We often get contacted by people looking to buy a residential investment property. In some cases, they already own a primary residence, and in others, they are first time buyers looking to rent part of their primary residence (e.g. buy a duplex).
I’m heartened that people are recognizing that investing in real estate can be a path to wealth creation. That said, many people may not realize just how big of an investment buying a piece of property can be.
Think about it, you probably spent months deciding which school to attend, car to buy, or health insurance plan to participate in.
Buying property will probably be a bigger financial investment than all three of these items combined so it’s absolutely imperative that you do your homework and be properly prepared.
I see people on social media with flashy cars and jewelry preaching how you should take their online course where they will tell you what you need to do to get rich quick like them.
You don’t get rich quickly in real estate; you get rich SLOWLY. It takes research, time, and patience.
It is absolutely possible to get rich with the right investments. However, you can also get yourself into a lot of financial trouble if you’re not careful so it’s important that you have a clear and complete understanding of your potential investment.
This brings up another point. Real estate is an illiquid asset-meaning, it’s not easily converted to cash. If you buy a stock on any of the major stock exchanges, you can easily convert your stocks to cash pretty quickly.
However, if you buy a duplex, for example, and you find yourself needing cash, it usually takes several months before you’re able to do so.
This is just one of the reasons why you should have an emergency fund to cover unexpected expenses. Repeat, do not buy property without having this rainy-day fund to cover emergency expense.
How much? It varies depending on your situation, but generally speaking, you should probably have 4-6 months’ worth of savings in case you lose your job, have sudden health issues, or even damage to your property.
I can’t stress this enough. Yes, it’s possible to put no money down when buying a property, but it’s absolutely imperative that you have money set aside to cover unexpected expenses.
In short, the ideal circumstances for you to invest are time, patience, and cash.
How To Invest In Real Estate
Now that we’ve covered the risks, let’s turn our attention to how you can potentially go about investing in residential real estate.
Full disclaimer, while I am a licensed real estate agent, I am not a seasoned investor who has made millions of dollars through real estate.
I am not going to share some amazing secret or formula that, when followed, will give you guaranteed results to make you an overnight millionaire. That said, you should run, immediately, if anyone claims they can help you get rich quickly.
This article is for the vast majority of people who are new to real estate investing. You should do your own research to decide which strategy is best for you.
And please, take the time to get your finances in order. Real estate isn’t going anywhere.
*Except in areas like LA and the Bay area where there’s a housing inventory shortage*
Types of Residential Investments
Every investor has their own strategy and they can all be successful under certain conditions. Some people like the fix and flip approach, popularized by TV shows like Fix or Flip and Property Brothers.
Other investors take a long-term approach and they buy and hold. In other words, they buy a piece of property and then wait for it to appreciate.
Generally speaking, in real estate, time is your friend. Property values tend to appreciate (go up in value) over time so if you’ve acquired land or, ideally, a structure on a piece of land, your investment will usually have a greater pay off the longer you wait.
Every housing market is different. It takes years for most real estate agents to fully understand their market, after years of helping people buy and sell homes and poring through MLS data.
Investing in an area that you know because you have lived there for several years is advantageous because you know the local market. You’ve seen the ups and downs of your neighborhood; you probably know the schools, churches, and even the individual residents.
The second advantage to staying local is that should you decide to buy a property that you will ultimately rent, you can make yourself readily available.
Being a landlord comes with responsibilities such as being available to make sudden repairs. There’s a good chance that you know a local handyman or contractor to help you repair an electrical or plumbing issue.
Being available to your tenants, and generally keeping an eye on your investment (as opposed to paying an property manager to do so) is usually much easier if your property is a short drive away from your primary residence.
You may also know other people that will come in handy such as accountants, real estate agents and attorneys.
Start Small – Single Family Houses & Duplexes
The bigger the risk, the bigger the reward. Yes, this is true. But the risk increases exponentially if you are not an experienced investor. There’s really no good reason to gamble with your money.
Most people have a goal of being able to generate passive income. Don’t buy a big multifamily property. Start small with a Single family house, or a duplex that is well within your budget.
This is of course after you’ve done your homework on the ideal location and worked with one of our partner real estate agents to help you close on a suitable property.
