Investing in real estate is one of the most common strategies used for building wealth to achieve financial independence. Buying property can help you build income that’s not tied to employment.
Once you build a portfolio that provides enough rental income, that’s it. That’s all you have to do to achieve some level of financial independence and quit the rat race forever.
Table of Contents
Real Estate Investing is Not What You Think
On its face, real estate investing sounds easy. Banks want you to buy a home. The government wants you to buy a home. So all you have to do is buy a home (with borrowed money), rent it out (or fix it up), and sell it for a tidy profit, right?
More realistically, real estate investing is one of those things that’s both easy and difficult. Doing it is easy. Doing it successfully is a bit more challenging. It’s certainly not as simple as some “gurus” (*cough*Grant Cardone*cough*) make it look on social media or TV.
Nevertheless, if you want to get started building wealth (and income) in order to work toward financial independence, real estate may be just the ticket. This guide will help you determine whether it’s right for you, and it will help you learn how to get started in the wonderful world of real estate.
Why Real Estate Investing?
There are many reasons that people invest in real estate as part of their journey toward financial independence. For one thing, real estate is a tangible asset. If the stock market imploded tomorrow, people who own real estate still own property. As the old adage goes: buy land – they aren’t making any more of it.
These words couldn’t be more true in modern times. With exponential population growth increasing demand and rising sea levels making less land habitable, remaining real estate is becoming that much more valuable.
But, really, the reasons to invest in real estate have nothing to do with Waterworld or doomsday prepping.
People invest in real estate to help them achieve financial independence for a few big reasons:
- Returns are often higher than traditional stock market investments
- Cash flow tends to be steady
- Big losses are uncommon
- Income from real estate investing is mostly passive
- You have a place to live if you need it
When you buy real estate, sometimes there’s a little bit of work to be done upfront fixing one thing or another. However, once you get a property ready, you can usually get it rented (and keep it rented) with minimal work. If something breaks, you can fix it yourself or call a handyman. If everything runs smoothly, all you have to do is sit back and cash a rent check each month.
Tax Treatment Advantages of Owning Income Property
Yet another reason that many savvy investors flock to real estate investing is due to favorable tax treatment. More than many other wealth-building strategies, real estate can get you to FI/RE faster by staving off the taxman.
Investing in rental property makes you a business owner, and that entitles you to dozens of deductions that aren’t available to most people.
Need to borrow to buy your rental? No worries—the interest on your loan is deductible.
Need a new water heater? You can deduct that, too.
Property taxes on your rental? Costs to advertise your property? Closing costs? Real estate agent commissions? Equipment you need to work on your property? All deductible.
You’ll want to speak with a local accountant before trying to claim individual deductions, of course. When you invest in real estate there are generally tons of opportunities to save money on your taxes.
Return on Your Real Estate Investment
If you decide to invest in real estate to build wealth your returns will depend on a few factors, including: where you buy, the type of property you invest in, whether you take out a mortgage when you buy, and whether you rent your property.
When purchasing residential rental properties, 12 – 15% annual returns are typically a good base expectation. This is several points higher than what investors can expect to earn in traditional stock market investments (averaged over the long-run) and more than double current bond yields.
Potential drawbacks to a real estate portfolio
While returns from real estate can blow the stock market out of the water and help you build wealth and passive income quickly, this investment isn’t without its disadvantages.
For one thing, there’s the carrying cost. If you take out a mortgage to buy your rental, your bank doesn’t care if your tenant moves out, they still expect their mortgage payment every month. Even if you get laid off at work, you’ll still have to pay the taxes. This makes it incredibly important that you keep your properties rented so they keep providing cash flow.
It’s also critically important when you’re choosing a property to make sure you understand whether it’s part of a homeowners’ association (HOA). If it is, you may get hit with additional expenses in the form of dues, assessments, or maintenance costs. In some cases the HOA is like $10 month and basically just covers meetings for people to decide whether you’re allowed to paint your house teal or bright orange. Others can be very oppressive. These costs can reduce or eliminate your cash flow, so it’s important to know the costs before you pick a property.
