Why Real Estate Investing?
What makes Real Estate a good investment? Well the first clue is in the name “REAL”. Investing in something that has a real value and a history of appreciating is always a good way to go. Yes, from time to time real estate markets have suffered pull backs but overall real estate is continually appreciating. You can increase your net worth just by waiting.
According to Zillow, national real estate prices have increased by 3% to 5% annually over time. What does that mean to you?
If you purchase a property for $100,000.00 today and assume a 5% annual appreciation, then in 5 years your investment would be worth $121,550.00. In 10 years it would be worth $162,889.50. In 20 years it would be worth $265,329.80. I think you can see how the appreciation value of real estate can may you rich just by waiting.
Although real estate can go down in value due to changes in cities, neighborhoods and the general economy it rarely experiences “flash crashes” like you can see in other investments such as the stock market, bonds, futures and now crypto currencies. Real estate has stood the test of time.
Real estate is an investment that also gives you the ability to leverage your investments if you are building a rental portfolio. What do I mean by that?
Look at it this way. If you purchased a $100,000.00 property and can rent it for $2,000.00 per month. To make this simple, let’s assume that there are no other expenses such as repairs, insurance, property manager, etc…
In the example above you are getting about $24,000.00 a year in rent or a 24% return on your investment of $100,000.00. 24% is very good, but you can do better using leverage.
Let’s assume that you paid $20,000.00 down to buy the property and financed $80,000.00 over 30 years at an annual rate of 4.5%. Your monthly payment is $405.35. Let’s take your monthly rental amount of $2,000.00 and subtract your monthly payment of $405.35. That leaves you with $1,594.65 or $19,135.80 per year instead of $24,000.00 per year. However, your investment is only $20,000.00 instead of $100,000.00 so your new return on invested capital is now 95.7% ($19,135.80/$20,000.00)! That is the power of leverage and real estate is one of the only investment vehicles that give you that option.
Now, I don’t want to paid too bright of a picture for you, remember I did leave out ALL expenses in both my examples. I just wanted to show you the power of leverage when investing in rental property.
This is just one reason of why real estate is a good investment.
Stable Income Return.
This applies primarily rental property investments as a way how to invest in real estate. As noted above you can invest your funds in real estate with or without using leverage and expect a relatively stable month to month income after your expenses.
Another advantage to this stable income is that your bank payment will stay the same, assuming you used a fixed rate mortgage instead of a variable one which I highly recommend, while your monthly rental amount should go up. Even if you are in a market which has a fixed 2% rent increase per year, your $2,000.00 per month could grow to $2,208.16 in 5 years and jump to $2,437.98 in 10 years. You will be making more money and getting a higher return on your initial investment JUST BY WAITING.
Not my favorite reason, I actually prefer real estate investing as my main portfolio investment. Real estate normally holds or increases in value even when other asset classes are going down. The biggest problem and with a buy and hold real estate rental property investment strategy is it is not a liquid investment. Selling real estate and converting it to another type of asset such as cash can be difficult sometimes, especially in a falling economy.
You might be able to borrow against the equity in your real estate portfolio depending on how leveraged you are. That would give you a quicker cash option as opposed to selling while letting you keep the asset. However, it would reduce your overall return. You just have to do the math and see what you think.
There is a positive relationship between GDP growth and demand for real estate. As the economy improves the value of your real estate and the rents you can charge typically to up at a faster rate than any inflation in the general economy. Of course, runaway inflation could make it impossible for your tenants to survive in an extremely volatile rental market.
Does Real Estate Investing Work?
That is really the question isn’t it?
During my research I have found that about 90% of the world’s millionaires created their wealth in real estate! That is an astounding number. I think that alone tells you all you need to know about whether or not real estate works. If 90% of the richest people in the world say real estate investment strategies work, then they work!
How do you find the best deals in Real Estate
This is really the most important section or at least the one that makes everything else possible in this entire article.
Finding the best deals will allow you to be profitable even if you make other mistakes most of the time. It will certainly make it easier for you to get out of a property if you need to if nothing else and gives you the ability to become a wholesaler which I discuss below.