Our partner agents can provide you with detailed advice depending on your requirements, but generally speaking you want to keep the following in mind.
- Location, location, location: is the property in an area that will attract tenants to ensure that you can easily rent it out? Is there nearby transportation? A nearby college or school district? Away from busy streets etc…
- Is the property in good shape? Make sure there’s no structural damage to the property (water, fire damage, issues with the foundation).
Real Estate Math
- First, figure out what your mortgage, insurance, and maintenance payments will be.
- Next, determine what you can charge for monthly rent and what your expected occupancy rate will be.
- Subtract this potential rent revenue from your mortgage * 12 = Your expected Annual profit. Rent prices in your market will hopefully increase, but your mortgage(ideally) should be relatively fixed, increasing your profit margins.
The vast majority of investments follow this basic formula. The only difference is the size of the property. A multifamily unit will have more tenants and more potential cash flow. But again, it’s a riskier investment.
What if you can’t rent out all of the units? Guess what, you’re paying out of pocket. Did you miscalculate the overhead costs? Or the rate of appreciation? Is the property out of state? You may need to pay for a property manager. Maintenance issues multiply with more units…You get the point.
If you start small, you’ll get much better at knowing your numbers. This comes with time, patience, and experience. Then, by all means, feel free to buy a 2nd, 3rd or 4th single or multifamily unit. Eventually. Get rich….slowly.
We see this one a lot. This is also a great way to dip your toes in the water of real estate investing.
In short, you buy a residence you will live in, then rent out part of the residence. The most common structure is a duplex, where you live in one half and rent out the other half.
If you have a slightly higher appetite for risk, you can go for a 3 or 4 building unit. Keep in mind you’ll have to ensure that all 3 units are occupied year-round with tenants or again, you’ll be losing money because you’re paying out of pocket.
Best case scenario, you can eliminate (or drastically reduce) your mortgage. Then, once you’ve generated enough savings, and built up a decent amount of equity in your duplex, you can take out a home out equity loan to fund the purchase of your next property.
Tip: Have you actually thought about what it’s like to have a roommate (separated by a wall of course). Did you hate having one when you were younger?
Perhaps you may want to start by renting out a part of your property to AirBnB tenants on a short term basis before you commit to long term agreements.
Fix and Flip
This is higher on the risk scale. You invest in an underpriced home or one that needs some rehab work, then resell it a short time later for a profit.
This is not as easy as it is made to seem on TV. Again, this is not easy. In fact, it can be pretty risky because there are more moving pieces where miscalculations can end up causing you to lose money in a hurry. You can flop very, very easily.
Math involved in house flipping
- A good realtor can help you acquire a property that may be underpriced because it needs a little love or its in an up and coming area. The agent can also tell you what the house can potentially sell for based on recent comps.
- Repairs: This is the hard part. Estimating the cost of repairs is where things get tricky. Are you an experienced general contractor(GC). Do you know one?
Want to know why The Property Brothers on HGTV are good at flipping houses? One of them is an experienced GC and the other is a real estate agent.
In other words, they can save a tremendous amount of money on cost, helping protect their margins because one of them can focus on repairs while the other can focus on selling the home as quickly as possible.
Again, the fix and flip strategy does not make sense for most people. That said if executed properly, you can stand to make a good chunk of change in a fairly short period of time…Or you can lose tens of thousands of dollars.
In short, be sure you have a lot of cash on hand, and partner with experienced contractors and agents if you’re going to adopt this strategy.
A basic rule in finance is that of the relationship between risk and reward. In real estate, the winners tend to be those that can play the long game. Again, time is your friend.
You want to hedge your risk by starting small and gaining more experience(and capital) over time. This is how you hedge your risk. This is now you win.
If you really want to start small, invest in a REIT. This is a financial instrument (similar to a mutual fund) that allows you to pool your money together with other investors to purchase a variety of residential and commercial properties.
You get to diversify your investment portfolio with a liquid asset (one that can easily be converted to cash).
Whichever route you decide to pursue, keep this in mind. Location, location, location are three golden rules in real estate. But time, patience, and cash are the golden rules of real estate investing.