Real Estate Investing
The Ultimate Beginner’s Guide to everything you need to know
|Written by Tom Yeung, CFA | CDFA
Investment Advisor & Fund Manager, Jurnex Financial Advisors
If you’ve heard it once, you heard it a thousand times: real estate investing is one of the most important investments you can make. In fact, the equity in the average American’s house is worth twice their retirement account.
But should you take the plunge?
I get it. There’s a lot of information out there, and buying any real estate is a massive financial commitment. But don’t put off buying a house or rental property just because you’ve never done it before!
Since real estate investing involves such a significant commitment, I always suggest people contact a qualified investment pro to discuss their financial situation first. They can help you make sure you’re making a real estate investment that’s both manageable and profitable to you.
But to help you get started, I’d like to offer you my Ultimate Beginner’s Guide to Real Estate Investing.
Why real estate investing is so important
Real estate investing can either involve buying a primary residence or buying a property to rent out. In both cases, you’re investing money into a physical property.
Why is it so important to put money into real property?
1. It’s a great way to build equity
Whether you’re living in your house or renting it out, every mortgage payment you make contributes to the principle on the property. In other words, having a 30-year mortgage means you will own the property outright after 30 years. And even if you sell the property before then, you would still keep a significant portion of the house value. That’s far better than throwing your money away with rental payments!
2. It forces you to save
Let’s face it. Saving can be difficult: emergencies come up, and bills need paying. And not only is saving hard. Once you’ve done it, you still have to think about how to invest your savings.
But having consistent mortgage payments can help control your cashflow. In one single payment, you’re both paying down the mortgage and contributing towards the house’s equity.
3. Gives you access to government incentives
Ever since the 1930s, the US government has offered numerous subsidies for homeowners. Here’s how you can tap into these programs.
- Subsidized mortgages. The US offers unusually cheap mortgages through Fannie Mae and Freddie Mac. Nowhere else in the world can you borrow money at 3.5% for 30 years.
- First-time homeowner incentives. As a first-time homeowner, you could be eligible for numerous government subsidies, including 0-3.5% down payments and subsidized loans.
- Tax write-offs. The government offers significant tax savings through depreciation, mortgage interest tax deductions, repair costs, and 1031 exchanges.
Is real estate investing safe?
Ever since the 2008 financial crisis, many people have become worried about the safety of real estate investing.
Let me tell you now: if you are investing responsibly, real estate can be an extremely safe investment. The key here is being responsible.
The 2008 financial crisis demonstrated what happens when people become irresponsible in buying houses they can’t afford. It also showed the problem of subprime mortgages. These are low-quality mortgages issued to people who can’t pay.
But if you talk to a well-qualified investment professional, you can significantly reduce the risk of making a bad investment.
To make sure real estate investing stays a safe investment for you: I give my clients four essential tips.
- Never buy more house than you can afford. You don’t want to get in over your head, so it often makes sense to start small.
- Don’t take a mortgage you can’t afford. The 2008 financial crisis plainly showed what happened when people take up too large of mortgages.
- Never buy based only on a trend. Fads come and go. And you don’t want to be left holding the bag when people’s interest moves to the next hot thing.
- Always seek a second opinion. Real estate agents and investment analysts can help make sure you’re not missing anything in an investment.
As long as you’re buying a reasonably-priced house that’s affordable to you, then you’re probably making a good investment. But to be safe, I always recommend people reach out to an investment pro before making a final decision. That’s because spending an hour or two with an investment pro is well worth the $100,000’s you’ll be investing in that property.
What is real estate investing?
There are several ways to make money in real estate investing. Here are the top-4 ways.
1. Primary home ownership
Rather than watch money disappear into a rental, you can use that money towards paying down a house in your name. Often, you’ll find that mortgage payments are even LOWER than your rent!
It’s hard to overstate the government benefits you get from primary homeownership. Not only are you exempt from rental taxes, but you can still deduct mortgage interest in property tax payments. And when you go to sell the property, you can exclude up to $250,000 of capital gains from the sale of a home.
2. Rental properties
Investors looking for a dependable revenue stream can also buy a property and lease it out for rental income. Often, the rental income alone will entirely cover the monthly mortgage, taxes, fees, and maintenance. That means your renter is essentially paying for you to own the property.
