Residential real estate investing is something that’s incredibly simple and complex at the same time. At the conceptual level, we all understand the end goal of buying property, letting it appreciate over time, and cashing out at a later date.However, moving from someone who owns simply owns real estate to someone who strategically invests and scales their portfolio requires a little more legwork—especially if you want to maximize your returns. There are also multiple investment strategies with real estate, and understanding your options will help narrow down the best approach for you.
But first things first. In this article, we’ll run through a starting checklist for residential real estate investing, beginning with strategy, tips as you go through the process, and conventional advice you might want to think twice about.
- Strategy - what's right for you?
- Quick checklist
- Conventional wisdom to ignore...or at least think twice about
There are plenty of residential real estate investing strategies, all varying in complexity. For the sake of this article, we’ll focus on high-level strategies to help get the wheels turning about which one might be a great fit for you.
Fix and Flip
The fix and flip business model is exactly how it sounds. This is where you find a property that you believe you can renovate and resell for a profit. This is usually a short-term investment strategy used by seasoned investors who can spot a good deal. Additionally, seasoned investors typically have connections and relationships with contractors they can call on right away to get renovations done within budget.
It’s important to note that short-term real estate transactions are taxed differently than long-term investments (longer than a year). We’ve compiled a list of easy to understand tax tips for real estate investors we recommend reading.
The self-managed strategy is one where you as the property owner will also take on the management responsibilities. This approach is often considered by real estate investors who live close to their properties and have the bandwidth/moxie to handle things like maintenance, tenants screenings, paperwork and marketing the property, not to mention staying abreast of current landlord-tenant laws and regulations. This strategy restricts your purchasing footprint since you’ll want to be within reasonable driving distance in case of emergencies or fix-it issues. On the flip side, you’ll receive 100% of the rent while taking on a full landlord role.
There are myriad benefits to going with a professional property manager. They save you time, stress, and even money by avoiding problems that could lead to legal fees, vacancies, and damages related to mishandled repairs. Working with an experienced property manager who knows the local market and rental dynamics also frees you up to invest without geographic barriers, and own income properties in markets that meet your budget and investing goals. (Buying outside your primary market is also a great strategy from a diversification standpoint). Remote residential real estate investing is a growing trend and we're seeing more and more of it at Roofstock. In fact, the majority of our buyers live more than 1,000 miles away from their properties.
1. Get pre-approved
If you're serious about buying an investment property, it's helpful to get pre-approved for a mortgage. By doing this, you’ll have an idea of what you can and cannot afford. Contact your local bank or mortgage officer to figure out what the top end of your price range is so you know where you stand. You can also take advantage of turnkey real estate marketplaces such as Roofstock, which provides trusted partners for all aspects of the investment process—including finance, insurance and property management.
It's also helpful to have a discussion with your lender about the type of loan that makes sense for you. For example, a 15-year mortgage may have lower rates and allow you to pay off your investment properties faster. With a 30-year loan, however, your money isn't as tied up. You may enjoy higher monthly cash flow and the added flexibility to use that income for an emergency fund or save it up for your next down payment on another investment property. It all depends on your budget and residential real estate investing criteria and knowing this upfront will help move things along. Be sure to consult your professional financial advisor about this.
Tip: When you purchase an investment property on Roofstock, you are free to use your own lender or one of our certified lenders. You can leverage Roofstock's resources and partners as little or as much as you want.
2. Set a few goals
These don't have to be set in stone and will likely evolve as you become more versed in the residential real estate investing space. But generally speaking, defining what's really important to you from the outset will make the decision process easier and also help you avoid analysis paralysis when narrowing down the sea of investment property options. Here is an example of some fundamental things to consider at the start of your investing journey:
- Budget: Set a threshold that makes sense for you (and your wallet) and stick to it. If you're financing, you don't want to over-leverage yourself.
- Risk/return tolerance: This is not absolute, but sometimes lower-yielding properties tend to be safer investments and higher-yielding homes come with a little more risk. Both potentially have a place in your rental portfolio—it's just a matter why you're investing in rental income properties and what you hope to achieve. Are you looking for higher monthly cash flow, more stability, or something in between?
- Appreciation: This is the increase in the value of your investment property over time. If higher monthly cash flow isn't as critical and you care more about building up equity over time, you might focus on properties with higher appreciation potential. Knowing this will help you in narrowing down your options. For example, you might focus on relatively "newer" properties (for example - built after a certain year such as 1980), certain markets, neighborhood qualities, etc. and less on cap rate or monthly cash flow.
- Cap rate: This is the estimated rate of return on an investment property. Cap rate is calculated by dividing net operating cash flow in the first year by the property purchase price. At Roofstock, our marketplace features a variety of cap rates generally ranging from 4-11%. As we touched on earlier, different cap rates (in theory) can signify varying levels of risk. Higher cap rates may correlate to a higher amount of risk in the purchase, and vice versa. This is why it's helpful to consider your threshold for risk vs. return.
Tip: Roofstock provides everything you need upfront to evaluate rental investment properties, including estimated returns, appreciation, inspection reports, market and neighborhood data and much more.