Even with its drawbacks, real estate is a powerful tool to reach your goals. If you’re trying to build wealth to achieve financial independence, real estate is a phenomenal way to go. Real estate investing can help you steadily build your nest egg with relatively safe assets that aren’t affected by the daily ups and downs of Wall Street.
Ways to Invest in Real Estate
If you’re thinking about investing in real estate, one of the first questions you need to consider is what type of property you may want to buy – there are loads of options.
- Residential rental property
- Development/redevelopment projects
- Raw developable land
- Farm land
- Wholesaling (flipping contracts)
- Short-term rental
- Commercial property
- REITs, crowdfunding, and other alternatives
Each of these approaches has advantages and disadvantages. For instance, buying raw land means you’ll never get a rent check. However, you could make 3 – 5 times your money if you buy in an up-and-coming area and flip your land to a developer in a few years.
Wholesaling is an interesting area of real estate that requires very little start-up capital. Essentially, wholesaling means that you identify properties that are good potential investments, make offers, and try to get contracts to purchase properties at set prices. Then, you find investors who want to buy the properties, and sell them your place in the purchase contract, giving them the right to buy the property at the prices and terms you’ve already negotiated.
Buying commercial property, on the other hand, typically has a much higher price tag. With commercial real estate, however, you’re typically buying property in high-traffic commercial areas where property values are stable and there’s steady demand for rent to businesses. This means it’s a remarkably reliable way to make money, despite the higher cost of entry.
Residential Rental Property Stands Out
For the purposes of this article, we’re going to focus on investing in residential rental properties. These are often single-family homes but can also be duplex, triplexes, four-plexes, apartment buildings, or condos.
We’re focusing on residential rental property as a strategy for a few reasons: it has one of the lowest costs of entry of the various real estate investing strategies, and it’s one of the easiest strategies to understand.
Last, but not least—in fact, probably BECAUSE of the other reasons—we’re focusing on residential rental property because it is the most frequently used real estate investing strategy for people pursuing (and achieving) financial independence.
REITs and Other Alternatives
For those who aren’t inclined to go through the labors of sourcing, vetting, and selecting deals—to say nothing of maintaining a property or dealing with tenants—real estate can still be a viable strategy for building wealth toward financial independence.
If you want to invest in real estate but don’t want the headaches that come with doing so much work yourself, real estate investment trusts (REITs) or other alternative deals may be just the ticket. These options are hardly the stuff of HGTV dreams, but they make it possible to invest in real estate with the help of industry experts. In fact, REITs operate a lot like a mutual fund.
In addition to traditional real estate investment trusts, recent changes in securities laws are also making it easier to invest in real estate using independent crowdfunding platforms. Using platforms like CrowdStreet or Fundrise, investors are able to invest smaller amounts of money in real estate deals that they normally wouldn’t have access to.
Everything You Need to Invest in Real Estate
The barrier to entry for investing in real estate is fairly low, but there are still some things that you need to get started. The first, and, for many people, the most challenging thing, is a down payment. If you want to invest in real estate, you typically need to have at least 20 – 25% of the purchase price as a down payment—and that’s if you qualify for financing.
In addition to a down payment, getting started investing in real estate typically means that you should live somewhere close to where you’re investing. This isn’t necessary but it’s helpful for assessing potential deals, securing financing from a local lender, reviewing inspections and other items, and doing whatever work is required on your property before getting it rented.
This can make it difficult but not impossible for digital nomads to make real estate a big part of their FI strategy.
Other things you need to know if you want to get started investing in real estate include:
- What kind of property you want to invest in
- What headaches you’re willing to deal with from your investments
- What returns you hope to achieve
Managing Investment Properties
One of the biggest downsides of investing in real estate—especially rentals—is managing your properties. This can be a real pain.
