It can be daunting to start investing in real estate, but it's historically been a solid way to build wealth. For people that are new to the game, we've compiled a list of real estate investing tips and tricks for beginners.
While YouTube personalities and investment "gurus" might tell you otherwise, real estate investing isn't a get-rich-quick scheme. When done right, though, it can offer monthly income, tax benefits, a potential hedge against inflation, and more.
When you buy real estate, you're making a long-term investment. Sure, some people might make bank fixing and flipping properties, but this is a fairly risky endeavor. It's the type of thing that works until it doesn't, and the illiquidity of real estate means you could end up losing big if you don't time things right.
So, without further ado, let's take a look at our tips and tricks for beginners that are considering entering the world of real estate investing.
One of the first things you'll want to do when you decide to invest in real estate is clarifying your investment goals. Some of the questions you'll want to ask yourself to help you structure your investment strategies include:
Once you have a better sense of what you want to get out of investing, you can start to narrow down your focus and create a plan that helps you meet your goals.
A certain level of financial capability is required to start investing in real estate. Even if you feel "ready" to start investing, you'll need to take a look at the numbers for a realistic sense of what is possible.
It's important to be honest when you're examining your finances. This is not the time to be overly optimistic or to bank on expected future income or windfalls. Real estate is not considered a liquid asset, so it's important to not invest more money than you can stand to have tied up in real property.
Some of the questions you'll want to ask yourself to get a sense of your financial readiness for real estate investing include:
With the real estate market a bit out of control since the pandemic started, it can be tempting to look at real estate investing as a get-rich-quick scheme. However, just like any investment, you should never risk more money than you are willing to lose. Be careful taking money that is earmarked for other purposes down the road and expecting to receive a specific ROI by a specific date.
Only you can decide whether you want to work with a real estate agent or not. Depending on how comfortable you are with negotiating deals on your own and navigating the purchase and sale process, you might find that you can save quite a bit of money by going it on your own.
That being said, real estate agents can certainly earn their keep if you want someone to help you find and purchase properties. There can be a huge range in quality of real estate agents, so it's a good idea to shop around and find one that you feel comfortable working with and that you trust.
If you're buying a property in cash, it might be tempting to avoid the cost of an inspection and an appraisal. Getting an inspection can be a major source of information about the condition of the property, though, and can help you get a sense of the work that will need to be done before you rent out or resell the property.
Appraisals can also be incredibly useful because they help you understand the value of the property. When you don't get an appraisal, you are to some extent guessing about its worth.
Real estate investment properties require a different type of insurance than primary residences. If you're buying the property to rent it out, you'll want to get a landlord policy that provides adequate coverage. Getting quotes before you buy the property can help you budget how much insurance is going to cost you each month.
Some investors also choose to get umbrella insurance on their primary residence that also covers their investment property.
If you're buying a property that needs work and you're not planning on doing the whole project yourself, you're going to need to find high-quality contractors you can hire to do the work. One of the benefits of purchasing a number of properties where you live is that you can create a relationship with contractors that you feel offer good work for a good price. They also might be willing to give you a deal because they know that you'll give them repeat business.
Similarly, you'll want to build a network of tradespeople you can call upon when necessary. Whether it be a plumber, an electrician, an appliance repair person, or another type of tradesman, having an existing relationship can make property ownership cheaper, less stressful, and more predictable.
Some real estate investors choose to place their properties in an LLC in order to further protect their assets. This can potentially help protect you in the case of a lawsuit.
However, financing a property with an LLC can be a lot more difficult than doing so as an individual. Lenders see investors as riskier than people who are buying a primary residence, and they see businesses as even riskier than individual investors. This means that the interest rate can be higher, the qualifications can be stricter, and the terms can be less favorable.
Additionally, you'll have to do some extra work to get insurance for a property that's owned by an LLC rather than one that's owned by an individual. Not all insurance companies will cover LLC-owned properties, so you'll have to shop around to find one that does. In general, you can expect getting a loan and insurance for a property owned by an LLC to be more expensive.
That being said, there are plenty of investors that are members of LLCs that own their rental properties. Talk to a real estate lawyer or a knowledgeable tax professional to help you create a plan that makes sense for you.
Be sure to check out our post about the disadvantages of using an LLC to purchase rental property before you make a decision one way or the other.
If you're new to the world of investing, you might assume that the place to own property is where the rents are sky-high. This isn't necessarily the case, as many of the most expensive rental markets in the US are also the most expensive housing markets. On top of that, these places tend to have higher property taxes and more regulations.
If you want to maximize profits with your real estate investments, try to identify emerging neighborhoods in which to buy property.
As is common with other types of investments, there is a direct relationship between potential risk and return. For example, you could take a gamble on a super cheap property in a really run-down, crime-ridden area based on an assumption that the area will improve over the course of the next ten to twenty years. If you're right, you could see impressive returns over the course of owning the property. If you're wrong, though, you'll likely wish that you had spent a little more money in an area that had expressed more definite signs of improving.
