Andrew Carnegie once said that “Ninety percent of all millionaires become so through owning real estate.”
If your goal is to become one of the 90%, keep reading to learn why so many people today are moving out of the stock market and into investment real estate.
Biggest Benefits of Real Estate Investing
No other asset provides the same benefits – all at the same time – that investment real estate does. Here are just a few of the biggest benefits of real estate investing:
- Net cash flow is similar to a dividend-paying stock, although the real estate the cash flows are much larger
- Appreciation over the long run historically outpaces the rate of inflation, making real estate the ideal hedge in any economic cycle
- Leverage can be used to buy rental property that produces double-digit cash-on-cash returns
- Low correlation between real estate and the stock market helps to insulate you from unpredictable stock market gyrations
- Value add improvements and updates allow you to increase rents to market, which in turn increase property values and equity
- Easy to diversify an investment portfolio with the power of long-distance real estate investing
- Multiple ways of investing in real estate include direct ownership of single-family houses and small multifamily property, crowdfunding and joint ventures, and private and publicly held real estate investment trusts (REITs)
- Tax benefits allow you to deduct operating and ownership expenses from gross income, while depreciation expense reduces taxable net income while potentially shifting into a lower tax bracket
When is the Best Time to Invest in Real Estate?
You’ve probably heard people say that when it comes to investing in real estate, you should “start as young as you can.”
While that’s true with most things in life, the fact is that it’s never too late – or too soon – to invest in real estate. However, before you invest, it’s important to understand the different ways to invest depending on your age, earning potential, and net worth:1. Investment Strategy
There are three main real estate investing strategies you can choose from. Some investors stick to only one, while others mix-and-match depending on the unique opportunities in different real estate markets:
- Core real estate is a newer property requiring no repairs, with a lower overall return in exchange for a lower level of risk.
- Value add real estate is often considered the sweet spot of investment real estate because it has a balanced blend of risk and reward.
- Opportunistic real estate is the preferred strategy for investors who fix-and-flip or develop property from the ground up, with a high level of potential return accompanied by a very high level of risk.
- Class A real estate is a property built within the last few years and generally provides more appreciation than cash flow.
- Class B real estate includes workforce housing rented to government and service workers, generating solid cash flow and average appreciation.
- Class C real estate includes “cash cow” rental property that throws off large amounts of cash flow but very little appreciation.
3. Investor Age
As a rule of thumb, the younger you are the more risks you can take. That’s because you have more time to recover from any mistakes and also wait for potential future returns. But as you age, your investment objectives change. The older you are, the more assets you have, and the more risk-averse you become.
For example, millennial investors in their 30’s may opt for an opportunistic investment strategy blended with Class A rental property. The first option generates consistent cash flow while the newer rental property is one way to invest for appreciation over the long-term.
On the other hand, baby boomers in their 50s may decide to put part of the retirement savings they’ve accumulated into a self-directed IRA for investment real estate.
There’s no limit to the initial rollover, and the cash flow generated from Class C and B property isn’t taxed as income until normal IRA withdrawals begin. Adding some Class A real estate to the mix is also a good way to help preserve capital.
4. Net Worth
Accredited high net worth individuals (HNWI) of any age frequently choose real estate to diversify assets and shelter income. While any investor can benefit from the tax benefits of owning income producing property, the higher your net worth the more money you need to protect from taxation.
- Real estate is an accepted alternative investment
- Inflation hedge of yield, leverage, and capital gains
- Stable returns with modest growth of capital
- Low correlation to the general stock market
- Residential income property performs well in all economic cycles
- A real asset that can be seen and touched
How to Start Investing in Real Estate
One of the most important things to keep in mind about investing in real estate is that real estate is not liquid.
If you own a stock and decide you made the wrong choice, you can sell online in less than 60 seconds. Selling real estate can take up to 60 days, sometimes much longer.
So, when you start investing in real estate, it pays to plan ahead so you can avoid making a mistake in the first place:
Start Small and Think Big1. Pay with cash or use a large down payment
Real estate prices have been steadily rising over the last 10 years, and even with the economy the way it is today, it looks like property prices are still going up. So, paying for real estate with cash may seem like a dream. But believe it or not, there are plenty of good deals on the market today if you know where to look.
For example, Roofstock’s investment property marketplace has almost 100 rental houses in decent neighborhoods across the country with asking prices of $100,000 or less and monthly rents of $1,000 or more.
