Congratulations! You are choosing to think about investing in real estate. I am glad you got to this point in planning for your future. Real estate is a great place to grow wealth by making your money work for you. In fact, if done correctly, you can amass great wealth. This is not meant to replace your own homework and research, rather it is meant to give you a jumping-off point.
I talk with people weekly about real estate. I invest personally and I advise people about their investments. You see, I am a Real Estate Attorney, and while I am not your lawyer, people come and see me about the matters below on a regular basis. I hope you find some good nuggets in here and they help to launch you into a great success.
Choosing What Kind of Real Estate You Want to Invest In
The first step to investing in real estate is figuring out that you want to. Good job! You know you want to invest in real estate. That part is now behind you. But, how do you do it? My intention is not to point you in any direction, rather it is to give you information about how YOU can decide what direction YOU want to go.
In this short outline, I want to introduce you to commercial and residential real estate — they are similar but very different. For the purposes of this blog post, I want to focus on residential real estate and the kinds of rentals, how you rent those out, and what other ways to invest in real estate exist for you.
Commercial Real Estate
Commercial real estate is basically anything that is not residential, meaning you are not living in it. While you may think you live at work, you actually do not. Commercial real estate is anything that is held for business or commercial purposes. A good example would be the fast-food restaurant down the road. That building and the land on which it sits is commercial space.
There are many types of commercial properties out there. There are retail spaces, office spaces, mixed-use (office and residential), mixed-use (retail and office), industrial, storage, hotels, and on and on. Each type of property is unique in and of itself with different classes for office (A–C), and air-conditioned or not for storage.
Commercial real estate has different tax treatments for depreciation and 1031 exchanges or like-kind exchanges. It is important for you to understand that things work differently in commercial real estate than they do in residential real estate. While this is a primer for the new residential real estate investor, just know this area can be complex and very competitive.
Residential Real Estate
Residential real estate is often where most new investors find themselves when they start investing in real estate. Whether someone inherits a house from a relative; outgrows their current house, buys another one, and decides to keep the old one to rent out; or they have found themselves in a situation where the opportunity was just right; most new investors find themselves involved in residential real estate.
There are myriad types of residential real estate out there. Anything that people live in can be rented out. Just think about that for a minute with apartments, mobile homes, houses, duplexes, triplexes, quadplexes, condominiums, fifth wheels, and on and on.
Short-term rentals (STRs) have been made famous by companies like Vrbo and Airbnb. These companies have amassed fortunes by allowing the average person like you and me to rent out our homes or other properties to the general public. There are other platforms out there that provide the same service, but for ease of reference, these are the ones that have found their way into the public lexicon.
STRs provide better returns than most long-term rentals (LTRs) because of the unique price points they are able to charge per night of stay. This unique animal has become a popular alternative to hotels with price points ranging from very inexpensive to quite costly depending on the level of finishes, location, rooms, and amenities available to the guests.
Many STRs have drawn the ire of city councils and homeowner associations (HOAs). The reasoning for such conflict ranges from unruly guests using properties as bachelor and bachelorette party pads to the properties not being designed for typical residential uses with small closets and little cabinet space in the kitchen. These issues act as double-edged swords to the investors that build properties specifically for STR usage. However, depending on the capital investment and the return on that investment, many STR investors find this area of the residential investment market very lucrative.
Below are some of the types of properties that STR owners rent out on a regular basis and locations for you to look into for your own research.
- Cabins — Gatlinburg, Tennessee; Big Sky, Montana
- Apartments — New York City, New York; Chicago, Illinois
- Condos — Destin, Florida; Scottsdale, Arizona
- Houses — Nashville, Tennessee; Lake Tahoe, Nevada
LTRs are a slower and steadier way to make money over time. Compared to STRs, LTRs make a lesser amount of money each month as tenants pay their rent. That being the case, there is usually less wear and tear on the property and market fluctuations do not correlate to larger losses in revenue, e.g., COVID-19. Further, LTRs normally do not have a conflict with city councils and HOAs.
Below are the two types of LTRs that real estate investors discuss most frequently:
- SFRs — Single-family rentals, which are stand-alone structures that usually house one family unit.
- MFRs — Multifamily rentals, which are usually duplexes, triplexes, quadplexes, apartment buildings, and mobile home parks.
Fix-and-flip investing is when a property is purchased, usually for a discount of the market rate. That discount provides the investor the opportunity to “add value,” a term the real estate investor comes to know well. Adding value to a property increases the market value of the property and allows the investor to increase the profit made on the sale of the property.
There are several television shows that focus on fix-and-flip investors. Typically, the investor will purchase a run-down property, and over the course of 30 minutes to an hour, they will deconstruct the property and sell it to a new owner for a tidy profit. This type of investing can be very profitable if done properly.
Bear in mind that if you do this type of investing, controlling your costs is imperative. Remember, unless you are going to do all the work yourself — a daunting task for even the most experienced investor — you will have to pay contractors and sub-contractors to perform services such as electrical, plumbing, drywall, roof repair, pest control, etc.
BRRRR stands for Buy, Rehab, Rent, Refinance, Repeat. This house hacking idea is brilliant in its simplicity. Not something recommended for the first-time real estate investor, this is a good way to achieve quicker financial gains over a shorter period of time.
For example, say Pat buys a property for $70,000 in an area where comparable homes are selling for $130,000. The rents in this area are $1,300 per month. Pat’s house could earn him the same rent if he made some improvements to the property.
Pat buys the house for $70,000.
Pat puts $30,000 down on the house.
Pat has closing costs of $3,500.
Pat takes a mortgage for 15 years at 4.5%.
The monthly payment is $332.
Pat makes the following improvements for $30,000:
- New appliances in the kitchen (refrigerator, oven, dishwasher, and microwave) for $6,000.
- Replace first-floor carpet with luxury vinyl planking (LVP) for $7,000.
- Update 2.5 bathrooms with paint, new lighting, two new fiberglass shower/tubs, and LVP flooring for $12,000.
- Landscaping for $2,500.
- Paint the exterior of the house for $2,500.
With these improvements, Pat has invested $100,000 in this property. It is now ready to show to potential tenants for a rental rate of $1,300 per month. Once this property is rented for $1,300 per month and can show approximately six months of rental history, Pat goes to his bank and refinances the property.
Through the refinance process, the bank appraises the house at $130,000. Pat takes a mortgage for 70% of the loan to value (LTV) of the property and is provided a 15-year mortgage at 4.5% with closing costs of $3,500 for a monthly payment of $791.
He is provided a check at closing for $91,000. This represents Pat’s original $30,000 down payment back, $30,000 in improvements, and $31,000 in equity handed back to Pat. Pat made $31,000 back and the tenant who is paying $1,300 a month is paying Pat’s mortgage of $791. Pat is grossing $509 each month from this property. This example does not account for depreciation, appreciation, property taxes, and insurance.
Through some searching and identifying the property, Pat was able to find a good property to invest in and turn the property into a cash-flowing rental while getting his money back and making some money along the way. This type of investing requires diligence on the part of the investor that is not required of those investors who buy turnkey properties that are rent-ready when purchased.
Good luck out there!