Investing in real estate is nothing at all like investing in the stock market, or most other financial markets for that matter. Successful investing in real estate requires a full understanding of what it is you’re getting into, and a willingness to get your hands dirty.
What can you expect in order to begin investing in real estate? Here’s what you need to know!
Know the Market
If you hope to make money investing in real estate, you have to know your market thoroughly. Consider the following:
Property values. The only way to know if you’re getting a good deal on a property is to know what the values are in your area. It is not enough to go by general property value estimates in the media. You need to get your real estate license and join a local broker to have access to both listing prices and especially closed sale prices. This point needs emphasis: market values are established by closing sale prices, not asking prices. Depending on market conditions, there can be a wide variation between listing prices and closing prices. Only closing prices matter!
Market rents. If you are planning on buying rental property, you will need to know what the going rents are in the area. The only way to make intelligent investment decisions is by getting clued in on what a property’s income potential is. Knowing the rents will tell you this. The best way to find this out is by asking an appraiser — classified ads advertising new rentals will only indicate asking prices, not actual rents.
You can’t afford to overpay. If you buy a house to live in for 20 years it may not matter tremendously if you overpay for it. But if you intend for the property to be an investment, you must buy at below market prices. This will be critical whether you plan to rent the house or flip it for profit.
Have Plenty of Investment Capital
As a real estate investor, you’ll need to have substantially more cash going into the transaction than you would if you’re buying a house you plan to live in. There are several reasons why this is true:
Plan on a minimum down payment of 20%. There are no zero down mortgage programs for investor properties. You should plan on a minimum down payment of 20% of the purchase price. There may be mortgage programs advertising lower down payments, but you probably won’t be able to qualify for them.
Plan on extra cushion for needed repairs. If you are looking for bargain-priced properties, there is an excellent chance they will be in some state of disrepair. You’ll need plenty of cash to bring the property up to the point where it can be occupied. That will determine how quickly you’re able to rent the property out, or even flip it.
Have a vacancy allowance. This is a cash concern that many would-be real estate investors try very hard to ignore. If you are going to be investing in real estate, you should completely expect that there’ll be months where you won’t receive rental income. This is very typical when you’re in between tenants, and it is even possible that a tenant will pick up and move in the middle of the night. You have to be covered with enough cash in the event that your cash-flow from rent comes to a sudden stop.
Be prepared for repairs between tenants. You will need to budget cash to make additional repairs each time a rental changes hands. It could be something as minor as a touchup paint job and a general housecleaning. But it can be something more extreme, such as having to have an entire house full of contents removed, or major damage to walls, floors and appliances.
Know the Laws and Protect Yourself
When you are investing in real estate, you need to be aware of the laws involved in the landlord–tenant relationship. Even though you are the owner of the property, your options are often constrained by state and local law.
Here’s some examples:
Eviction process. Even if a tenant is not paying their rent, you will still be required by law to give a certain minimum amount of notice on eviction (generally not less than 30 days). In some states, the tenant may even be able get a stay of execution, particularly if they have young children. You will have to be very familiar with these laws and with your rights as a landlord.
Do background checks on prospective tenants. Preventing problems is always preferable to being blindsided by them, and the best way to do this is by doing proper background checks. You should plan on doing credit checks and criminal background checks on all potential tenants. You may also want to ask them to supply canceled rent checks for the past 12 to 24 months on their previous rental situation.
Rent security deposits. Each area of the country has different practices when it comes to rent security deposits. In some areas, a typical security deposit is equal to one month’s rent, plus the first month rent upon moving in. In other areas, it’s one month’s rent as the security deposit, the first month’s rent and the last month’s rent. Whatever the practice is your area, make sure that you adhere to it. Some tenants, who are short on cash, will promise you the sun, the moon and the stars if you will waive the security deposit requirement — don’t! It’s your best protection in the event there is damage to the rental unit, or the tenant breaks the lease early.
Different insurance coverage. You should understand that homeowners insurance for an investor is very different than it is for an owner-occupant. As an investor, you have to insure against the possibility of injury to your tenants. Your regular homeowners insurance will not cover that kind of situation. You may also want to consider getting general liability insurance coverage, just in case a tenant, or one of their guests, is injured on the property decides to bring a lawsuit against you.
Four Basic Ways to Make Money
Before you buy your first investment property, you should first have an idea how it is you intend to make money and turn a profit. There are four basic ways to do this:
Buying for income. This is buying property for the purpose of renting it out to produce a stable monthly income. In order to do this, the property will have to be acquired at a low enough price that the rents will more than cover the basic house payment. This is easier to do in some markets than in others. In some areas, where property values are seriously depressed, it’s possible to buy such property. In others, property values are so high that it is almost impossible.
Fix and flip. This usually involves buying a property that requires a significant amount of repair work. Because the property is in disrepair, you’re typically getting it at well below market price. You’ll have to be capable of giving a reasonable estimate of what it will cost to fix the property before buying it. If you can buy it and fix it for less than what you can sell it for, you can make a large amount of money quickly.
Buy at a discount and flip. Every now and again you may come across a property you can buy for such a low price, that you are able to sell it shortly afterward at a substantial profit. Once again, you’ll have to be well aware of market values in your area in order to take advantage of the situation.
Buy-and-hold. Similar to what you would do with stocks, you want to make intelligent purchases, then hold onto the property for years or even decades to make the greatest possible windfalls. This will not only require buying a property at below market prices, but you’ll also have to be sure you will be able to carry it for many years at a profit. That means it will need a profitable cash flow from rents.
Real Estate Investing is NOT Passive
There are a lot of books and programs out there promising you that you can get rich in real estate without having to do anything. They are all complete nonsense!
If you’ve ever owned your own home, you know that real estate is not a passive investment. It has to be maintained and repairs made on an ongoing basis. And eventually, you’ll need to begin replacing major components.
Now add tenants to the mix, and consider that you will need to find them, qualify them, keep them happy, and then deal with their not always pleasant departures.
There’s nothing passive in any of that!
Investing in real estate can be very profitable, but you have to go in with the right expectation and attitude — and then be prepared to work.