Paying with cash makes it easier to quickly lock in real estate bargains, then refinance at a later date. Making a big down payment can also make it easier to get approved for a loan, by focusing on an LTV (loan-to-value) of 75% or less.
With both options, your cash flow will be greater, giving you time to learn the real estate investing business without having to worry about negative cash flow.
2. Crunch the numbers and analyze each market
Macro factors you can look at to determine how good a market is for rental property investing include:
- Population and job growth
- Median household income levels
- Percentage of renter-occupied households
- Vacancy rates and median rents
- Property value trends
- Neighborhood and school rankings
- Crime rate
Once you’ve narrowed down your market choices, you can dig deeper into the potential performance of selecting property by looking at financial metrics such as:
- Net operating income (NOI)
- Net rental yield
- Cap rate
- Net cash flow
- Return on investment (ROI)
- Cash-on-cash return
- Internal rate of return (IRR)
- Weighted occupancy
- Debt service coverage ratio (DSCR)
- Loan to value (LTV)
Finally, create a pro forma financial statements that includes individual line items for income and expenses:
- Gross rental income
- Other income such as application or late fees
- Vacancy and credit loss
- Expense items including leasing and property management fees
- Repairs and maintenance
- Property taxes and insurance
- Contributions to a capital reserve account for future major improvements
Sometimes real estate investors have their eye on a property that isn’t actively listed for sale.
If you’re wondering whether or not a single-family house would make a good rental property, Roofstock Cloudhouse is the perfect tool to use. By entering the address of any house in the U.S. you can receive a complete forecast of potential return.
3. Scale up one property at a time
Some investors begin by buying a turnkey single-family rental house that is already rented to a good tenant. Cash flow starts the day escrow closes, and the risk of unexpected repair expense is minimized because the property has been pre-inspected. Other investors focus on ‘units’ or “doors” by investing in small multifamily property to generate more cumulative cash flow.
Either option is a good way to learn the best real estate investment strategy for you. While your property manager takes care of the property and your tenants, you can focus on funneling your free cash flow into a special account for future investments.
After a surprisingly short period of time, you’ll have enough capital accumulated to buy another rental property. As your real estate investing experience grows, so does your comfort level, and scaling up your portfolio with more income-producing property becomes easier and easier.
Avoid These Potential Problems1. Focusing on appreciation
Many beginning investors focus on property appreciation with the mistaken belief that prices always go up. Historically, real estate prices do rise, but there are always peaks and valleys along the way. Buying a property for appreciation that is cash flow negative is usually a big mistake.
2. Overestimating income and underestimating expenses
Entrepreneurs – and this includes real estate investors – are an optimistic bunch. While that’s an important trait, being overly positive can also lead to another big real estate investment mistake.
Be sure to include a market vacancy and bad debt factor to reduce your income projections, and allocate 15% to 20% of your monthly gross rental income for recurring maintenance expenses.3. Managing your own property
When you’re just starting out in real estate investing it’s tempting to cut corners by trying to self-manage your rental properties. On the one hand, that’s perfectly understandable, because most property managers charge a fee of between 8% and 10% of your gross income. However, successful investors view property management fees as an investment instead of an expense.
Great rental property managers handle the daily details of tenant issues and repairs, dealing with vendors, and increasing the market value of your property. A good local property management team also makes it very easy to be a long-distance real estate investor, and own rental property in markets where prices are lower and potential returns are higher.
Where to Find Investment Real Estate
Unlike a generation ago, finding the right investment real estate is extremely easy today. Some people decide to work in real estate full-time as active investors. Others take the more common route by passively investing in real estate through direct or indirect ownership options:
- REITs own and operate real estate in specific asset classes such as residential homes, apartment buildings, health care, or commercial real estate.
- Crowdfunding pools money from large groups of investors to buy or develop large Class A real estate projects such as luxury apartment buildings or ground-up development.
- Partnerships offer the opportunity to invest as a silent partner while others use their skill and knowledge to actively develop and manage the project.
- Foreclosure and rehabs are two classic, active investment strategies that are a good match for experienced investors with the time and in-depth market knowledge to turn a high-risk investment into a potentially high reward.
- Turnkey rental property offers a good blend of cash flow and ease of getting started, because all repairs have been done and cash flow begins the day escrow closes.