9 Ways To Get Started With Real Estate Investing
“Ninety percent of all millionaires become so through owning real estate. More money has been made in real estate than in all industrial investments combined. The wise young man or wage earner of today invests his money in real estate.”
Most investors I know park their money in the stock market. It’s arguably one of the best ways to build wealth, and it doesn’t require much cash to get started. Many of those same investors hear about the potential of real estate investing, but most of them don’t know how or where to get started. Luckily, there are many ways to dabble into the world of real estate investing nowadays, and they don’t all require large amounts of capital.
REITs
REIT stands for real estate investment trust. Most REITs are publicly-traded on the stock market, where you can purchase individual shares of the company, just like any other stock. Think of REITs as real estate ETFs that are required by law to distribute at least 90% of their taxable income to shareholders. If they don’t, they’ll give up their company’s legal classification as an REIT. Because of that requirement, REITs tend to have relatively high dividends even compared to high dividend payers like Coca-Cola or 3M. There are different types of REITs, but their dividends usually range anywhere from 3-12%.
One of the most overlooked aspects of REITs is their tax treatment. The majority of their dividends do not count as qualified dividends. Therefore, their dividends are taxed as ordinary income and not capital gains, which is usually a lower rate than income tax. There are exceptions to this, like when a REIT sells an underlying asset they own and decides to distribute those capital gains to their shareholders. However, that’s not the common case. Of course, when you sell shares of the REIT, the sale is still treated as a regular stock sale and, therefore, has capital gains tax treatment.
Rental Properties
When someone mentions real estate investing, most people think of rental properties right away. Investing in rental properties is the traditional way of real estate investing and usually requires a significant amount of cash to get started. Lots of folks out there will advertise that you can get started with $0 or with a low down payment, but don’t get lured in by them. They usually recommend riskier investing strategies by using additional debt, making you overleveraged. Instead, use conforming loans (loans that meet strict standards and are backed by Fannie Mae and Freddie Mac) to purchase your rental properties. For single-family homes, you’ll have to put in at least 15% down; for multi-family homes with 2-4 units, you’ll have to put in at least 25% down. While those are the minimum down payment requirements, the lender may not offer the best interest rates unless you have a 25% down payment.
Once you acquire the property, you’re responsible for paying all the bills associated with it. To name a few:
Mortgage payment (unless you own it outright by purchasing it all cash)
Property taxes
Insurance
HOA (if the property is in a community)
Capital expenditures like home improvement projects or landscaping costs
Other operating expenses like lawn care or repairs
If you want to be hands-off or are an out-of-state investor like I am, consider hiring a property management company. A typical property management fee is 8-10% of your gross rental income.
Your mortgage payment, property taxes, and insurance can all be paid as part of your monthly mortgage payment through your lender. If you don’t want to have to remember paying those bills, you can set up an escrow account with your lender so that they collect a percentage of your property tax and insurance bills on a monthly basis. When it’s time to pay those respective bills, the lender will automatically pay them out of the escrow account on your behalf.
Now that you have an idea of the costs associated with owning a rental property, here are the landlord responsibilities:
Finding tenants by posting listings (mostly online nowadays through real estate websites like Zillow or Redfin)
Screening tenants (e.g. background check, employment verification)
Signing a lease (usually 1 year increments)
Collecting monthly rent checks and/or late fees
Staying in touch with tenants should they have any issues with the property
Staying in touch with tenants should they skip a payment or pay them late
Possibly evict a bad tenant by working with the court
Biannual inspections to review the state of each unit
Renewing leases before they expire, possibly raising or dropping the rent depending on how the local rental market is performing
If a landlord’s job sounds like too much work for you, consider hiring a property management company to handle all of it on your behalf. Again, they typically charge 8-10% of your gross rental income.
That’s essentially the gist of rental property investing. You buy it, maintain it, and rent it out over the years. Hopefully the tenants you lease to are good ones so you don’t run into too many headaches. To reduce that risk, it’s important to do your due diligence on the area and demographics of the property you’re interested in purchasing.
