The real estate investing business is growing by leaps and bounds. In the best and worst of times, people always need a place to live. That’s one of the many reasons why so many beginning investors are wondering how to invest in real estate.
If you count yourself as one of us and would like to know more about the best real estate to buy, keep reading to learn everything you need to know about real estate investing for beginners.
Why Invest In Real Estate?
Some of the main ways to generate passive income include buying dividend-paying stocks and bonds, owning a business, and investing in the housing market with rental real estate. Of these top three investment choices, real estate provides unique benefits that other assets simply do not have.
Net cash flow is the number one reason why real estate investors buy rental property. When you buy a single-family home in the best market rented to a quality tenant, the rental income paid by the tenant will pay for all of your operating expenses, property management, and mortgage, with profit left over at the end of each month.
While both commercial real estate and residential property generate rental income, single-family homes can be the best choice for beginning real estate investors. That’s because everyone knows how a house ‘works’, houses are easy to finance, you can find homes for sale with or without a real estate agent, and the demand for single-family rental property is surging.
Value add income
You can also create additional income streams with investment property for extra cash flow. For example, many tenants don’t have their own appliances, so you can provide them and charge a little bit more each month in rent.
If you own the home where you live, you can ‘house hack’ by renting out an extra room or convert the attic or basement into an apartment to generate rental income. Some real estate investors start out by buying a 2-unit duplex property, then live in one unit while renting the other unit out to a tenant.
Another reason for investing in real estate is property appreciation. Over the long-term, home values in the U.S. appreciate well above the rate of inflation. As the Freddie Mac House Price Index (FMHPI) report shows, house prices in the country have increased by 77.8% since January 2008 and by 10.82% over the last year (as of November 2020).
In other words, if you had purchased an average single-family house for $100,000 about 12 years ago, it would be worth $177,800 today.
How To Make Money Investing In Real Estate
Those are the top three reasons why people invest in real estate. Now let’s look at some of the different strategies you can use to make money investing in real estate.
Real estate wholesalers are experts at finding undervalued property, getting the seller to accept a ‘low ball’ offer, then assigning the purchase contract to another investor in exchange for a wholesale fee.
One of the benefits of wholesaling real estate is that you don’t have to have a lot of money, only a small down payment because you don’t actually close on the deal.
However, real estate wholesaling takes a lot of time, requires in-depth market knowledge, and is high risk because if you can’t assign the contract you will have to buy the property or risk losing your earnest money down payment.
Fixing and flipping is another high-risk way to invest in real estate, in exchange for hopefully a high reward. There are plenty of shows on television that glamorize the fix-and-flip real estate investing strategy, but it isn’t always as profitable or easy as the professionals make it seem.
For example, you could actually lose money if you underestimate the cost of repairs, or overestimate the resale value of the home, or both. Fixing and flipping real estate also is dependent on finding an extremely motivated seller, oftentimes a homeowner who is facing foreclosure.
With the way home prices are rising in the U.S., finding a seller who has negative equity is becoming more and more difficult. As ATTOM Data Solutions reports, foreclosure activity in the U.S. has reached historic lows.
Owning a single-family rental property can be one of the least risky ways to invest in real estate. But, you have to make sure to buy the right home in a market where the economy is strong and the demand for rental property is high.
Many beginning real estate investors are surprised to learn that in many cities – including St. Louis, Houston, and Atlanta – the percentage of rent-occupied households is 50% or more.
Buying rental property is also a perfect option for remote real estate investing.
Many people live in urban areas where real estate prices are out of control and yields are hard to find. By using an online platform like Roofstock, you can find good single-family houses to rent in smaller markets where property prices are low and returns are high. After you purchase the house, you can hire a preferred property manager in the local market to take care of the tenant and your rental property.
Real estate investing is best for people who plan on holding the house for at least five years or more. Although home values historically increase over time, housing prices can also fluctuate downward over the short term. As a real estate investor, the last thing you want to do is buy high and sell low.
Buying and holding rental property over the long term can provide a winning combination of monthly cash flow plus an increase in equity. For example, let’s say you paid $100,000 for a single-family rental property today that generated a monthly net cash flow of $1,200 per year (after all of the expenses and mortgage is paid).