Let’s start with the Multiple Listing Service (MLS). That is the place most people start when looking for a property to buy. Yes you can find some good deals here but they are rare and difficult to get to before the other investors. Everyone scans the MLS. Everyone is looking for a good deal. You might be able to find an acceptable rental property on the MLS but finding one to flip or wholesale is extremely difficult.
Wholesalers are a very good and convenient option especially if you are looking for a rental home. They already have a network set up to find the best deals and can save you a lot of work and time. As a flipper you can also find some deals with wholesalers especially if you are looking for home that you can fix up and sell for over $100,000.00. Wholesaler fees vary and are usually between $2,000.00 to $10,000.00 so the higher the price the house will eventually sell for the lower the overall percentage you have to pay to a wholesaler is.
If you purchase a home you can sell for $50,000.00 from a wholesaler for $2,000.00 then their fee is only 4%
If you purchase a home you can sell for $100,000.00 from a wholesaler for $2,000.00 then their fee is only 2%.
I highly recommend using a wholesaler if you are starting out. If nothing else it will give you an idea of the kind of deals that are out there.
Below are some other ways and ones that are most likely to be used by the wholesalers themselves.
You can use a direct mailing campaign in your target area offering to buy their homes cash. You are looking for motivated sellers that need to sell fast and will give you a discount for buying their house ‘as-is’.
You can put up ‘bandit’ signs. You have seen them. Signs like “We buy houses” or “We Buy Ugly Houses” or “We buy houses for Cash”. You get the picture.
You can drive around your target area and look for homes that are run down. Then either mail them a letter, put a flyer on their door or go knock on the door and tell them you are an investor and want to know if they want to sell their house. This is not my favorite but they say fortune favors the bold.
You can run advertisements in the newspaper, Craigslist or something like that saying you buy houses for cash with a fast closing.
Use your social media contacts to help you find a potential target house.
You can look for houses that have for rent signs and call the owner to see if they want to sell the house. You would be surprised by how many investors would like to get out of owning investment properties. Most of these only own one or maybe two houses and have not taken the time to learn the proper ways to manage a rental portfolio.
There are lots of other ways, just use your imagination and you will be surprised where it leads you.
How to Invest in Single Family Home Rental Properties.
One key when looking for rental properties is to remember you are not necessarily looking for a house you want to live in. You are looking for a house that will be of interest to the greatest number of renters in your area. What that number is depends on where you live. Obviously the mean rental rates in New York City are much higher than Huntsville, Alabama.
In addition to finding rental properties that are in the income range of the majority of the renters in your area you typically want to find properties that are in stable safe neighborhoods that are on the rise. Wanting stable safe neighborhoods with above average schools is a no brainer but a lot of people miss the trying to find neighborhoods on the rise. If you are able to find neighborhoods where the value of the homes is increasing or likely to increase you create built in appreciation on steroids.
What do I mean by that? Well as I stated earlier if real estate normally appreciates at about 5% if you find the ‘right’ neighborhood you could see that jump to 10% per year or more! What would it mean to you if you purchased a property today for $100,000.00 and it appreciated by 10% instead of 5% per year over the next 5 years? At 5% your property would be worth $127,628.20, at 10% it would be worth $161,051.00 in 5 years.
Besides the obvious increase in your net worth by $33,423.00 in selecting the right neighborhood over a normal neighbor, I want you to look at this from a leverage standpoint.
If you were able to purchase the $100,000.00 home for 80% down or $80,000.00 your initial investment would be about $20,000.00. If you wanted to refinance after 5 years to pull out your investment you would probably only be able to refinance up to 70% of the value of the home. So if you only had the 5% appreciation you would be able to refinance up $89,339.60 which would give you back $9,339.60 of your initial $20,000.00 investment after 5 years.
If you found a 10% appreciation house, you would be able to refinance $112,735.70! This would give you back your initial $20,000.00 investment PLUS another $12,735.70! That is why you should never EVER forget to look for those up and coming neighborhoods. Too many rental property investors forget that key point.
As I keep mentioning, investment in rental properties is a GREAT way to build your wealth and diversify your portfolio. I am a firm believer that the best way to be successful with rental properties is to purchase the properties using as little of your money as possible, or to get it back as above.