There are several categories of rental properties:
Single-family rental: the most common form of leasing is to buy a single-family unit and rent it out to a single tenant or family. You could invest in a house, apartment, or condo unit
Multi-family rental: some investors buy larger townhouses, duplexes, or apartment blocks to lease to multiple renters. Often, the landlord might even live in the building too. Some homeowners also rent part of their house for additional income!
Commercial real estate: commercial tenants such as stores or small businesses often make the best renters. These are businesses that need long-term leases and are generally willing to pay additional for the right to stay put.
Keep in mind that rental properties come with risks too. You should have enough cash budgeted to cover emergency expenses and for times where the property isn’t generating rental income. Starting small can be a great way to make sure you’re not getting in over your head.
3. Fix and flip
Investors can also buy a property, make improvements, and then sell it for a profit.
Fix & Flip has the advantage of generating quick income. Because once you sell a property, you can use the cash to buy another, and so on. Fix and flip is particularly ideal for people who are comfortable with home improvement skills (or knows good contractors). That’s because the amount of profit you can make per sale depends on both the quality and desirability of the improvements you can make.
The key to a successful fix and flip is finding a cheap property that you have the skills to improve. For those with significant experience, this could even mean foreclosed houses and doing gut-renovations! But if you aren’t so comfortable doing substantial renovations, smaller projects can still yield great results.
Before you try to fix and flip, make sure you have a good real estate agent and contractor in mind. That’s because you need to work quickly to reduce risk. Getting stuck with a property can be a recipe for losses. It’s hard (if not impossible) to generate rental income from properties undergoing renovation.
The final way to invest in real estate is to buy a REIT (Real Estate Investment Trust). REITs are funds that invest in real estate on their investors’ behalf. They’re also exchange-traded, which means you can use your investment account or 401(k) to buy them.
Essentially, a REIT is a managed trust. Their job is to pool investor money to invest in real estate. For example, the Empire State Realty Trust owns the Empire State Building in Manhattan, along with 19 smaller properties. Investors can buy shares of this pool on the New York Stock Exchange under the ticker ESRT.
There are many different types of REIT investments you can make. Some REITs invest in residential housing, while others specialize in hotels, hospitals, and data centers. There are even REITs that invest in cell phone towers!
Some of these REITS can have very high dividend yields that approach 10%. Be careful of unusually high yields though, because this can signal something wrong with the underlying REIT. And if you’re ever unsure about investing in a REIT, you can always contact a qualified advisor to help.
Should I start investing in real estate?
For the average American, real estate investments make up 37% of total household equity, more than twice the amount of retirement accounts (15%) and five times the amount of other investment accounts (7%).
But should YOU start and join the millions of Americans who have already started investing in real estate?
While real estate investing can be incredibly important to your financial wealth, there are several considerations you should make before taking the plunge.
1. Have you paid off high-interest debt?
If you have any debt with an 8% or higher interest rate, you should focus on paying those off first. That’s because paying those debts off can help you save even more money in the future.
For those with good credit scores, refinancing high-interest debts can be another option. That’s when you consolidate interest on zero-percent credit cards, which helps you pay off debt even faster. To learn more, see my article about refinancing high-interest debts.
2. Are your finances in order?
Once you’ve paid down your high-interest debt, you should make sure your finances are in order. Here’s where a financial advisor can help.
401(k) and other retirement accounts. Do you have a savings plan in place that’s putting away at least 15% of your income?
Budget. Are you in control of your cash flow? And does your budget have enough breathing room in case of emergencies?
Income. Do you and your family have a stable income that can be used to pay for real estate?
3. Are you ready to commit?
Because real estate is such a substantial investment, you need to make sure you are prepared to commit.
Is your living situation stable for the next 2-3 years? More than ever, people have to move around for work. But because real estate is so local, you’re better off knowing if you’ll be in the same location for at least 2-3 years. (You can always SELL your house if you need to move later)
Are you ready to be a landlord? Owning property means you are responsible for the up of the property. Whether you are living in it yourself or renting it out to others, you have to be prepared to maintain the property and make upgrades as needed.
Once you’re ready to commit, do it!
But once you’re ready to commit, you should start investing in real estate as soon as possible.
Why, might you ask?
That’s because you want to make use of the incredible tax breaks and incentives that the US government provides to first-time homeowners. And even if you’re not buying your first property, you’re still probably eligible for plenty of programs.
Don’t delay real estate investing just because you haven’t done it before. It’s far too important to your financial health. And if you’re still worried about investing alone, don’t be. That’s because I’m here to help make sure you’re making a great investment. If you want to learn more about affordability, you can also check out my article on How Much House Can I Afford?
