Considering getting into real estate investing but don't know where to start? This guide is for you.
As Andrew Carnegie famously said, "90% of millionaires got their wealth by investing in real estate." The amazing thing is, you can do it too. Real estate investing has been a wealth-building vehicle for people of all backgrounds. So, regardless of your experience, consider what real estate could do for you and your financial legacy.
Let's dive in.
Reasons to invest in real estate
Real estate can be a secure investment
People just getting started in real estate investing often wonder about the risk. And while no investment is ever entirely without risk, the real estate market is, as a general rule, much less volatile than, for example, the stock market.
This is because external factors impact the real estate market less, and it experiences much fewer fluctuations. So rather than tying up all of your funds in more vulnerable investments like stocks, you can invest in different hard assets such as residential or commercial real estate investments.
With many investment strategies comes the opportunity to make a passive income. In many cases, after your initial investment, you can take your hands off the wheel while property managers, cleaners, and other service providers run the day-to-day operations.
Hedge against inflation
Real estate is often considered a hedge against inflation because as the home value rises, our mortgage payment stays the same. So as hard assets like real estate and land become scarcer and more in demand, investors and homeowners can ride the wave of inflation.
As Mark Twain said, "Buy land. They're not making it anymore."
The thing about real estate is that it is almost always going up in value. With the exception of the 2008 housing crisis, home values in the United States have consistently appreciated.
In 2022, Fannie Mae forecasts housing prices will increase by 10.8% and an additional 3.2% in 2023. So in most cases, you will come out of a sale with a profit.
Real estate tax deductions
Tax deductions are expenses you can deduct from your income to reduce the total amount of taxable income. And as an investment property owner, there are several tax deductions you can take advantage of:
- Property taxes and insurance
- Mortgage interest
- Property management
- Property repairs and improvements
- Advertising expense
- Legal and professional fees
Real estate investment strategies
So you know you want to invest in real estate, but how do you know the best way to do so? Let's look at a few of the most common real estate investment strategies.
Long term rentals
Long-term rentals are ideal for those looking to collect a monthly paycheck without dedicating too much time or energy daily. With long-term rentals, you'll find tenants to lease the property for typically between 6 months to a year.
The great thing about rentals is that you can hire a property manager and cleaners to take care of the operations. Long-term rentals are typically what come to mind when people think of real estate investing, and they can be a great alternative to house flipping for beginner investors.
- Steady cash flow
- Tax deductions
- Relatively hands-off once you find the right tenants
- Interviewing and managing tenants (unless outsourced)
- Lower ROI than short-term rentals
- Upfront cost
Short term rentals
Also known as vacation rentals and Airbnbs. These rentals typically generate higher returns than long-term rentals because you can charge more in the short term.
Many short-term rental owners hire cleaners and property managers to handle maintenance between guests. This way, you can outsource the day-to-day work and oversee your business as it runs itself.
- High ROI
- Visiting the property between guests makes it easier to keep up with property maintenance
- Tax deductions
- The expense of hiring help
- Fluctuations in demand (on and off seasons)
- Bad guests mistreating the property
Looking to put your handyman skills to work? You might enjoy house flipping.
House flippers buy low-priced homes in run-down condition. They make all of the necessary repairs and then sell for a profit. Your other option could be to use the newly renovated home as a rental property.
Flips are more suited for investors willing to have a hands-on role. It's more of a risk than buying a property in better condition, but the rewards are often high-ticket.
- High rate of return
- Lower upfront cost
- Flexibility to sell or rent
- Higher risk
- More work involved upfront
- Costly if you can't do the work yourself
The BRRRR method
The BRRRR method takes house flipping a few steps further. Also known as "house hacking," this investment strategy has four steps: buy, rehab, rent, refinance, and repeat.
After you've fixed up your distressed property, you'll rent it out, then refinance to cash out on the equity. With the funds you get from the cash-out refinance, you'll purchase your next BRRRR project. Repeat!
This strategy is more for investors playing for the long run. It is very profitable but comes with its fair share of work.
- Source of passive income
- Tax benefits
- Equity and appreciation
- Build a diversified portfolio
- Several risk factors
- Loan terms less favorable
- Closing costs for purchase and refinance
- More involved than other investment strategies
How to choose an investment property
Identify your investment strategy
Before choosing your investment property, you need to know the type of investor you will be. Consider each strategy's pros and cons, and think about the time, effort, and money you're willing to invest.
Do you prefer renting to long-term tenants in a single-family home? Or maybe an Airbnb condo in the downtown area?
Real estate investing is not one-size-fits-all, and it's essential to choose the strategy best suited for you.
Location, location, location. Put yourself in the shoes of your renters. Why should they rent from you?
Is your property close to the restaurants and downtown offerings they're after? Or are your ideal tenants more concerned about schools and public transportation? Successful investors tend to go with the up-and-coming neighborhoods with something to offer their target tenants.
Lastly, you need to consider what you serve to gain from investing.
If you're considering renting out the property, use a simple formula to calculate your rental yield. Let's say you make $2,000 / month on a property worth $300,000.
Annual rent ÷ The value of the property x 100 = Gross rental yield
$24,000 ($2,000 x 12) / $400,000 = 0.06 x 100 = 6% Gross rental yield
A good gross rental yield will typically start at around 3%.