The temporary exception to using as little money of your own money as possible is purchasing properties at an auction or where you get a substantial discount for paying cash. However, in these cases I would typically finance the house once it had seasoned (waiting period before a bank will finance a house that you paid cash form). Using this method it is possible you might be able to finance close 90%, 100% or even more of what you actually paid for the house, but it might take six to twelve months to get your initial investment back out of it.
Here is an example. Let’s say you find a house that at a foreclosure auction. You do your due diligence and determine that the house needs about $10,000.00 in repairs and the estimated value of the home after repairs is $70,000.00. You set your maximum auction price at $30,000.00 (we will assume that includes closing for this example) and you win the auction.
After you do your $10,000.00 in repairs you have $40,000.00 invested in the house. You are able to rent it for $700.00 per month. That gives you a rental gross income of $8,400.00 per year excluding expenses. Right now you have a return of 21% (8,400/40,000). Not awesome but not bad either.
However this is where purchasing the house a way below market value helps you. In about six to twelve months you can finance the house. If the house appraises at $70,000.00 and the bank will let you borrow 70% of that value you will be getting $49,000.00 in cash. That is $9,000.00 more than you paid in plus you still have the property.
Assuming you get a 30 year loan at 5% then your monthly payments on $49,000.00 will be $263.04 per month. You are renting the house for $700.00 per month which will now be $436.96 to you after you make the mortgage payment. Again, here is the magic … you have $0.00 of your own money in the house, in fact you got back $9,000.00 that you can use on your next purchase.
Do not worry if you are not interested in going the auction route, there are still good deals out there when looking for rental property investments.
How Much do your Charge for Rent and what Makes a Good Rental House?
Here are some things I look for when selecting a good property to consider as a rental property. These are in no particular order.
- Is the rent I can charge at the amount I can attract the greatest number of renters? If you live in an area that has a mean income of $50,000.00 per household you do not want to purchase rental homes that will rent for $3,000.00 per month. Those might be great houses but you are limiting your number of renters.
- What kind of rent can I charge versus the value of the house? Just as a very quick way to look at this, in my area a good price for a rental house that will be available to the greatest number of potential renters in my area is about $65,000.00. I know what most of my expenses will be and I have determined that if I can rent houses in this price range for about 1% of their value I will do pretty good. In this example of a $65,000.00 house I would need to rent it for 1% or $650.00 per month. A $70,000.00 would rent for about $700.00 month. I have noticed in my area that this does not hold true as the price of the house increases. In my area a $200,000.00 house only rents for about $1,650.00 or .8% which does not give me the return on investment I need.
- Are the schools at least average?
- Is the neighborhood safe? If I am afraid to go there after dark then it is doubtful I will be able to get quality renters.
- Can I purchase the house with minimal investment on my part? Remember the less money you put into the house the more the return on your investment will be. Purchasing cheap at auction is an exception because I know in about a year I can get most or all of my initial investment back out of it.
- Does it have a swimming pool? NO SWIMMING POOLS!
How to Invest in Multi-Family Rental Properties.
The advantage of multi family rental property investment is you get a larger gross income for the initial investment.
Example. If you had $200,000.00 to invest you might have two options?
- Purchase one single family home for $200,000.00 and rent if for $2,000.00 per month or $24,000.00 per year for a 12% return assuming you paid cash.
- Purchase a quadraplex (4 unit) building for $200,000.00 and rent the units out at $700.00 per month per unit or $2,800.00 total. Your gross would be $33,600.00 per year for a 16.8% return assuming you paid cash.
There are some disadvantages to multi-family rental properties.
- They are typically harder to resell. Single family homes are the easiest to sell if you decide to get out.
- You may have fewer finance options as compared to a single family rental property. As long as you do not get to the commercial rental properties (more than 4 units) it is not too bad but keep it in mind.
- They can appreciate REALLY fast if you get a good deal in a good area or they can be stagnant. You probably would not lose value but they do not always appreciate as well as single family homes. Some of this depends on your area, some larger cities can see explosive appreciate if you picked the right area.
To me the biggest drawback is the difficulty you can have if you need to sell in a hurry. In smaller towns I would stay with single family homes. In larger cities it might be beneficial to take a close look at multi family investment properties.
What is Real Estate Wholesaling?
Whether you are wholesaling investment properties or wholesaling to a flipper, wholesaling is a great way to get started in real estate investing; especially if you have limited funds.