3. Learn some industry lingo
Like many first-time real estate investors, you've probably been browsing forums on Bigger Pockets, checking out articles from Landlordology, downloading Listen Money Matters podcasts, and spending some quality time with Investopedia (or not...we don't judge). What may seem like a lot of industry jargon and endless acronyms—1031s, REI, REITs, NOI, leverage, LTV, amortization, Cap Ex—will all become familiar territory in due time. By learning more about the language investors use—and not just what it is, but why it matters—you’ll feel more confident and be in a better position to make informed decisions.
4. Be conservative when it comes to estimating your costs
From closing costs to unexpected vacancies to renovations and fixes, there's a good chance operating costs will be more than you initially expect. This doesn't mean you made a bad investment, it just means your expectations around potential operating expenses may have been underestimated from the outset. Some costs are easy to predict. These include basic operating expenses, closing costs and other assumptions outlined in your financial pro forma such as property taxes, management fees and insurance (Tip: Roofstock provides all of this for you upfront, which will help you budget accordingly when you're getting ready to purchase an investment property). Other expenses are impossible to foresee and simply come with the territory of owning rental property. We suggest maintaining a minimum contingency fund of about 1-2% of the purchase price.
5. The place you buy doesn’t have to be in a place you’d live
Judging a property based on curb appeal alone is a common mistake new real estate investors frequently make. While it’s natural to form an opinion based on personal bias, remember: You’re not the one who's moving in. Instead, ask yourself: "Is the property I'm buying going to be desirable to some set of tenants? Whether it's a retiree, a group of college students, a family with kids in high school or someone who needs to live near the airport, different things are going to matter to different people. As an investor it’s not about your personal preferences—it’s about whether the property will drive the the kind of returns you're looking for. Don’t pass up a property based on aesthetics alone as some of the most profitable rental homes don’t look that special at first glance.
"It's not an emotional buy like it would be for a home that you're going to live in, where you fall in love with the countertop or the backyard. You're looking at what's the data, what's my return, and where do I want to invest?"—Gregor Watson, Roofstock Co-Founder & Chairman
6. Focus on the area, not just the home itself
As an investor, location should be an important factor in your purchase decision. Is the city growing? Does it have a diversified economy? Did a major company recently re-locate there or open a second headquarters? What about the neighborhood? How are the schools and what kinds of nearby amenities are there? Do a little research on the market(s) you're considering (this can actually be kind of fun and exciting) to get an idea of what's happening in the area. You can even speak with a local property manager and get their take on the rental market dynamics. Tip: At Roofstock, we can connect you directly with one of our certified property managers who would be happy to give you some additional insight.
7. Partner up
The company you keep will define who you are as investor and help you get the most out of your investment properties. By leveraging the tools and data of today with the knowledge and services of traditional real estate professionals, the possibilities increase tenfold. From property managers and real estate agents, to handy apps and software, to innovative marketplaces that let you buy turnkey properties fully online, they all have value to provide.
Conventional wisdom to ignore...or at least think twice about
1. You should own where you live before you buy a rental
Successful real estate investor Grant Cardone says, “you should rent where you live and own what you can rent to others.” He says this because it gives you more flexibility to scale as a real estate investor. There is nothing wrong with owning your own place, of course. But suggesting it’s necessary to own your home before you can become an investor is an increasingly dated school of thought.
2. You should buy locally
Speaking of dated things, here's another one: The idea that you have to purchase all of your rental properties near where you live, because it will give you the access and security to handle issues as they arise.
This advice would have been a lot more useful before we had the Internet, or end-to-end real estate investing solutions like Roofstock. Today, you can own investment properties thousands of miles away from where you live, which frees you up to invest in the market that's right for you. It's easy with a trusted local property manager and smart technology that lets you monitor and track the performance of your rental portfolio from anywhere.
3. You need to spend a lot of time working on/managing your properties
This is a yes and no myth. If you decide to go with the self-managed investing approach, you will undoubtedly clock a lot of hours into running your property—especially once you scale your portfolio to include more than a couple homes. Alternatively, you can take a more passive approach and separate investing from the day-to-day tasks of being a landlord by hiring a property management company.
4. You need a lot of money to get started
Investment properties that cash flow and cost less than $100K really do exist—you just have to know where to look (hint: it's the Midwest and South). For as little as $20K down, you can own a quality investment property that generates passive income and helps you build long-term wealth. We know $20K isn't chump change for the everyday investor, but saving up for that down payment is definitely attainable with a plan and a budget.
5. You should wait for the next crash before investing
If there’s one guarantee we’re going to make in this post, it’s this: no one can fully predict the future real estate market. Rather, we like the approach of top investment minds like Ray Dalio and Warren Buffett: They focus on the fact that you can’t predict the future but you can prepare for it. And as the old Chinese proverb goes, "The best time to plant a tree was 20 years ago. The second best time is now."
6. You should pay for the seminar that’s being advertised to you
Pause before forking over thousands of dollars to attend a local real estate seminar or receive coaching from a "guru." It's hard to measure what kind of ROI you'll get out of this, if any. Nowadays, there are so many fantastic (and free) educational resources for real estate investors, some of our favorites being podcasts, forums and blogs.
For newbies, investing in your first rental property can be equally exciting and terrifying. One of the best advantages you can give yourself is to continually seek education, community, and new technology that streamlines processes and enables better decision-making. This is a journey, and you don't have to go it alone.