7 Things to Know About Real Estate Investing
Adam Luehrs is a writer during the day and a voracious reader at night. He focuses mostly on finance writing and has a passion for real estate, credit card deals, and investing.
When initially thinking about residential real estate, your mind might wander to the painted porches of Savannah, the log cabins of Vermont, the clapboard cottages of Cape Cod, or the Victorian homes of San Francisco. All types of residential homes help to shape cities, towns, and communities. What’s more, they help to drive an economy—and residential real estate investing has a large role in the upkeep of this. Getting involved in residential real estate investing is an excellent way to have a positive impact on a community, as well as earn financial freedom.
Some people assume that investing is only an option for a specific financial tier of people. However, potential investors have more tools and resources at their fingertips than ever before. In the past, it was difficult to access the funding and connections necessary to even get a foot in the door. Now, the gates have been opened for anyone willing to put in the time and work it takes to properly invest in real estate.
However, there are a few things to know, understand, and keep in mind when investing in residential real estate. Read on to discover what will keep you prepared and ahead of the curve.
1. Understanding what residential real estate is
Residential real estate investing relies on the fact that people will always need places to live. This creates a remarkable opportunity for making consistent money as an investor. The key rules to follow when investing in residential real estate are:
- An investor needs to identify properties that make good investments
- An investor must secure reliable and appropriate funding
- An investor must know how to make a business plan
- An investor must know how to properly market an investment property
One way for new investors to make money is through flipping houses. This relies on buying low, investing in profitable updates, and selling as high as possible. Speed is a major factor in the fix-and-flip approach. It’s important to make your turnaround time as quick as possible to shield against market cycles.
Investors can also consider investing in residential real estate and turning the property into a rental. This approach involves finding a property, getting the property up to livable standards, and charging a monthly rent amount to tenants. You can also hire a property manager to do your landlord responsibilities, but it is important to budget for this as it will affect your income.
Another way to get involved in residential real estate investing is putting money in passive investing platforms and earning off of the interest rates. This is one of the simpler forms of getting involved, but it comes at the sacrifice for management in the project and other tax advantages that come alongside investing in directly owned real estate.
The advantage of investing in residential real estate versus commercial real estate
One of the first things a new investor decides is whether they prefer to invest in residential real estate or other types, like commercial real estate. Both options have their advantages. The general belief is that commercial investing can be much more profitable than residential investing. However, commercial properties often require bigger upfront investments to properly prepare them for tenants. Here are some of the advantages that investing in residential real estate offers over commercial real estate:
- A lower cost of entry
- A lower turnover rate for tenants
- Easier zoning and permit requirements
- A bigger roster of available properties to work with
Many first-time investors quickly learn that obtaining a residential real estate investment loan is much easier than obtaining a commercial mortgage. Banks will typically only provide commercial mortgages to companies. A borrower applying for a commercial mortgage will sometimes need to go through the steps of creating a company before applying for a mortgage. So, as many have found, setting your sights on investing in residential real estate is a much easier starting point than investing in commercial real estate, when you’re looking to begin investing.
2. The importance of having a strong business plan
A fix-and-flip project or a buy and hold project can’t go anywhere without a business plan. It should cover these key points:
- Your master objective
- A market analysis
- A strategy for flipping or renting
- An exit strategy
- A financing plan
When it comes to generating real estate leads, fortune tends to favor creativity. You may be able to gain access to properties that aren’t on the market by reaching out to property owners directly. In addition, some investors use traditional and digital ads to target people who may be thinking of selling their homes.
As for financing, many up-and-coming investors are moving away from traditional banks and lending institutions. These investors favor bridge loans because they offer more freedom and flexibility, in addition to fast closes, ability to fund more deals, and reliable financing.
Keeping these lead generation and financing tactics in mind—along with extensive market research—will help you overall come up with a strategy and decipher your exit plan. Remember to network and build a community as well. It will help you to find some great partners.
3. The risks
Popular television shows tend to sugarcoat the hard work that really needs to go into investing in residential properties. There is no denying that there’s potential to make money quickly. However, residential real estate investing does have some risks. The biggest mistake is failing to educate yourself about what property investing fully entails before you start. Take a look at a comprehensive list of the top websites for investment education if you’re just getting started.
It’s easy to become blinded by a home that looks like the perfect investment. Don’t fall in love until you know all the facts. Many rookie investors make the mistake of underestimating just how much work it takes to actually fix up an investment property. In fact, underestimating costs is one of the biggest reasons for failure in this industry. Here’s a rundown of important things to remember:
- Expect the unexpected. Always assume that unexpected costs will pop up during the renovation process. Many investors don’t discover serious flaws in homes until they start ripping up carpets and tearing down walls.
- Don’t overestimate your own ability to be a handyman. Many investors inaccurately believe that they can take a full do-it-yourself approach to fixing and flipping. There could be times when you’ll need to bring in plumbing experts, electricians, and general contractors. The cost to bring in help must be factored into your investment plan.