Lastly, a few final thoughts and factors to consider when investing in real estate properties:
Loans for investment properties have higher interest rates than for primary or secondary homes. Adding 0.5-.75% to normal mortgage rates is a good rule of thumb.
As you accumulate more rental properties using conforming loans, lenders will require you to put more % down in an attempt to prevent you from overleveraging and to reduce their liabilities.
You cannot have more than 10 conforming loans at a time. If you’re married, there’s a way to get up to 20 loans, but let’s not worry about that right now. Let’s focus on the 1st investment!
When searching for the best mortgage, take your time shopping around. Big banks may not have the best rates, so call smaller lenders in the rental property’s local real estate market. Also, remember that interest rates aren’t the only metric to focus on. Watch out for hefty fees. After all, lenders are happy to drop interest rates if you pay them a hefty amount for points!
Fannie Mae requires you to have a DTI (debt-to-income) ratio of 45% or less. To calculate your DTI ratio, sum up all your monthly debt payments and divide it by your gross monthly income. Again, they require this to make sure you’re not overextending yourself.
Crowdfunded Real Estate
In the past several years, crowdfunded real estate has become quite popular. Essentially, there are companies out there that offer a service to do all the “hard work” by identifying potential real estate deals and pitch these opportunities to their clients. After the sales pitch, they open up the investments to their clients. Each company has different investor qualifications, like requiring clients to be accredited investors, but some of them allow their investors to invest as little as $500 per investment. Additionally, crowdfunded real estate opens up access to opportunities not normally offered to individual investors and only offered to larger corporations.
Crowdfunded real estate can be nice for individuals who want to be hands-off and want to invest relatively small amounts. However, it’s still a nascent way to invest in real estate. Many of these companies have actually gone bankrupt and left their clients out to dry. If you venture into this niche, it’s very important to do your due diligence on the company as well as each individual opportunity they offer.
Lending
Lending doesn’t always have to involve a traditional bank; it can be you. As a lender, you don’t own any equity on the real estate investment itself. Instead, you collect interest payments from the buyer, just as a buyer would normally pay their monthly mortgage to a bank. Acting as a private lender, the interest rate on the loan tends to be much higher than a traditional loan issued by large banks. Anywhere between 6-12% is not unheard of, so the ROI is relatively solid.
Generally speaking, debt investments are viewed as less risky and more stable than equity investments. If the underlying real estate asset appreciates or depreciates, the lender still collects the same payment from the buyer, but they don’t have any potential to earn above that amount. The primary risk involved with lending is a buyer not paying you on time or if they stop altogether. If the problem doesn’t go away, you’ll have to go through a foreclosure process to force the buyer to sell their property and take a portion of their proceeds to recuperate what’s owed to you.
Flipping Houses
Unless you’re well-established and have a team behind your business, house-flipping can be quite hands-on with a significant time commitment. The goal of flipping houses is to buy low, sell high as fast as possible. There are two primary ways to flip a house:
Time the real estate market and hope that a property continues to appreciate in a short time span.
Renovate a property to increase its value quickly.
In the first approach, the house-flipper need not renovate the property at all, but they’re certainly trying to time the market, which is hardly ever a good idea.
In the second approach, house flippers usually get a hard money loan (usually with double-digit interest rates) from private lenders to purchase homes all-cash. Doing so allows the house flipper to purchase a home at a lower purchase price and avoid a lengthy closing process. Once they own the property, they renovate it as quickly as possible and sell it for a profit.
Here are some of the primary risks with house flipping:
Paying a double-digit interest rate for a hard money loan
Trying to time the real estate market
Higher-than-expected capital expenditures like renovation costs
Longer-than-expected renovation project, increasing costs
Real estate depreciation
Difficulty selling the property, increasing the time you own the property
Forgetting about having to pay closing costs
Clearly, there are quite a few risks involved with flipping houses, many of which revolve around paying a double-digit interest rate on a loan. If the house-flipper doesn’t do their math well, their project can easily ring up high capital expenditures due to renovation. Couple that with a double-digit interest rate on their loan, and the deal can quickly result in (heavy) losses in a relatively short time span.