So, what is real estate wholesaling? Simply put you do what I consider the hard part, you find the deals. Once you find a deal you either get it under contract (or option) for a specific period of time. Try to get at least 14 days.
[If you have a good investor that you trust, you could skip the getting the home under contract part and simply introduce your investor to your find for a finder’s fee. Typically this would be less than a normal wholesaling fee since you have less effort. Trusting your investor is the key here because with no type of contract they could just cut you out of the deal. ]
Once you have the property under contract you then sell you option to another person for a fee. The fee depends on the deal size but I usually try for between $2,000.00 to $10,000.00. However, ultimately as long as you get enough to justify your effort then you are building your funds so you can eventually invest or flip yourself. Of course, if you set up a good wholesaling business you could keep doing it either full time or as a supplement to your other real estate investments.
I normally consider wholesaling as the best real estate investing for beginners. It not only helps you generate income it helps you learn the needed negotiating and deal making skills you will need to be successful long term in real estate investing.
Advantages of Wholesaling?
- Helps you gain capital for further real estate investing. Having the necessary capital to invest in real estate is one of the biggest barriers to entry. Yes there are some ‘creative’ finance options such as getting the owner to finance which is great if you can do it without overpaying in terms of interest rates.
- You learn to find the right properties. This in itself can be something of an art form until you get enough practice and have leads coming in from reliable sources or actions you started.
- You learn the art of negotiating the deal. Also somewhat of an art form. Practice, practice, practice.
- If you are successful, not only will you get needed capital for investing in other real estate ventures you could keep doing it for supplemental income.
It is not easy to become a successful wholesaler, in fact I think it is the most difficult way to make it in your real estate career. However, if you are successful you will have the skills and capital you need to be hugely successful in real estate investing. The things you learn and perfect as a real estate wholesaler will pay dividends throughout your investing career.
What do you have to know to be a successful wholesaler?
- How to find properties. Best way is ‘off book’, You will find it very difficult to check the MLS and find a good prospect for wholesaling. Investors track the MLS and snatch up the few good deals that might be on there.
- You have to be able to estimate the value of a property. Since you are wholesaling you will probably not be using a real estate agent so you will have to know how to determine a property’s value. You can use sites like Zillow or if you are more ambitious go to the court house and find out what similar properties in the same area are selling for. Be careful about basing the property value on what others are listed for sale at. Trying to sell something at a price and actually selling it are different things entirely. Also make sure the homes you are comparing are similar. If two homes are right beside each other but on has 2 bedrooms and 1 bath and the other has 4 bedrooms and 3 baths those are not comparable.
- Make sure you know what kind of repairs are needed in the house and how much they are going to cost. You might need a contractor’s help to estimate this. Be sure to subtract the cost of the repairs from the estimated sales price as well as a mark-up; just in case you missed something.
- Always remember investors are looking for deals.
You have to be careful how you pursue houses to get them under contract. Be sure to check your local laws to make sure you cannot be accused of practicing real estate without a license. Because the laws can be so different in each state I am not going to go into them all here, just know that you need to research it before you begin.
Everyone who watches HGTV wants to learn how to flip houses. If you have watched Tarek and Christina from Flip or Flop I am sure you are thinking, “wow that looks easy, let’s get rich doing that.”
It is not by the way. I will give you some insight into it, although this will not be a guide to flipping houses or a how to flip houses with no money blog.
First of all, what is flipping a house; just in case you do not know or do not have HGTV on your television network or have not been taken in by a radio advertisement promising riches in your area like SuccessPath. Did I sound a little bitter there? Well, follow this link to a review on SuccessPath. That will same you some reading here if you are curious about it. That review is pretty good and accurate based on my personal experiences.
House flipping is basically buying a house with the intent of selling it for a profit (usually in a relatively short time frame). Normally in order to do this the house will probably need some work (or a lot of work) which enables you to buy it well below market value. Do the work and then sell the house for a profit.
Still sounds easy right?
First things first. The key to a successful flip lies in your ability to purchase the house at a low enough price to enable you to do the work and still get a good profit for the risk you took. As a VERY general rule, your profit will probably be less than 20% of the purchase price. How much less than that you are willing to attempt a flip for is up to you but do not cut your margin too small or you may end up with a loss.