How to make money investing in real estate
There are several great ways to make money in real estate. And these can be divided into three key categories:
- Rent out for income
- Sell for profit
- Trade-in for a larger property
1. Rental income
One of the most common ways to profit from real estate investing is to lease out the property for rental income. For residential or commercial property, this involves finding tenants. For vacant land, this might even involve conversion into farmland, storage units or parking lots.
Even if you’re living in a house, you can still rent out part of your property for extra income.
2. Sell for profit.
When people think about making money in real estate, it’s usually about buying low and selling high. Selling real estate for profit has been done for centuries. Historians have even found land transfer records from early Mesopotamia!
3. Trade-in for a larger property
You can also trade in a smaller property for a larger one. By trading out for larger properties with more units, you’ll be able to increase the size of that rental income stream. And the additional profits can be used to upgrade to even larger properties, and so on.
Four things to know before you invest in real estate
Before we move onto how to start investing in real estate, I’d like to share my top four suggestions for real estate investors.
1. Buy the neighborhood, not the house
When most people think about buying a house, they often focus only on the house itself. Rookie mistake!
That’s because the neighborhood is often far more critical to the value of the house. You can change the house over time by remodeling and making improvements. But you can’t change the neighborhood.
It’s far more common to hear people say “my uncle made 100x on the townhouse he bought in midtown Manhattan when prices were low in the ’70’s”. Does it matter which townhouse he bought? No! Forty years later, no one cares whether someone built that townhouse in 1910 or 1940. It’s the neighborhood that matters!
2. Know your first-time homeowner deals
As a financial advisor, I want to let you in on a little secret. What’s the ONE biggest real estate mistake? It’s failing to check for first-time homeowner deals. And even if you aren’t a first-time homeowner, you’ll still qualify for plenty of deals.
There’s so much going on already. Now you have to worry about these deals too? I get it. But you must do your homework. Alternatively, you can call me today and learn about them first-hand.
Gone are the days where you need to put 20% down to qualify for a sub-4% 30-year mortgage. By applying for the right FHA programs, almost ANYONE can reduce their down payment to just 0-3.5%, and mortgage rates 3.5% or lower. Of course, you STILL have to make sure the purchase is affordable. See what happened in 2007-08 to those who didn’t! But the lower down and mortgage payments mean you can purchase the same house for far less investment.
3. Know the full costs of real estate investing
If you’re new to real estate investing, make sure you understand the full costs involved. Nothing shrinks your profits faster than unexpected costs.
- Transaction fees and taxes: most states have a 3-6% broker fee that’s paid by the seller. And as a buyer, you should expect to spend at least 2-4% in closing costs, which include an appraisal, title insurance, recording fees, and more.
- Maintenance and HOA fees: if you’re new to homeownership, you’ll have to prepare yourself to pay for necessary repairs.
- Real estate taxes: these vary widely depending on your state. Washington DC, for instance, has a 0.85% property tax rate, while New Jersey can have upwards of 2.5-3.0%.
Most importantly, don’t get blindsided by unanticipated costs. These costs can eat into your investment profits and cause headaches for years.
4. Have special insight into the property
It’s not hard to make an average real estate investment – open up a public listing service like Zillow and put your finger down anywhere on the map! But what if you want to do better?
That involves having some insight.
In other words, you need to tell me: what’s the ONE thing people are missing about an investment?
- Improvements: perhaps there’s a house in a great neighborhood, but it has an outdated interior?
- Location: Is the neighborhood is gentrifying in ways that people haven’t yet recognized?
- Conversions: do land rights permit building a granny flat or subdividing the property for extra income?
How to start investing in real estate
Now that we’ve covered the key points of real estate investing let’s examine the step-by-step process of how you can get started.
Step 1. Figure out your budget
When it comes to real estate investing, it’s important to NEVER go in over your head. That means knowing how much house you can afford.
So before you even START looking at properties, I want you to know your budget. Since this is such a personal endeavor, I suggest you contact an investment pro to discuss your options. But here are my three tips to get you started:
If you’re buying a house to live in:
Your total monthly payments for EVERYTHING related to real estate should fit within 35% of your household’s after-tax income. That means a family earning $100,000 after taxes should look to spend no more than $35,000 per year (or $2,917/month) on housing.
