Over the past fifty years or so, real estate prices have skyrocketed. Even accounting for inflation, homes are worth a lot more now than they were a few decades ago. And that’s not all. The cost of rent is rising around the country, too.
For everyday homebuyers and renters, these figures can be a real bummer. But for potential real estate investors like you, they can spell good things.
Investing in real estate may seem like something only the uber-rich can do. But, actually, everyday investors can often invest in real estate, as well. Sure, you might not buy up a multi-million dollar apartment building. But you could invest in a starter home, pay off the mortgage, and then rent it for a profit when you buy your next home.
Real estate investing can be a bit more complicated and tricky than just purchasing mutual funds with your 401(k), though. So even though everyday investors can put money into real estate, you shouldn’t until you know what you’re doing.
Not sure where to begin? Here are some steps to take if you’re interested in real estate investing.
Step 1 – Before Investing in Real Estate, Understand Your Earning Options
First, you need to decide how you want to invest in real estate. There are actually a lot of different ways to earn money by investing in real estate. And there are lots of different property types you can choose to invest in. First, though, the options for earning money:
Traditional real estate investing means owning a property, either on your own or with others. But these days there are lots of options that let you invest in real estate without owning a property. For instance, you can invest in real estate exchange-traded funds for a more traditional-investing option that hinges on rising real estate rates.
Or you can invest with a crowdfunding company like Fundrise. Fundrise let you get a piece of the real estate pie by investing in REITs–real estate investment trusts. Another option is PeerStreet. Using PeerStreet, accredited investors purchase notes that represent a piece of a vetted real estate loan. If you’re curious about what it takes to become an accredited investor and if this type of investing is for you, take a look at our PeerStreet review. These may look a bit more like traditional investments, but you’ll still want to do your homework before you put money into them.
Cash Flow from Rent
One of the most accessible options for real estate investing is from rent. Becoming a landlord is within reach for many frugal spenders. One option is to get a larger home than you need and to rent parts of it while you live there. (My family does this with Airbnb, which pays our mortgage.)
Or if that’s not your speed, buy a small starter home with a teeny mortgage in the town where you want to settle down. Take five years to pay down (or pay off) the mortgage. Then purchase another home to live in, while you rent the first home. As long as you choose the right side of town and can attract steady, good tenants, you can outearn your spending on the first home.
Buying property in the hopes that it will appreciate can be tricky. You might buy homes in a developing area with a long-term plan of selling them at a profit. This can work. But it can also backfire big time.
Another option that many are familiar with is the concept of “flipping” homes. This is where you buy homes, often foreclosures or tax sale homes, for cheap. You put money and time (or paid labor) into the home to turn it into a nicer place. Then you sell, hopefully for a profit. Again, though, this can be risky if the project becomes more expensive than you think or real estate values plummet unexpectedly.
This isn’t to say you should never invest for the sake of appreciation. But putting too many of your eggs in this basket just courts disaster.
If you’re good at investing in real estate, you can benefit from doing it for other people. It’s more complicated to set up a brokerage where you make money from investing other people’s money in real estate. So we won’t talk much more about it here. But that is one option for earning money through real estate investments.
If you invest in commercial properties, you can benefit from doing things like keeping vending machines on the property that you stock. Then you can get both the rent from the companies that use the building and the money from the vending machines.
Again, since this relies on commercial real estate investments, it’s a little less beginner-friendly. If you’re like most people, you’ll begin with residential property, which typically has lower up-front costs.
Step 2 – Get Your Legal Ducks in a Row
It’s typically a bad idea to invest in property directly. Even renting to friends when you move out of your current home can be a legal disaster. If you own the property directly, you could be held liable for any issues with the property. Which means you could lose your personal assets in a lawsuit.
If you hold the property in a limited liability company (LCC) or limited partnership, you could be more legally protected should the worst happen. Opening an LLC doesn’t automatically protect you from everything, though, so be sure you understand what you’re getting into.
The best bet here is to spend a little time and money chatting with a knowledgeable lawyer about the best way to go about this kind of investing legally. They’ll likely advise one or the other of these options to offer yourself more protection.
While you’re at it, look at different tax-paying options, too. You’ll need to figure out how you’ll properly pay taxes on your investments, especially if you’re investing with a partner. The tax status and legal status aren’t necessarily the same thing. But it’s a good idea to consider them both before starting out.
And when you’re considering this, figure out how to do your bookkeeping well from the start. It’s much cheaper to pay a bookkeeper for some help up front than it is to pay them later to clean up the mess you’ve made.
Step 3 – Research the Real Estate Market
Good investors always understand the market and what’s going on with it. This is true whether you’re investing in stocks or homes. If you’re planning to buy and sell property often or to be a landlord, it usually makes the most sense to start near where you live. This can keep your costs for traveling to and from properties down. And it’s easier to have a hands-on approach with your tenants this way.
You can get to know your local market by keeping an eye on home listings and talking with realtors. You might also check with local community development corporations, which many urban areas have. These local entities are focused on redeveloping property and often have an eye on affordable properties. They may not be targeting the same market you are, but they can give you some insider knowledge on which areas of town are developing most quickly.
Step 4 – Keep a Handle on Your Expenses
It’s absolutely essential that you keep track of all your investing expenses. This includes things like property taxes, taxes on the investment income itself, and maintenance and insurance on the property. It’s easy to look like you’re making a profit only to get hit with a big tax bill that suddenly puts you in the red.
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Make sure you completely understand the expenses of investing in a particular property. Look into things like what you’ll pay for utilities if the property goes unrented. Find out how much it’ll cost to insure, and understand what you’ll pay in the mortgage and for taxes. Then account for costs like a fresh coat of paint between tenants, larger but less frequent upgrades, and any services you’ll need to pay for to be a successful investor or landlord.
You may not make much money from real estate investment at first, especially if you have to mortgage your first investment property. (Which is definitely something to be careful about, though it’s not always a terrible idea.) But if you keep your expenses down and make smart choices over time, you’ll be able to build wealth so that you can invest in better properties that make more money.
Step 5 – Make a Plan for the Future
Investing in real estate is a little different from investing in more traditional options in the way you plan for the future. With your 401(k), you just need to keep an eye on your portfolio balance. You may not need a more specific plan for the future other than knowing your portfolio may need to be slightly more conservative as you get closer to retirement.
With investing in real estate, though, you really need to approach things with mid-term and long-term plans. How much real estate do you ultimately want to own? Do you want these investments to turn into a full-time job?
If you do it right, investing in real estate can also be your job. But if you want to keep your day job, then you need to keep your property portfolio manageable or consider hiring a property manager to do the day-to-day operations. Either is a viable option, but you need to have some idea of what you want for your future.
So as you get into investing in real estate, take the time to think through your direction and write out a plan. You don’t have to stick to it, and it can change. But having a guiding plan can ensure that you make good decisions about your investments over time.