Why Invest in Real Estate?
Real estate has been proven to be one of the best vehicles to achieve wealth. Different investors have different methods but whatever method you choose if done correctly you can become wealthy and financially independent. There are several ways to invest in real estate that are relatively safe. The problem and main reason people lose money is because they are speculating not investing. If you invest and the numbers check out it will be difficult to lose money with real estate. The best part of investing in real estate is the passive return that you will receive. If you find the right property that meets your investment needs you can cash-flow every month without lifting a finger. Your money is now working for you as opposed to you working for money! Once your money starts working for you it is easy to accumulate wealth.
Different ways to Invest
There are many ways to skin a cat (sorry cat lovers). There are multiple approaches to invest in real estate. Some are more passive than others. We will be focusing on the more passive ways to invest in real estate. We will be focusing on passive ways to invest because the other ways can be quite time consuming, in some ways they become a job. Remember we want our money to work for us not us working for money. Having said that the types of real estate investing that we are going to look at will be single family real estate investing, multi-family real estate investing, REIT (real estate investment trust) and Vacation Rentals.
Single family real estate investing is an investment vehicle that a lot of people choose to get into real estate investing. I would argue that multi-family investing is better but let’s look at single family investing. Single family real estate investing is very simple; it involves taking control of a house either by buying it (outright or with a mortgage), getting it subject to a loan or getting it with a lease option are popular forms among others. Purchasing techniques can be learned about in a different article. Once the house is acquired you rent it out for more than ALL your expenses combined. This is where it becomes a numbers game. You need to check the math on all real estate that you plan on purchasing BEFORE you buy the house. This sounds like common sense but you would be surprised how many investors buy a house because they think it is a good deal but end up losing money every month. To sum it up you buy a house and rent it out for more than ALL your expenses combined. Some investors will factor in price appreciation for the house, tax benefit and other factors that do not affect cash-flow. I do not invest this way. If the house cannot NET me a positive cash-flow every month I do not desire the real estate. (I do not invest for anything other than cash-flow.) This is the point of if you invest correctly it will be hard for you to lose money. The drawback to single family houses to me is that if the house is vacant (nobody paying rent) I am stuck with the entire bill myself. This is why I prefer multi-family real estate investing more than single family real estate investing.
Multi-family real estate investing is the same as investing in single family residence except there are more than one unit per building. In other words you have more people paying the bills. There are multiple benefits of investing in multi-family real estate as opposed to single family real estate. When you buy a multi-family the cost per unit is typically lower than single family homes. For example if I buy a single family for $100,000 the cost per unit is $100,000. If I buy a 2 unit multi-family (known as a duplex) for $140,000 the cost per unit is $70,000. Another benefit that multi-family investments have over single family investments is that when a unit is vacant you are not paying 100% of the bills yourself you have other tenants “helping” you pay the bills. For example if your monthly bills for a single family investment are $1,200 per month total and the tenant moves out you are going to pay $1,200 every month the unit is vacant. Now let’s say you have a 2 unit multi-family investment. The monthly expenses are $1,500 per month and the rent from each unit is $900 per month ($1,800 total per month). If one unit goes vacant you would only need to pay $600 per month of vacancy ($1,500-$900=$600). This can be a big benefit! The drawback in some investor’s eyes is that you typically have double the appliances and other things that can go wrong so it could be more expensive to fix. This is true but there are also fewer big item things in multi-family investments, the roof for example. Also the likelihood that all the appliances will need to be replaced at the same time are small and if you budget correctly when buying the investment you will have reserves to cover the costs. With this type of investing there is still a little bit of risk involved. Some people prefer even less risky ways to invest in real estate such as real estate investment trusts (REITs).
REITs are the most passive form of real estate investing for beginners. Real estate investment trust is in most cases a company that owns and operates commercial real estate and you invest hoping to get a return. This is typically a safe way to invest because the investment is backed by real estate but like all investing there is some risk involved. The return that you get on a REIT is typically a lot lower than you could get yourself if you own the real estate. More information about REITs can be found in other articles. REITs are not as “fun” as some other types of investing. Some investors wish to invest in vacation rentals because they are able to use the investments once in a while and some even retire in the vacation homes mortgage free!
Vacation rental real estate investing is a great way to get a property, and then have other people pay for it. It doesn’t matter if your plans are to one day retire and live in the house or just to hold as an investment. Investors will buy a vacation rental in a desirable area such as a ski house or a beach house. Then they rent the property out and have the rents pay for the mortgage. This is very similar to single family real estate investing except the term of rental is much much shorter. Some homes can demand more than $3,000 per week during peak season. There is a lot to know about when investing in vacation rentals. How long the peak season is, how many seasons are peak, how long works best to demand the most profit are just a few things to consider. The benefit is that if you do it right and buy the vacation real estate early enough the people renting will be paying for your dream home. Just as with all other forms of investing it comes down to the numbers.
It’s a numbers game
As I stated earlier it all boils down to the numbers. This is where in my opinion a lot of investors go wrong. They will not calculate all the expenses, forget to add the profit that they need, bank on appreciation when there is none, calculate profit before debt service and end up losing money after debt service. There are a lot of ways to go wrong here. In order to calculate if an investment is worth, while there are a few different ways to do it, this is how I do it. I first take the property that I am looking at and research it. I look up how much the taxes are, get a estimate of insurance costs, drive the neighborhood during the day and at night, find out what current rents are, compare current rents to market rents. After that I perform my “cash-flow” analysis, notice I do this before I look at the property.
This is an example of what my calculations look like when analyzing a property that rents for $700 and $750 per unit and costs $134,500 (assumptions 20% down with a 30 year conventional mortgage):
This is not a “cash-flow” that I would be interested in buying at that price. I look at it as if I am buying a cash-flow because that’s really what you are doing. For my down payment of $26,900 plus closing costs I would be getting a $245 per month cash-flow. A 10.9% return on cash ($2,940 first year return / $26,900 down payment= 10.9%) in the first year is nothing to laugh at, it beats most markets, but there are even better deals out there for my money. This is how I analyze every property that I am interested in. Maybe the previous example is a great deal if I could get the seller to reduce their price or maybe even hold the note at very agreeable terms with little money down. This is where a true investor shows his or her colors by being able to “create” deals. Take the previous example; let’s say we are able to convince the seller to carry a note on the house. We negotiate that we will give the seller $5,000 down and make payments of $500 per month till the note is paid off. Because the seller agreed to carry the note they wanted a higher price for the house so we agreed to pay $145,000 for the investment. This is not an issue because we are worried about the monthly cash-flow and return.
Our new return becomes $323.33 per month or $3,880 annually. The new return on cash for the first year is a whopping 77.5% ($3,880 annual return / $5,000 down payment = 77.5%)!!! I would much rather purchase a $323 per month cash-flow for $5,000 than a $245 cash-flow for $26,900.
You can see how deals can be “created” from what seems to be a bad deal. No matter what the fundamentals must remain. You need to calculate all of your expenses including debt service to see if the deal is worthwhile. You must determine the level of risk you feel comfortable with and how much you are willing to “pay” for a cash-flow. Some people will pay more for certain cash-flows because they find the property to be much safer than another. Sometimes you would pay a lot less for a cash-flow because the investment is not appealing as others. This is where personal preference comes in but in no instance (except vacation rentals in some cases) should you be willing to lose money per month on your investment.