- Mortgage and principal
- Mortgage insurance (if necessary)
- Utilities & Maintenance
- Common charges or HOA fees
35% might sound low to some people, but I prefer people to start conservatively. Remember, you can always upgrade to a larger house later if you find yourself with extra income.
If you’re buying real estate to lease:
Since renters will cover mortgage payments, rental properties are more about risk management than affordability.
1. Make sure you have the cash to cover 3-6 months of mortgage payments. You need some cash cushion in case you find yourself without a paying tenant. This can happen during a gap between renters or if your renter suddenly becomes delinquent on paying their rent.
2. Beware of taking out a mortgage more than 3x your gross annual income. While many lenders will allow far larger mortgages, I recommend people start smaller until they’re comfortable with buying and managing real estate. That means a family earning $150,000 pretax should take out a mortgage no larger than $450,000.
Step 2. See what mortgage you qualify for
I’m suggesting you do this BEFORE you start looking at properties. That’s because you don’t want to fall in love with an unaffordable property.
I know it’s tempting to skip this step! But I’ve seen plenty of people go into a real estate transaction with a clear head and walk head-over-heels, smitten by an amazing-looking property. And it ALWAYS seems that property is JUST outside their budget.
And if you’re not careful, it can happen to YOU!
By prequalifying for a mortgage first, you vastly reduce this risk. Suddenly, it becomes 100% clear how much real estate investment you can afford. Additionally, you may find yourself qualifying for special rate mortgages that are contingent on where you buy. For example, the Good Neighbor Next Door program gives police, firefighters, teachers, and EMTs 50% off list-price in redevelopment neighborhoods. Rural areas (covering 97% of the land in the US) qualify for special-rate mortgages from USDA’s Rural Development programs.
Step 3. Identify the right property
Now that you have your budget, it’s time to look at some properties.
- Primary Residence. If you’re buying real estate for yourself, pay attention to the neighborhood. Is it an area you can see yourself living in for many years? Is the commute manageable for you and your family? And if you have children, how good are the school districts?
- Rental properties. For this, I suggest you start local. It’s far easier to manage properties closer to home. Imagine having to fly across the country every time something happened to your investment!
Step 4: Prepare yourself for risks.
In most cases, investing in real estate won’t go 100% to plan. It is usual for properties to take a month or two to rent out, but some may sit empty for even longer. Unexpected repairs may also come up. For example, if you’re buying a house during the summer, you may not know about a $4,000 furnace problem until winter arrives.
But as long as you’re financially and emotionally prepared for the risks in real estate investment, it’s easy for you to overcome these issues. After all, one-third of all Americans rent. And every rental property has a landlord, just like you will be.
Step 5: Find a professional to help.
In most cases, I recommend finding a real estate agent to help. Experienced agents tend to know the local market well, and they can help you through the real estate purchasing process. Additionally, I suggest you find an investment professional as well. That’s because when it comes to investing significant sums of your assets, it’s worthwhile to make sure you’re getting a great deal.
You don’t need to hire a full-time financial advisor either. I usually work with clients full-time, but I also do one-off consultations for clients because I understand the importance of making such a large financial decision.
Is real estate investing right for you?
Many people often aren’t sure whether to invest in real estate. But when it comes to growing your nest egg, it’s not even a question of whether real estate investing is right for you.
It’s whether it’s the right time for you to invest.
With so many government incentives available to homebuyers, I tell everyone this. If you don’t own a home yet, buy one once you can afford it. And if you already own a home, by a second one and rent it out. And what if you already have a second property you lease? (You know where I’m going with this) You should buy a third one!
What’s stopping YOU from investing?
I commonly hear people say, “well, I don’t know whether real estate investing is right for me.” But the hang-up usually isn’t a fear of fixing broken toilets. Instead, it’s a fear of making a significant investment.
But you know what? That fear is unfounded. That’s because once you have the right information, you’ll realize how powerful real estate investing is. By keeping your investment reasonable and affordable, you can avoid the pitfalls most novice investors make.
And if it seems like a lot of information, don’t worry. The great news is you don’t have to do it alone. That’s because a qualified investment pro can help you figure out whether you’re making the right real estate investments.
Where to find more resources
If you’re looking for even more investment tips, you’ve come to the right place.
That’s because I’ve helped invest client money for over a decade in the same old-fashioned way. And that’s to seek out great companies in great industries that can you can buy at a discount to their fair value. Sounds too simple to be true? Give me a call today, and I’ll show you that it’s still possible after all these years.
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