Flipping as fast as possible is crucial. If renovation takes longer than expected, the hard money loan will quickly sour a deal. And if the real estate market depreciates over the course of a house-flipping project, the lower the odds of a profit will be realized.
While there are lots of ways house-flipping can go wrong, if well-timed and well-calculated, it can certainly be a lucrative business. Imagine flipping a handful of homes per year, each of which nets $50-75K in profit and requires $0 of your own dollars!
Wholesaling
Wholesaling is the practice of finding investment properties and selling the purchase contract to real estate investors. The wholesaler makes money by taking a cut from each real estate transaction. This real estate investing niche is one of the few ways for people to invest in real estate without having to use any of their own money.
A successful wholesaler is one who builds a network of real estate investors. Once a wholesaler establishes a reputation for finding solid cash-flowing deals for their clients, their network of investors will continue to come back for more!
House Hacking
This is one of my favorites, as it helped keep my costs down significantly when I bought my first property. The main way to house hack is to buy a multi-family property (2-4 units), live in one unit, and rent the others out. The other way is what I did back in 2012 by using your primary residence, whether that be a single-family home, condo, or townhouse, and rent out 1 or more rooms. Check out my post to look at my numbers in detail and see how house hacking can really make a big difference! It certainly makes living in a high cost of living area (HCOL) like Silicon Valley much more affordable.
Airbnb (or Vrbo)
The two primary ways ways to invest in real estate through Airbnb are:
Rent out a room in your primary residence
Buy an investment property to rent out
The first option is very much like house hacking, and the second option is similar to owning a traditional rental property, except that we’re talking about short-term rentals instead of long-term rentals. As an Airbnb host, you basically act like a property owner + hotel manager + housekeeper. You have to own and maintain the property, provide excellent service and amenities to your guests, and do proper cleaning in between every stay (especially during COVID times).
Compared to typical 1-year leases for apartments, Airbnbs have short-term renters. Therefore, nightly rates can be quite expensive, just like hotels, which is how running an Airbnb business can be very lucrative.
Laws allowing, prohibiting, or limiting short-term rentals like Airbnb or Vrbo vary city to city. For example, some cities outright ban short-term rentals; others have strict regulations on short-term rentals, like requiring the host (owner) to live in the residence 275 nights of the calendar year and prohibiting guests to stay longer than 30 consecutive nights. Oftentimes, cities require Airbnb hosts to register their listing as a business. So be sure to check the prospective city’s short-term rental laws before you decide to run an Airbnb business there.
Subleasing
As a renter, your name is on the lease. If subleasing is allowed by your landlord, you can lease out a part of the home to another tenant. The subtenant is not on the original lease; only yours is. So you are still obligated to pay the full rent in the original agreement. That means that if the subtenant fails to pay you their rent or late fees, you’re solely responsible for paying the landlord the full rent.
Conclusion
In summary, there are many ways to get started with real estate investing. If you’re serious about getting started, think about how hands-on you want to be with your investment, how much money you’re able to invest, what your risk appetite is, and what your investment time horizon is.
Personally, I’ve invested in real estate through REITs, sub-leasing during my college years, house hacking, and traditional rental properties (check out the top 6 reasons why I love traditional rental properties). I know others who invest in real estate through crowdfunded real estate platforms, wholesaling, and house flipping. If you’re having difficulty deciding which method is suitable for you, feel free to reach out to me for help!
Lastly, there’s one more way to invest in real estate that I didn’t mention, so keep your eyes peeled for a future blog post on it! I’m also working on another post on how I analyze rental properties, so subscribe below and follow me on Instagram @buckbybuckblog so you don’t miss out!
