Investing in property is one of the best ways to build wealth for the average person. When you can build wealth through capital appreciation and rent appreciation, you've found yourself a powerful wealth creator.
As an investor in real estate since 2003, I've seen many of the positives and negatives of investing in property. Personally, I prefer investing in real estate over stocks due to more stability and the desire to own tangible assets.
Your real estate returns may not be as fast as stocks. But at least you own a tangible asset that doesn't disappear in value over night. Real estate has been a proven asset class for hundreds of years.
Investing In Property: Things To Know
The first thing to know before investing in property are the three types of real estate. I'm an investor in residential and commercial, but not land.
Three Main Types Of Real Estate
- Residential – Residential includes single family homes and condominiums.
- Commercial – Commercial mostly includes office buildings and multifamily homes. Commercial can also include Industrial property such as manufacturing, storage, and production. Storage real estate has taken off post pandemic.
- Land – Raw land and farmland. Farmland investing is one of the oldest ways to invest in real estate. As the population grows, so does th demand for food. Here's a comprehensive overview of farmland investing.
Now that you know the three main types of property, let's take a look at the main things you should know or do before investing in property.
1) Choose Your Real Estate
First, you must decide on investing in one of the three types of property above. Do you want to be hands on and own residential property? Are you interested in being a commercial real estate landlord? Or do you want to earn income passively through REITs or real estate crowdfunding?
Investing in publicly-traded REITs is very common. However, investing in REITs can be highly volatile, as we saw during the March 2020 crash. REITs fell even more than stocks!
Alternatively, investing in real estate crowdfunding also provides 100% passive income, but with much less volatility. Personally, I've invested $810,000 in crowdfunding to gain exposure to 18 commercial real state investments across the country.
Personally, I've invested $810,000 in real estate crowdfunding to take advantage of cheaper property across the heartland of America. I love earning income 100% passively.
2) Optimize Your Debt
Mortgage rates are at all-time lows thanks to Central Banks cutting rates to zero during the global pandemic.
Take a look at Credible for the lowest mortgage rates. The platform has six competing lenders vying for your business. You'll get no-obligation quotes in minutes.
To get the best mortgage rate, you need a high credit score. Therefore, getting your debt under control is an important steep.
Great investors always seek to minimize their debt and cost of funding. Keeping interest rates low is very important for higher returns.
I personally got a 2.125% 7/1 jumbo ARM for my new home. I can't believe mortgage rates are so low!
3) Invest In The Best Location Or Up And Coming Location
Location is the most important criteria for successful real estate investing. You must invest in a prime location or in an up and coming location.
In addition to investing in superstar cities like San Francisco, my hometown, it's worth investing in 18-hour cities due to positive demographic trends. Smaller cities are gaining more popularity due to the work from home trend. People are relocating to these 18-hour cities like Memphis and Charleston because they are more affordable.
4) Buy With Cash Or A Mortgage
Paying cash is a great way to get a great deal. However, paying cash means your cash-on-cash returns from your property will be lower. Here's how to pay cash without actually paying cash.
Financing a property is the most popular way to buy property due to low mortgage rates and leverage. If an investor puts 20% on the house, compounding at 4% on the mortgage, the cash-on-cash return is closer to 20%. With mortgage rates at all-time lows, financing a property is the preferred way to go for many.
5) Calculate Your Expected Profits
You must create a prom forma analysis of what your expected profits will be one you invest in a property. In addition to mortgage and property taxes, costs can include homeowners insurance, association fees, property taxes, monthly expenses and general maintenance costs. You may also have to pay for natural disaster insurance.
Ideally, you want to follow the 1% rule where rental income per month generates 1% the purchase price of a home. And more expensive cities, this role is very hard to follow. Therefore, you may wan to follow a rule where the Cap Rate is at least three times greater than the risk free rate.
6) Get Landlord Insurance
Owning rental properties is very attractive right now because rental income is much more valuable in a low-interest rate environment. It takes a lot more capital to generate the same amount of risk-adjusted income.
However, once you become a landlord, you need insurance, including landlord insurance. You’ll want to protect your property investment by covering damage, lost rental income and liability protection.
7) Factor in Unexpected Costs
There are unexpected costs that com up when investing in property. As a result, it's good to set aside a reserves each year to pay for such costs. Unexpected maintenance costs and other costs is why some investors like to invest in a REIT or private real estate syndications.
Fires, leaks, floods, termite damage and foundation work can happen at any time. These unexpected costs will certainly reduce your net returns.
Set aside one month's rent in cash reserves for unexpected costs.
8) Keep Taxes Under Control
Taxes and fees are a part of investing in property. Even if you pay off your mortgage, there are still fees and procedures to know. When you sell a property, you have to pay a commission. Then there's ongoing property taxes as well.
The great thing about owning real estate is the non-cash depreciation expense which shields your rental income from taxes. Further, being able to sell your real estate for $250,000/$500,000 in tax-free gains for singles/couples is HUGE.
If you are in a high tax rate, the tax-free real estate profits is especially attractive. Joe Biden is set to raise the capital gains tax rate for the highest income earners.
At least with real estate, you can deduct all expenses associated with managing the property to reduce taxable income. Further, you get a non-cash amortization expense.
Real Estate Investing Suggestions
Once you've purchased your primary residence you are considered neutral real estate. Since you have to live somewhere, you will simply ride the real estate cycle. To be truly long real estate you must own investment property in addition to your primary resident.
Once I had my son in 2017, I decided to sell my PITA rental house and reinvest $550,000 of the proceeds into real estate crowdfunding. My favorite two real estate crowdfunding platforms are:
Fundrise: A way for accredited and non-accredited investors to diversify into real estate through private eFunds. Fundrise has been around since 2012 and has consistently generated steady returns, no matter what the stock market is doing.
CrowdStreet: A way for accredited investors to invest in individual real estate opportunities mostly in 18-hour cities. 18-hour cities are secondary cities with lower valuations, higher rental yields, and potentially higher growth due to job growth and demographic trends.
Both platforms are free to sign up and explore.
With the intrinsic value of real estate going up since we're all spending more time at home, investing in real estate is my favorite way to make money. It's a tangible asset that just doesn't lose 30% of its value in one day like stocks can. The millennial generation will be buying in droves. I want to be there to profit.
Investing In Property: Main Things To Know, is a Financial Samurai original post. All information is based off firsthand information.