What is a fair price to purchase a house at in order to flip?
Up to you really but many flippers use the 70% rule. The 70% rule states that you should not pay more than 70% of the after repair value (APR) of a property minus the repairs needed.
What does that look like? Let’s assume we found a home that according to our comparative home sales analysis will sell for $200,000.00 once all repairs are completed. We get a couple of contractors give us estimates on the repairs and feel it will cost us about $30,000.00 to repair and/or update the house.
Based on the 70% rule the most we could pay for this house is $200,000.00 x 70% which equals $140,000.00 minus the estimated repairs of $30,000.00 which gives us an offer price of $110,000.00.
Do I recommend using this rule? Sure if you can get a house for that price, but in some areas flipping houses has become VERY competitive so you might find it is easier to back into your numbers another way. For instance, if you want to shoot for a 10% profit on a $200,000.00 house that needs $30,000.00 in repairs you would need to clear about $20,000.00 on the project.
So, start with your $200,000.00 and subtract your profit of $20,000.00 and repairs of $30,000.00 which gives you about $150,000.00 as a purchase price. However, you need to always add in at least another $5,000.00 for unforeseen repairs and your closing costs which we will assume are about $10,000.00 which drops your offer to about $135,000.00.
Please keep in mind these are just rough estimates as to your numbers. You financing charges need to be considered as well as utilities or anything else you might run into.
I think coming up with a 70% rule number as well as a backed into number and trying to shoot somewhere in between those is the best advice.
There are a number of things you need to watch out for when flipping a house.
- Make sure you have solid repair numbers. Multiple estimates and padding the numbers up some is recommended.
- Not having the right comparative home sales numbers. Do not compare a 2 bedroom 1 bath you just purchased to the 4 bedroom 3 bath with a 3 car garage next to it. I know this is an extreme difference but I am trying to make a point.
- Not having enough money to finish the project. Remember you not only have to buy the house; you have to pay for repairs and holding costs also. This may include a monthly payment.
- If you do not have the knowledge to do the repairs yourself hire a professional. You can watch and they may even let you help some so you can learn to do some of it yourself overtime.
- Letting time get away from you. Set your holding time when you start based on the best estimates your contractor can give you. Financially, add at least another 30 to 60 days to that for expense calculations just in case.
- Remember you goal is to move the house as quickly as possible and still make an acceptable profit. If you can sell in one week after completion for a $15,000.00 profit, sell it. Do not get stuck holding the house for six months just so you can get a $20,000.00 profit. Holding costs will eat you alive!
- This may be the most important. You make your money on a flip when you buy it, not when you sell it. If you buy at the right price you will be fine. If you overpay you are screwed!
What is the real hard part in my opinion about flipping? Simple, finding the right house. Maybe you need to find a good wholesaler in your area or maybe you need to start as a wholesaler in order to get a number of properties moving through your pipeline. You can pass most of them off to another investor making a little money while keeping the best one(s) for yourself when you are looking for a flip.
As an investor I really do not want the hassle of managing my own properties. It can be a real pain. In addition there is a certain amount of legal knowledge you need when it comes to processing applications and evictions. Yes, you can learn all that and you can take all that hassle on yourself and increase your overall profit but I have found that in most areas property managers are relatively inexpensive for the service you are getting and they allow you to avoid the worst parts of owning investment properties.
So what do they do?
- They find renters to fill your properties. This includes the application and background process.
- Move out/move in inspections
- The deal directly with your tenants on most issues. Including rent collection and evictions.
- They handle repairs.
- They respond to tenant complaints.
They can do even more that this for you but most do at least this much. I would only hire the ones that could do the above at an absolute minimum. Most will let you pick and choose what services they supply.
One work of caution is to make sure you keep an eye on the repairs. While most property managers are honest there have been cases when some have padded the repairs, which to me is the easiest way for a property manager to take advantage of you with the least probability of getting caught. You can only authorize the property manager to do repairs up to a certain amount or ask that you are notified on all repairs. You can also give the property manager a contractor they have to use, but if you do not have a lot of properties it is very possible the property manager can get things repaired cheaper than you can using their resources.
One really big advantage they offer which I touched on above is their knowledge of the landlord tenant law.