As a real estate investor since 2003 with over $10 million worth of properties, let me share some tips for investing in real estate for beginners.
Real estate is my favorite asset class to build long-term wealth. If you're a beginner, then real estate is great because it is much easier to understand than investing in individual stocks, bonds, and other investment classes.
Unlike stocks, real estate doesn't just disappear into thin air at a moment's notice when volatility strikes. Real estate generates rental income and provides shelter. Real estate tends to always inflates with inflation at the very minimum.
Best Ways To Invest In Real Estate For Beginners
The main ways to invest in real estate are by buying real estate-related stocks, investing in Real Estate Investment Trusts (REITs) and investing on a eal estate crowdfunding platform like Fundrise. Fundrise is the creator of the private eREIT, which is much less volatile than a publicly-traded eREIT.
Personally, I've invested $810,000 in real estate crowdfunding to diversify and earn income 100% passively. You can also invest in individual commercial real estate and multi-family deals through CrowdStreet. CrowdStreet focuses on opportunities in 18-hour cities where valuations are cheaper and cap rates are higher. You just have to do extra due diligence on the sponsors.
I've been a landlord in San Francisco and Lake Tahoe since 2003 and I can tell you, owning rental properties is not for the faint of heart. The older I get, the more I like investing in REITs and real estate crowdfunding.
As a beginning real estate investor, it's wiser to invest in REITs, real estate stocks, and real estate crowdfunding as well. There's no need to leverage 5:1 or 10:1 to buy property. Instead, you can invest for as little as $100 – $500.
Let's review the following ways in detail on how to invest and profit from real estate. Here are my tips for investing in real estate for beginners.
Investing In Rental Properties For Income
We can break real estate investing into two primary categories:
- Investing in a property to potentially resell it quickly for a profit (flip)
- Investing in a property for the long-term and renting it out (landlording for semi-passive income)
One potential benefit of investing in a rental is that it has the possibility to provide two types of return.
First, rental properties can provide appreciation over the long run, if the property value increases over time and due to improvements made by the owner, and as the owner increases equity in the property by paying down the mortgage.
Second, the owner also has the potential to realize an ongoing return in the form of positive cash-flow on the investment — earned by renting the property out to tenants for monthly payments that exceed the owner’s overall monthly expenses to maintain the property.
Personally, I own rental property for semi-passive income to fund my early retirement lifestyle.
Cash Flow Is Important When Buying Rental Properties
If an investor can obtain attractive financing to secure a rental property that produces positive cash-flow in an appreciating market, that is a double win. If the investor is willing to take on the responsibility of managing the property (or working with a property management company) — then rental property investing can be a viable real estate investment strategy.
Below is a chart of my rental income history and mortgage pay down. Notice how the rental income stayed sticky during the financial crisis and kept on going up after the crisis ended. This widening spread in profitability is one of the main reasons why real estate is my favorite asset class to build wealth.
Rental Property Investment Strategy
To determine whether a rental property investment can work for you, you first need to come up with an informed estimate of the return on investment (ROI) that the property is likely to generate.
For many types of investments, you can determine the ROI by calculating a simple formula: gains minus cost, divided by the cost. In the case of a stock investment, for example, if you pay $10,000 for stock in a company and sell your shares later for $12,000, then you’ve realized an ROI of 20%. That’s a net profit of $2,000, divided by the original $10,000 purchase price — giving you a 20% return on your investment.
In reality, the ROI calculation will be more complicated than this, because you will need to factor in expenses such as capital-gains taxes on your stock sale and any broker fees you incurred while buying and selling your shares.
But things get more complicated still when you are attempting to determine the ROI potential in advance of investing in a rental property — because there are so many variables that can affect both the income potential and the expenses of the property.
Determining the possible ROI of an income-producing property will require you to make estimates (based on whatever historical data is available) on market rental rates, vacancy rates of similar properties in the area, ongoing expenses for maintaining and operating the property, and other variables that might change at any time. And bear in mind, as stated previously, rental property investments carry risk of loss just as any other type of investment, and returns can never be guaranteed.
See: How To Correctly Analyze And Value Rental Properties
Assessing A Good Rental Property For Investment
If you’re looking for a residential rental property — such as a single-family residence or a small apartment complex — you may want to focus your search within neighborhoods with homes appreciating in value, low crime rates, strong employment figures and well-rated schools.
Find a rental property that generates positive cash-flow — where the rents and any other income you earn on the property is greater than all expenses, including your mortgage payment, property management fee, property taxes (calculated monthly), repairs, insurance, etc.
Imagine you were to purchase a four-unit apartment complex for $300,000, and you took on a $1,900 mortgage payment (which included impounded property taxes, paid by the mortgage company). You then hired a property management company for $150 to handle screening tenants and managing repair and maintenance issues.
Further assume that ongoing maintenance work like landscaping for the apartment runs you another $200 and that for expenses you are responsible for on the property, such as some of the utilities and property insurance, cost an additional $500. Your total costs, then, come to $2,750 per month.
Finally, assume you can charge $800 per unit and that all four units rent. That gives you a gross income of $3,200 — a net operating income of $450 per month.
The 1% Real Estate Investing Rule
Another way to determine whether or not a rental property might be viable for you is to use the simple 1% rule. This guideline allows you to take an estimate of your monthly income on a rental property and divide it by the purchase price. The rule argues that if that number is in the 1% range, then you might have a good rental property.