Tenants can be difficult. They aren’t always thinking about it as a long-term residence and that can lead to somewhat careless or less-than-considerate treatment of the home and its fixtures. Plus everyone is always going to have a different standard of housekeeping—after all, there’s nothing common about common sense. In some cases, you may be renting to students or young adults who are still learning how to maintain the basics of a home—like how often to clean a shower drain or lint trap.
Perhaps most important, tenants don’t care about your property as deeply as you do. They may inadvertently cause damage to your property. They may overreact when something—anything—goes wrong, and look to you to deal with a lot of maintenance issues that aren’t actually pressing.
Financing options for purchasing a rental property
The cost of purchasing property is the single biggest barrier of entry for most people thinking about investing in real estate. The vast majority of people who are investing in real estate use financing , even if it’s just to get started.
Before you try to purchase a property, use a site like NAV or Credit Karma to check your credit score. You should aim for a score of at least 650 if you want to use financing to buy your property. This is in addition to money for a down payment. You should also plan to have enough income to cover your loan payments. Financing can be more difficult to manage when you depend on your rental income to make your loan payments, especially if you’re a new investor.
One of the most important things to remember when financing rental property is that you need to finance it as an investment property, not as a house you’re buying to live in. Owner-occupied real estate is treated totally different than investment property. Interest rates are lower for owner-occupied real estate, as are property tax rates.
However, financing a property that you’re buying for investment purposes as owner-occupied is actually a form of fraud. People do it sometimes to get lower rates, but it’s a huge risk, and they can get in a lot of trouble if caught.
Goal-setting for rental income
One of the most important things for you to consider before investing in real estate, or anything, for that matter, is what you hope to achieve through your investment.
In the case of real estate, this means you should understand what form your earnings will take. Are you aiming to buy property cheap and sell it for more? Or are you buying rental property to collect monthly income?
If you want to build a portfolio that will help you achieve financial independence, first consider how much you need in monthly income. Add up your monthly expenses so you can see how much income you’ll need to generate to support yourself. Then, figure out what kinds and how many properties you would need to earn that amount of income.
For example, let’s say you look at your household expenses and see that you need about $2,000/month in order to support yourself. This means that in order to achieve financial independence through real estate you need to build a portfolio that provides about $2,000 in NET earnings every month. Keep in mind that these earnings are after taxes, insurance, mortgage payments, maintenance, association costs, and any other outlays—aka your profit.
This may mean you need to own 2 single-family rental properties outright, or a portfolio of 5 – 6 rentals (each with 20 – 25% down), to produce the net revenue you need to support yourself.
Dealing with the Drawbacks of Real Estate Investing
As discussed, there are several potential drawbacks to investing in real estate. However, many of them can be addressed if you’re willing to give up a portion of your earnings.
As a case in point, Avail is an online property management platform that you can use to help manage your rentals, collect rent, and address tenant maintenance requests. This service can help alleviate the need to live in a particular location to manage your properties in-person.
For investors who only need help in certain areas, there are also companies like MyRental and RentPrep that can help you do things like market properties and screen tenants. If you’re willing to handle maintenance requests yourself (or outsource them through a platform like TaskRabbit) you can use a platform solely for marketing your property or running tenant background checks.
The Best Real Estate Investment Books for Beginners
For those who are interested in learning to build wealth or income, here’s a list of the best real estate investment books that we’ve come across.
Before writing this cult classic, Robert Kiyosaki actually built his fortune in real estate. As he writes in his book, he focused on accumulating assets that would put money in his pocket every month. This is the exact kind of investment strategy you should be trying to utilize if you are interested in using real estate to achieve financial independence.
This book is a ground-up how-to-guide for investing in real estate. Whether you’re hoping to conserve savings and add a little extra income or build a multi-million dollar portfolio and achieve financial independence on a massive scale, you need to check this book out.