Assuming the house appreciates in value by 5% each year, at the end of five years the home would be worth $126,628. By buying and holding the rental property for only five years you would have $27,628 in equity plus $6,000 in rental profit, for a total of $33,628.
Real estate investment trusts (REITs) are publicly traded on the major stock exchanges. You can buy and sell shares of a REIT the same way you would any other stock. REITs can be an easy way to invest in different types of real estate asset classes.
There are real estate investment trusts that focus on assets such as cell site towers, industrial storage space, shopping centers, and even single-family rental property. Unlike owning real estate directly, shares of a REIT are highly liquid, meaning that you can buy or sell them quickly and easily.
However, investing in a REIT also means you may lose out on some of the biggest advantages of owning real estate directly.
Real estate crowdfunding platforms provide a way for a large number of investors to pool their capital together to invest in projects such as new home developments, or commercial real estate such as shopping centers, and office buildings.
Crowdfunding can be a good way to diversify into real estate without tying up large amounts of capital. Crowdfund investors normally receive quarterly dividend payments and a share of the profits when the project is sold. However, crowdfund investments are very illiquid because they are not publicly traded, and oftentimes the best deals are reserved for high net worth accredited investors.
Advantages Of Real Estate Investing
Key advantages of investing in real estate include:
Passive income with recurring cash flow.
Appreciation in property value over the long term.
Ideal for remote real estate investing.
Tax deductions including property operating expenses and taxes, mortgage interest, and depreciation expense to reduce taxable net income.
Lower correlation to the stock market, which means returns from real estate can be more reliable and less volatile than owning stock.
Drawbacks To Real Estate Investing
Real estate investing isn’t the right choice for everyone. Some of the potential drawbacks of investing in real estate include:
Requires a lot of cash upfront, with conservative down payments usually 25% of the property value.
Real estate is illiquid because it can take one month or more to sell, which is why most investors buy and hold over the long term.
Self-managing rental property is time-consuming and difficult, two reasons why experienced real estate investors hire a local preferred property manager.
Real estate investing requires a lot of education and investing knowledge, although you can learn from the mistakes of other investors by enrolling in the Roofstock Academy training program.
Real Estate Investing Terms To Know
Before you begin investing in real estate it’s important to understand how the business works. Here are some of the most common real estate investing terms to know:
Cash flow is the revenue stream from a rental property. Gross cash flow measures the total amount of income, while net cash flow is the money left over at the end of each month after the operating expenses and mortgage has been paid.
Capitalization rate (Cap Rate) is a market-specific metric that measures the value of a property by dividing the net operating income by the property value.
Net operating income (NOI) is calculated by subtracting the property operating expenses from the gross cash flow. NOI does not include the mortgage expense, because investors may finance rental property in different ways.
Cash on cash
Cash on cash return compares the cash income generated to the cash invested. For example, if your annual net cash flow is $1,200 and your down payment is $25,000, your annual cash on cash return for one year is $1,200 / $25,000 = 4.8%.
Return on investment (ROI) compares the net profit you receive over the holding period to the total capital you invested.
How To Get Started Investing In Real Estate
If you like what you’ve read so far, follow these five steps to get started investing in real estate:
Identify your long term goals, such as a high level of cash flow or a balanced blend of appreciation and monthly income.
Select a specific real estate investing strategy, or a combination of two, like rental property combined with buying and holding over the long term.
Choose a real estate market to invest in by analyzing key criteria including job and population growth, percentage of renter-occupied households, and cost of housing.
Shop for a rental property on the Roofstock marketplace, where you can make an offer online and receive recommendations for local property managers and lenders.
Talk to different local lenders about the best options for financing rental property and the down payment required.
After your offer has been accepted, work with your local real estate team to conduct your due diligence. After everything checks out, close on the deal while your property manager handles the day-to-day details and you collect the monthly passive income.
Investing in real estate can be intimidating if you’re just starting out. But once you know the basics of the real estate investing business, you may wonder why you didn’t start buying rental property sooner. With passive monthly cash flow, long-term appreciation, the tax benefits from owning rental property, it’s easy to understand why so many beginning real estate investors are adding rental property to their portfolios.
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