In this episode of Getting Money Right we’re talking about investing in real estate. We’re going to go over the types of real estate investing available and drill down on two or three that are most common for the average investor.
Why Invest in Real Estate?
- Diversification - multiple streams on income
- More control than stocks or bonds
- Multiple tax benefits not available with other types of investments
Types of Real Estate Investing Options:
- Single-Family Home
- Duplex/Multifamily - 2 to 4 units
- Fix and Flip
- Many, many, other types of real estate investing -
- Commercial (offices, retail)
- Wholesaling - deal making (find a buyer and connect to a seller)
- Large apartments multi-family - 5 or more units (8, 16, 32, 64, 100+)
- Mobile home parks
- Owner finance owned properties
Multiple benefits of Real Estate Investing
- Equity - Value of property increase
- Write off for depreciation - less taxes/more income (explain this)
- Cashflow - make money each month to reinvest or pay down principal
- Returns are usually higher than investing in the market and you have more control (12-15% or more)
- ROI (Return on Investment) = Gain (Gross) - Cost / Purchase Cost
- Leo's results:
- $113,000 purchase price
- 25% down - $32,500 (down payment and closing costs)
- Average gain $16,700 (Gross) - $11,111 (Cost) = $5589 (Net Gain)
- $5589 / $32,500 = 17.2% average (11.4% - 29.6%)
Real estate associated costs and requirements
- 20-25% down
- Loan Payment - Principal and Interest (online mortgage calculator)
- Insurance - Agent quote
- Taxes - County Tax Assessor
- Maintenance - 1% of property value per year for maintenance. Ex. $200,000 value = $2,000 in maintenance cost.
You can buy or build the property, or pick it up on a short sale or foreclosure. You may want to buy a fixer upper and flip it, or rent it out for income. Investments can be rather modest compared to those for larger properties and are generally 15%-25% of the total value of the home with a personal guaranty on the loan.
- Longer tenant leases can yield a higher annual ROI.
- Value increase through upgrades and repairs - value may greatly exceed purchase price.
- Holds its resale value if the community is thriving and the home is well-maintained.
- Property taxes are often lower than those for multi-family units and commercial real estate.
- Less diversified rental income cash flow compared to multi-family properties. If the one tenant moves out, you have no cash flow from the property until you find another tenant.
- Property costs may be higher due to homeowner association fees.
- Fix-up costs may be high and you may have to renovate the property before renting it out or selling it.
- Turnover cost could be high - More square feet to clean and repair between tenants.
Usually two to four units, this is a popular investment for those just starting out. Owner occupancy is possible and is generally 15%-25% of the total value of the home with a personal guaranty on the loan.
- Less risk of zero income.
- Always in demand.
- Spreads costs of improvements and repairs over multiple units.
- If four units or less, doesn't require special financing.
- Convenient to manage rather than having multiple single-family homes geographically dispersed.
- Can choose to passively invest in a professionally managed property.
- Higher turnover rate in multifamily - turnover is costly because property must be cleaned and repaired, plus the legal fees and other associated costs could eat into your profit.
- Higher taxes due to higher value.
Real Estate Investment Trusts (ReiTs)
- Passive investment in real estate.
- Mutual Funds that hold real estate assets.
- Similar returns as the general market.
Other things to consider
- When looking to buy, take a general contractor with you to inspect the property - motivated to find issues because you’ll probably hire him to do the repairs
- If you don’t have adequate knowledge of property condition, hire an inspector ($500) - well worth the cost.
- Include a termite inspection when necessary ($100) - do this either way!
- Learn your state laws regarding renters and landlord obligations.
- Knowing what’s expected of you and what the renter’s obligations are will prepare you to navigate through issue that may come up and keep you legal.
Fears of real estate investing:
- Nightmare renters: not typical and can easily be avoided by knowing how to screen your tenants. Avoids 95% of bad renters.
- Maintenance issues (inspection and basic knowledge, which can be learned will keep this number low and manageable).
How to succeed?
- Save the first year’s income and build a cash cushion for unexpected expenses - the property should support itself through rents not through ongoing cash infusion from you.
- Run it like a business - separate budget with all expenses allocated for (taxes, insurance, repairs and replacement costs, etc.).
- Take the profit and reinvest or pay down the mortgage.
- Don’t think of this money as a way to increase your lifestyle. Think of the long-term benefit!
- The Intelligent Investor by Benjamin Graham
- The ABC’s of Real Estate Investing by Ken McElroy
- The Book on Investing in Real Estate with No (and Low) Money Down by Brandon Turner
- What Every Real Estate Investor Needs to Know About Cash Flow by Frank Gallinelli
- The Millionaire Real Estate Investor by Gary Keller