Using our example above, if the purchase price were $300,000 and the estimated monthly income were $3,200 (assuming no vacancies during the year), then that would give you a better-than-1% return, 1.06% in fact.
Just know that there are many variables that go into calculating potential rental income, including the job market, the overall economy, interest rates, tenant turnover, maintenance costs, and more.
Knowing All The Property Expenses
Failure to take into account even one upfront capital outlay or ongoing expense can lead you to an inaccurate estimate of the cost and income potential of your property. Real estate for beginners requires a very detailed estimation of all expenses.
That list of expenses is long and includes agent/broker commissions for acquiring the property, mortgage fees, cleaning and maintenance, repairs, utilities, insurance, advertising for tenants, mortgage interest, property management, your time and expense traveling to and from the property, taxes and tax-return prep, legal fees, the costs to replace appliances, etc.
It is extremely difficult if not impossible to know in advance all of the expenses your rental property may require. For this reason, as you are calculating a property’s income potential, it is important to gather as much information on the property and similar properties in the area as possible and have a buffer. Unforeseen costs tend to show up when you least expect them to.
Here are some warning signs to look out for when buying property. Large expenses such as fixing a faulty foundation, leaky pipes, a leaky roof, and updating the HVAC unit can be very costly.
How To Finance A Rental Property
Financing an income property is typically more difficult than financing a home or other primary residence.
The major distinction is the size required for the down payment. Home buyers with strong credit can find financing opportunities that require just a few percent down on a primary residence. Investors, on the other hand, typically must put down at least 25%, and sometimes 30%.
There are other financing options available, however, some quite creative. For example, an investor can ask for “seller financing” or “owner financing,” where the owner of the property serves as the bank or mortgage company. The investor places an amount of money down for the purchase and promises a certain amount monthly — just as they would do with a traditional mortgage company.
Related: All The Mortgage Fees In A No-Cost Refinance
Indeed, these transactions in most ways mimic a standard mortgage arrangement, involving agents and an escrow company, and the investor’s credit and good name are just as much on the line for satisfying the mortgage responsibility as they would be if the loan were held by a big bank.
An investor can even raise the needed down payment through other means, such as by taking out a home equity line of credit on their primary residence (or other property), or even through a real estate crowdfunding platform like CrowdStreet, largely for accredited investors.
Buying A Vacation Rental Property
Real estate for beginners should not include buying a vacation rental property. Instead, real estate for beginners should focus primarily on buying a primary residence or buying a rental property.
I am not a fan of vacation property rentals. They generally have a lot of turnover, more maintenance, and don't appreciate as quickly. Buy a vacation rental for lifestyle first, and then income second.
One challenge to owning a vacation rental is that, because they will likely not be rented 100% of the year — and in many cases only for a few months of the year — your per-night or per-week rental rates will need to be high to keep your investment cash-flow positive for the year. (After all, you can’t take a break from your mortgage payments in the slow season).
Another thing you should consider when deciding whether or not a vacation rental is a smart investment for you are the expenses of owning such properties — and these are often higher than they would be for comparable properties not in vacation hotspots. The cost of advertising your rental unit, for example, will almost certainly be high because it could take slick, elaborate ads to entice prospective vacationers.
Additionally, because your vacation property can be turning over much more frequently than would a standard residential rental, you could also need to spend more money per year on cleaning, replacing broken or missing items, insurance, etc.
For these reasons, vacation rentals can be among the most challenging types of rental properties for investors. I would NOT recommend buying a vacation rental property before you buy your primary residence.
Real Estate Crowdfunding To Make Investing Easier
If the thought of searching for the right rental property, trying to calculate your return on investment, and dealing with tenants’ leaky faucets sounds like more than you’re willing to take on — but you’re still interesting in investing in real estate — one alternative might be to invest in a REIT through the Fundrise crowdfunding platform.
Investing in Fundrise is one of the best real estate for beginners investment. No leverage is required to invest in Fundrise. With an investment in a REIT through Fundrise, you can enjoy many potential benefits. These include the chance to realize a long-term return through appreciation of the properties in your REIT and the chance to enjoy ongoing income typically paid out quarterly.
Additionally, because a Fundrise eREIT is a truly passive investment . Real estate and property management professionals find and then manage the day-to-day operations on these deals. If you are a buys person like I am, you will truly appreciate passive real estate investing.
Stick with the best real estate crowdfunding platforms with the most amount of funding and longest track record. Fundrise was founded in 2012 and they have one of the most stringent vetting process.
Real Estate For Beginners Is Straightforward
Even you are novice, you can build a real estate portfolio by buying REITs, private eREITs, and real estate stocks. Real estate for beginners doesn't have to be difficult or complicated.
The great thing about investing real estate crowdfunding for beginners is that you can start small and slowly work your way up. Fundrise allows investors to invest with as little as $500. This compares favorably with coming up with a 20% downpayment and then borrowing the remaining 80% as real estate investors usually do.
About the Author:
Sam has $810,000 invested in real estate crowdfunding to take advantage of lower valuations and higher net rental yields in non-coastal city real estate. He believes there will be a multi-decade migration away from expensive coastal cities due to technology. The emergence of real estate crowdfunding platforms will help fund new developments.
In 2012, Sam was able to retire at the age of 34. His investments now generate roughly $300,000 a year in passive income. He spends time playing tennis, taking care of his family, and writing about financial independence.