On the other end of the spectrum, you could purchase an expensive property in an area where demand and rental rates are high. While it might be easy to find tenants and management is a breeze, your cash flow and ROI won't be nearly as impressive.
For investors that are first starting out, it's best to look for a neighborhood that has already started to show signs of improvement. Things like population growth, job growth, downtown revitalization projects, reduction in crime, and other investors moving in to fix up properties can be signifiers that a neighborhood is moving in the right direction.
Remember, you're always taking a risk when you buy an investment property regardless of how certain it seems at the time. A few changes to a neighborhood (a major employer leaving the area, for example) can send it right back in the other direction, and it's important to understand exactly why a certain area is starting to improve.
Debt can be a powerful tool, but you'll want to be really careful to not over-leverage yourself when investing in real estate. There is always going to be some uncertainty in the national and local economy as well as in your personal finances.
Consider having a mix of properties you own outright and properties with mortgages. This way, if you have unexpected dips in cash flow or more vacancies than anticipated, it doesn't have to end your career as a real estate investor.
If you're about to begin your first adventure rehabbing a property, it's easy to get carried away. After all, there is something so exhilarating about taking a run-down property and breathing new life into it. That being said, you'll want to carefully analyze the return on investment you can expect from any and all upgrades you make.
(While you're at it, check out our article on calculating ROI for your rental property.)
Something like fixing a leaking roof or replacing major systems can make a lot of sense no matter where your property is. If you're investing in a lower-end area, though, you'll probably find that putting top-of-the-line fixtures and amenities in the home won't pay for themselves in increased rental rates.
When you're first starting out, it can be tempting to buy that 10-unit building for sale in your city. After all, the more units you have, the less painful it is financially to hold a vacancy or two, and having the units consolidated in one place can make property management much simpler.
In reality, though, jumping into the deep end of the pool could leave you in over your head. For this reason, many experts recommend starting with single-family homes when you're first building your portfolio.
There are a number of reasons that single-family homes are attractive as starter investments.
For one, single-family homes tend to be more affordable than other types of properties. The process of purchasing a single-family home is generally easier than qualifying for multi-family or commercial property financing.
If you are planning on managing your own property, to begin with, having a single-family home as your first rental property can also help to keep the process of management, well, manageable.
Single-family homes are also a way to mitigate risk when investing. If you decide to sell sooner than you expected, it will typically be easier to sell a single-family home than it is to sell a duplex, multifamily, or commercial property. After all, when a single-family home goes on the market, the pool of interested buyers can consist of both primary residence purchasers and investors. Once you start having several units in one building, you are marketing to a smaller pool that only contains investors.
When you're trying to keep your cash flow high, it can be tempting to let little problems build up without attention. It's important to realize that a little money now can save you a lot of money in the future, though. It's a good idea to do a bi-annual walkthrough of your properties and encourage your tenants to let you know if they are aware of any problems with the property.
If you're investing in properties in the city that you've lived in for three decades, you might feel like you know the place like the back of your hand. However, you'd be surprised how much information can slip between the cracks when you aren't looking at the area through the lens of an investor, and it's important to make sure that your assumptions and beliefs are founded on actual data and not just a gut feeling.
Similarly, it's important to understand the way that cities and neighborhoods can change drastically over time. This might be harder to see when you're in the thick of it, and it's essential that you don't use information you gathered twenty years ago to inform the decisions you're making now.
If you're investing in properties in a place that you don't live in, you're going to want to know just about everything there is to know about the area. Don't pick a city off a list of the best places to invest and buy the first property you find that fits within your budget. Every city is going to have different neighborhoods that are improving and declining, and you'll want to make sure any property you buy is located in a place that's headed in the right direction.
You'll want to understand everything from major employers in the area to average rental rates and income levels. You'll want to understand the demographics of the area and the percentage of homeowners vs. renters.
What do most people want when they're looking for a new apartment or home to rent? While some more affluent renters might get to be picky about their location and amenities, pretty much everyone shares the desire to live in a relatively safe place, regardless of how much money they can afford to spend on rent.
If you're investing in the city you live in, you might have a good sense of neighborhoods that are considered to be safe. Remote investors, though, should take crime rates seriously.
The thing about unexpected expenses is that you never know when they're going to crop up. You might assume that a hot water heater has plenty of life left in it, for example, only to find that you need to replace it way sooner than expected.
When you choose a property that offers positive cash flow, be sure to put a percentage of your monthly rental income aside each month to build an emergency fund that you can call upon when you need to. Otherwise, you'll find yourself reaching into your own pockets to pay for surprise issues.
If you're buying a property that doesn't immediately generate positive cash flow, you'll need to make sure you have cash reserves elsewhere that can be used in the case of an emergency.
While YouTubers and get-rich-quick gurus love to talk about how passive the income from real estate investing is, it's important to understand that real estate investing is a business. When you invest in the stock market, you might be able to get away with a set-it-and-forget-it mentality.