- Don’t commit to a property until you’ve researched the neighborhood. Some deals really are too good to be true. Even a home with all of the luxurious features and updates in the world won’t sell for the price you want if it’s located in a neighborhood where homes don’t sell.
4. How to avoid and mitigate risk
There’s always going to be some level of risk involved when it comes to residential real estate investing. You can’t control what happens with Wall Street or Washington. The good news is that you still have a lot of control when it comes to mitigating risks.
Many first-time investors fall into the trap of selecting a property just because it is extremely cheap. These naïve investors assume that a big profit can be made just because they are paying so little. The reality is that the price you pay for a home is only one piece of the puzzle. An asking price can only be measured properly when you view it against the total investment that will be needed to get a home sold.
The 70 percent rule
Introducing the 70 percent rule. The rule states that you should never pay more than 70 percent of the after-repair value (ARV) of a property when buying an investment property. ARV is the estimated value of a property once all of the necessary repairs have been done. The 30 percent that is left over when you apply the 70 percent rule will be your profit. However, it’s important to keep in mind that many investors use that 30 percent to cover assorted fees and soft costs.
Let’s put this into an example:
- A property’s ARV is $200,000
- Your inspection of the home reveals that it will need roughly $50,000 in repairs before it can be sold
The 70 percent rule dictates that an investor should not pay more than $90,000 for this property. That puts your total investment at $140,000. You stand to make a profit of $60,000 in this scenario.
Room to work with
There is some wiggle room when it comes to the 70 percent rule. What if you decide that you’re willing to pay $100,000 for this home? Your total investment will now be $150,000. That could still work if you don’t uncover any major problems with the home. However, things could get hairy if you discover that the home actually needs $75,000 in repairs instead of $50,000. This revelation brings your investment total up to $175,000. That still leaves you with a potential profit of $25,000. However, depending on your goals, this would still be considered a great deal.
Let’s change the scenario around though a bit to see how things could go south. Making $25,000 on a property isn’t a bad deal. However, the extra repair needs that were discovered could take some time to address. A home that you planned to sell in the fall may not be able to go on the market until spring if serious work needs to be done. Factors like weather conditions, the availability of contractors and wait times for permits could create major delays. A delay could mean that your $25,000 profit will need to cover you for many months. What’s more, all of the time, money and energy you need to put into a problematic home could prevent you from investing in other properties.
This scenario isn’t meant to scare or intimidate you. Encountering a few hiccups along the way won’t negate your ability to make a good deal. However, staying at or under the 70 percent rule could help you avoid heartache.
Other tips to avoid risk:
- Have a realistic start date and end date for your deal
- Study how long comparable properties have remained on the market
- Break down your profit by the number of months you will be putting work into your investment property to get a realistic view of how much you’re really making
- Try to leave room in the background for a second flip to help you sail through lean months
You never want to bite off more than you can chew as a first-time investor. Starting off with a property that only needs a few repairs can be a great way to get a taste of what the fix-and-flip lifestyle is all about. Of course, it could only be a matter of time before you feel confident enough to take on huge renovation projects with big payoffs. Everybody needs to start somewhere!
5. Financing is key
Obtaining the right financing for your fix-and-flip project is essential. Some people go it alone when it comes to financing investments. Others will approach friends and family members to ask for funding. Of course, not everyone is comfortable with the idea of relying on people they know when it comes to launching a new business pursuit.
It’s okay if you haven’t fully pinned down a plan for financing your dream of becoming a flipper just yet. There are many options available for borrowers. In fact, many real estate investors are now obtaining hard money loans without ever walking into banks or going through the traditional mortgage process. It’s a good idea to look into a bridge loan to see if this type of financing could serve your needs. Bridge loans are favored by investors looking for more flexibility. They offer a short-term financing option that’s tailored for the pace of a fix-and-flip investment.
6. Location matters
You aren’t ready to invest in a home unless you know roughly how much each home would sell for. Eat, breathe, and sleep neighborhood stats. Properties that are located near corporations, economic hubs, universities, good schools, and reliable transportation options generally present better opportunities for making money.
Take your time when searching for a property. Don’t purchase a flip property in a neighborhood where homes sit on the market for a long time. Your profit will be reduced for each day your home sits on the market without an offer. How can you properly estimate the value of a home you’re eyeing? Look for a comparable home that has been sold within the past three to six months. A comparable home must be located in the same neighborhood, offer all the same features, and contain the same square footage.
7. The creative benefits and freedoms of investing
Being a property investor allows a person to exercise their creativity and business acumen simultaneously. Many fix-and-flip investors are genuinely passionate about renovating homes.
In addition, many investors take pride in building communities by providing attractive, valuable places for people to live. The money that can be made through property investments provides a new level of freedom for people who want to escape the nine-to-five lifestyle. An investment in a property is an investment in your own business.
The final word
The first step to becoming a successful real estate investor is becoming a student of real estate investing! Diving into this exciting world can help you to unlock the income potential that is hiding in plain sight right in your own town or city. Take these things into strong consideration when venturing into this world and you will be a step ahead in the process.