This is a book for people who want to make real estate investing their primary source of earnings. The book will teach you how to build, manage, and finance a sizable portfolio of properties.
4. What Every Real Estate Investor Needs to Know About Cash Flow… And 36 Other Key Financial Measures
This is great reading if you want to learn to assess real estate deals based on ability to produce cash flow, It’s good to consider the insights from this book in light of your household budget and monthly cash needs.
Fixing and flipping houses is riskier than investing in rentals, but lots of people boost returns by buying fixer-uppers, repairing them, and keeping them as rentals. This book will teach you to do all of that and more.
This book is specifically geared towards people who want to make real estate investing a core part of their FI strategy. The book will teach you how to make real estate your primary source of income.
An oldie but a goodie, this classic teaches principles for stock market investing that can be applied to other investments like real estate.
People who want to develop a base-level understanding of how to invest in real estate, including fundamental knowledge like sourcing and negotiating deals, will benefit from this book. Principals from this book can be applied to investing in your own residence in addition to income-producing properties.
Expert Tips for Investing in Real Estate to Build Wealth
Some top tips from investors who have made their money in real estate:
1. Focus on Long-Term Rentals
“The best types of deals to create financial independence are long term rental properties in areas that are either well established, or up and coming. Being a slumlord is not ideal for anyone, so buying rentals in areas that quality tenants are going to want to live in should be priority number one.” – Brittany Hovsepian, owner of The Expert Home Buyers
2. Don’t be Afraid to Finance
“If you have the fundamentals correct with regards to the purchase and rehab price and your property is in a high rental demand area you should be confident that any financing expenses can be covered by the rental income. Owning a property outright is both an equity trap and tax-inefficient which is expensive peace of mind.” – Eugene Gamble, UK property investor
3. Learn the Players
“Develop a rapport with a top real estate agent. As a realtor, friends of mine let me know about a property that may come to the market before it does. A well-known realtor makes an invaluable ally.” – Benjamin Ross, Real Estate Agent, Mission Real Estate Group
4. Fix Up and Refinance
“If you buy a rental property below market value, then fix it up to add even more value, you can then refinance it for 75% of the appraised value. The value that you gained from buying low and fixing it up can be pulled back out in the form of a cash-out refinance. In other words, you set up a new mortgage and the bank writes you a check for the amount that you originally invested.” – Dawn Holley, Personal Finance Blogger, Stepping Stones to FI
5. Hire an Expert Property Management Company
“The single greatest way to manage a rental portfolio void of headaches is to enlist the services of a third-party property manager. Not unlike an investment in and of itself, hiring a truly great property manager can save investors more money than their services cost. Perhaps even more importantly, however, is the amount of time investors will save by expediting menial, everyday tasks to a professional property manager.” – Than Merrill, CEO, FortuneBuilders
6. Know the Area
“Looking for properties involves a good working knowledge of the real estate market. Aside from that, looking into communities just outside the metropolitan area can give you a great headstart into finding good properties. In vetting the property, I believe in inspecting the area first and knowing every nook and cranny of the property to see potential challenges once acquisition begins, as well as looking into the maintenance fees to see if it’s really worth investing.” – Izzy Regan, Design Consultant, Urban Exteriors
7. Look for Off-Market Opportunities
“If you have time you can obtain a list of property from the courthouse (Pre-foreclosure or Tax Deed properties) or you can join a local real estate investor association to network and find off market properties. In 2020, real estate information is now online, you just have to know where to start.” – Chris McDermott, Principal, Jax Nurses Buy Houses
If you’re looking for ways to invest that can help you achieve financial independence, real estate may be a great option. Learning to successfully invest in real estate is definitely a process, and you need to be willing to be more active in your investments that you might in other options like index funds. However, the returns offered by real estate can be substantially higher than more passive options. Used properly, real estate investments can help you achieve financial independence much faster than just hoarding your money in the bank.
Originally posted at https://thinksaveretire.com/ultimate-real-estate-investing-guide/