to a loan so the bank can get the collateral from you if you default on the loan. A collateral loan is also called a secured loan.
Hard Money Loan
Get some money from a private investor or loan company. Short term loans with high interest rates and only made out for asset-based loans like real estate.
Send them a check!
The world of creative financing is ever expanding and as they say, where there’s a will, there’s a way. Bigger Pockets has a creative financing forum that I’ve got linked up below where members share their creative financing ideas, so if I didn’t list enough for you, you can find more there!
Final Words (until part 2)
I don’t know if I mentioned it but I love real estate. It gets me so excited.
I mean, if you have a checklist and you have the right numbers to plug and chug, it would take a catastrophe to sour your investment. With due diligence, real estate can be one of the highest return investment strategies possible.
To bring out a quote from the 19th century by, eh… one of the richest people ever, Andrew Carnegie, who said:
“Ninety percent of all millionaires become so through owning real estate.”
So, pick your strategy, figure out your financing and once you’ve got that, go to part 2!
In part 2 we will get to:
- The Players
- Best Practices/Potential Pitfalls
- Final Words (just getting started!)
Thank you for reading/listening!
See you in part 2!
References are in part 2.
Subscribe to Average Optimized
For a reliable, weekly dose of healthy perspective and actionable tactics, subscribe!