With real property, though, you need to treat it like a business. Just like any other business, success requires deliberate planning, management, and execution.
It isn't particularly useful to assume that your units will be rented out 100% of the time. It would be great if that happened, but if you bank on it you're going to find yourself in a pickle.
While there are ways you can work to reduce vacancies, you can't assume that you'll be able to avoid them altogether. Instead, you should factor in the cost of holding vacancies when you're creating your financial plan.
In order to determine how many vacancies you should build into your projected income and expenses, you'll want to consider the type of tenant you expect to find, the type of property, and the local rental market.
Understanding the landlord-tenant laws in your state and any municipal laws that relate to rentals is absolutely essential. Some states heavily favor tenants while others favor landlords when it comes to issues like evictions and failure to pay rent. While it might not be the most thrilling reading material, you'll want to know the ins and outs of the laws in your state and city.
In May 2022, the average price for US homes hit an all-time high of over $400,000. Though the market has been responding somewhat to the rise in interest rates with existing home sales hitting a two-year low at the same time, prices at the national level haven't yet proven that they're ready to budge after a few crazy years of rapidly increasing price tags.
If you've stayed attuned to professional and amateur conversations about the current state of the housing market, you find opposing camps of people with very strong views. In one corner, there are those who believe a brutal housing crash is imminent. In the other corner are people who firmly believe that the historic appreciation of homes will continue as a trend, even if there's a slowing rate of price increases right now.
And, of course, there are a lot of gray-area opinions in between.
No one precisely knows what's going to happen at the national level, and real estate is essentially so localized that it's a bit pointless to talk about it at that scale.
The point is, though, that purchasing a property with the expectation that you will be able to cash out big-time and retire in a specific number of years isn't a great investment strategy. There are so many factors that influence housing prices, and if the market is cycling in the wrong direction when you want to sell you might find yourself disappointed.
Buying a property that you believe (through thorough research) will appreciate over time isn't a bad idea at all. However, it's best not to solely rely on appreciation and hold a property with negative cash flow for twenty years expecting a big payout in the end. Instead, you'll also want to look for a property that provides positive cash flow right away.
Related to the above point, anyone who is expecting to hold real estate as a long-term investment would benefit from researching market cycle theory. The idea is that there are four primary, cyclical phases to markets, which are:
While the accumulation/recovery phase is typically listed as the first phase of a market cycle, it's important to remember that this is a cyclical process.
During the recovery phase, the market has found its bottom after a recession phase. Property is cheap, rental rates are low, and there isn't much new construction occurring. Experienced investors and market insiders start to buy back into the market, while homeowners and renters might struggle to see that recovery has begun.
When the expansion phase begins, the market is very strong after having fully recovered from the recession. Rent rates are high and going higher, vacancy is low, and home values are high. It's also common to see new construction at this point. For new investors, this can be a good time to buy, as it is difficult to time the bottom.
During the hyper-supply phase, high demand starts to be outpaced by supply. Vacancies start to increase and growth in rent starts to slow down. Some investors will buy at this point as other owners start to get nervous about an oncoming recession, and the purchasing investors plan to buy and hold so they can cash out when the market returns to an expansion phase.
Finally, there is the recession phase. Supply far outweighs demand and there are high vacancy rates. Rent growth turns negative or at least is rising below the inflation rate. Some investors will buy at this point in order to grab foreclosed properties and others at rock-bottom prices, but it can certainly be nerve-wracking to do so.
If we haven't overwhelmed you yet with tips for beginners, stick with us while we check out a few more nuggets of advice.
Buying real estate can offer some truly awesome tax benefits, but it's important to firmly grasp exactly how you can use your investment properties to your advantage when reducing your tax burden. Tax law is complicated, and it's not a bad idea to work with a real estate attorney and tax professional when you create your investment strategy.
Rehabbing a property on your own can save you a lot of money, but it's important to remember that you'll be spending a potentially more valuable asset: your time. Depending on your experience with doing repairs and renovations, you might find that it's worth hiring out the work.
The same is true when it comes to property management. Being a landlord and maintaining a property isn't as easy as you might expect, and some might find that hiring out management is worth the cost.
If you have more time than money, you'll likely be able to get the most bang for your buck by doing rehab work and management work yourself.
Here are a few more tips to chew on:
Investing in real estate for the first time can be exciting and terrifying all at once. When you get to the point of being a seasoned investor with decades of experience under your belt, you can feel free to take all the risks you want to. In the beginning, though, it's a good idea to be more cautious and tempered.
Buying a property simply because you have a great gut feeling about it really isn't enough when you're first starting out. Sure, it might work, but you're ultimately leaving things up to chance. If you want to build a sustainable real estate investing business, you'll need to carefully analyze the numbers and make sure they add up in your favor.
To help you identify properties that will produce positive cash flow and otherwise support your financial goals, you can use our rental property calculator.