Guide to Real Estate Investing for Beginners
Real estate has remained a sound investment that can yield large profits for beginners and veterans alike. Even if you have been considering real estate investing, you might not know where to start. This guide real estate investing for beginners provides you with broad overviews of some basic real estate investment concepts you need to understand, as well as in-depth information about how to invest in real estate as a beginner.
What Is Real Estate Investing?
Real estate investing is an umbrella concept that includes a wide variety of financial activities tied to property, like investing in REITs or renting out a home. Your ultimate goal when you invest in real estate is to put your money to work so that you make a profit in the future. Once you do your homework and learn how to invest in real estate, you can make some serious money.
Yet, you can lose money too if you don’t make the right choices. Investing in real estate has several advantages and disadvantages. Being successful as a beginner means you need to have a clear understanding of what you are getting into. We cover some of the main advantages and disadvantages of real estate investments below:
Advantages of Real Estate Investing for Beginners
1. Lower Risk
If you choose to invest money in the stock market, trade options, or sell commodities, you face high to obnoxious amounts of risk and volatility. Although the real estate market does move up and down, it moves much slower than the stock market. Also, in the long-term, the housing and real estate market tends to move up. This strong historical trend tends to make real estate investing a lower risk than many other options.
2. Cash Flow
Many types of investments can make you money, but how many give you continuous income flowing into your bank account? For example, investors who lease houses or apartments to others receive rents each month. When you’ve invested in the right amount of income-generating properties, you can create a dependable revenue stream.
3. Tax Deductions
Depending on the type of real estate investments you make, you can have several tax deductions. This allows you to realize profits without such a tax burden. Some examples of deductions you can take include interest on loans and mortgage payments, repair costs, home office expenses, and insurance costs.
4. Good Long-Term Return
Investing in real estate doesn’t move fast like the stock market might. Your profits come from holding the property and reaping its benefits for years or decades. Real estate investments notoriously have good returns in the long run because they typically appreciate in value.
Disadvantages of Real Estate Investing for Beginners
1. Less Aggressive Returns
Although you can make piles of money investing in real estate, your profits do not typically come from a high rate of return like those associated with more aggressive and risky investment strategies. The S&P 500 gained more than 600 percent from 1991 to 2019 compared to a 160 percent increase in housing prices during the same period.
2. Requires Cash
Real estate investing can require a lot of cash, making some investments a poor choice for those who are cash-strapped. You need cash for maintenance, making building improvements, and in some cases, paying for a management company, as well as several other things.
3. Poor Liquidity
The vast majority of real estate investments are not liquid. If you want to get cash out and have to sell your property or sell your interest in a property, you can typically expect to wait weeks or months.
4. Tenants and Maintenance
Any investor will tell you collecting rent and fielding maintenance calls from tenants is the least favorite part of their job. Not all real estate investments require such a hands-on approach, but those that do often come with many challenges such as late rent, power outages, and plumbing issues.
Types of Real Estate Investing for Beginners
Investing in real estate is more than simply buying a property and renting out space. Several different types of real estate investing for beginners offer opportunities for interested parties, each with their own set of advantages and disadvantages. The most common types of real estate investments include:
“Airbnb”-ing a Room in Your Home
The increasing popularity of sites like Airbnb and VRBO makes it an appealing choice for real estate for beginners. It gives you an opportunity to dip your feet into using a property to make money on a small scale. You can set your availability, price, and requirements for those who you host. Yes, these sites do focus on leisure travelers who normally stay for a short time, but you can also offer long-term rental if you prefer. Renting out a room in your home gives you the chance to play with pricing during different times of the week and the year to really learn your short-term rental market and find the sweet spot where your room is rented more often than not.
One of the most popular choices in real estate investing for beginners and experts alike is to purchase rental properties. You can choose to rent out a condo, townhouse, or individual home, or purchase a building with multiple units. You will find there are many ways to approach rental properties. If you’re looking for ideas for real estate investing for beginners, many participate in house hacking, a term that real estate investing resource Bigger Pockets coined. House hacking is the notion of investors living in their investment property. You can do this with a single-family home, but most often, house hacking refers to multi-family properties that have up to four units. Brandon Turner at Bigger Pockets shares several reasons why house hacking is a good choice for first-time real estate investors, such as:
- Low down payments
- An opportunity to learn the business
- The ability to monitor your investment
- Lower expenses
Whether you have seen Property Brothers, Fixer Upper, Beach Flip, or one of another dozen or shows about flipping houses, you have likely been intrigued by the process and the profits these programs reveal to viewers. As you look into real estate investing for beginners, you should know that flipping a house isn’t as easy as they make it look on television. It’s also not likely you can do it as quickly as they do on TV.
But you can make some money if you make careful and accurate decisions while doing a house flip. The risk of house flipping lies in its uncertainty. You make calculations about renovations and upgrades based on estimates and an established time frame. If all goes well, you will come in at or under your budget. This, however, is not always the case.
The demolition process during a house flips can reveal problems with electrical, plumbing, and other systems once you start opening up walls. You simply will not find out about some costly issues during the inspection, which injects more risk into house flipping. You can reduce some of your expenses by living in the home as you fix it up. Alternatively, consider finding an investment partner to share the risk. If you are looking for your first house to flip, you may want to begin slowly and look for homes that only need cosmetic updates. Try looking for some of the most popular types of houses in your market.
Online Real Estate Investing for Beginners
That’s right — you can invest in real estate online! For new real estate investors, investing in real estate online can be less risky. But it also offers several other potential benefits over other types of real estate investments. If you want to make money with real estate but have no interest in being a landlord or engaging in activities like fielding tenant calls, fixing things, and collecting rent, online real estate investing will interest you. Similarly, if you are worried about the risk of flipping a property or have no desire to oversee this kind of project, you can invest online and let others worry about the minutia. There are two main kinds of online real estate investments:
1. Real Estate Investment Trusts (REITs)
The best way to think about a REIT is to think of it as a mutual fund. A REIT is an entity that owns a wide variety of real estate, including commercial office buildings, apartments, hotels, shopping malls, and other retail spaces. You buy shares in a REIT and earn money in the form of dividends.
Historically, REIT dividends are fruitful, making them especially attractive. If you do not need the money or you don’t want the income stream, you can reinvest your dividends into the trust.
The biggest difference between a REIT and a mutual fund is that not all REITs are publicly traded, making some much riskier than others. You cannot sell your interest in a private REIT as easily because it is hard to value. As a new real estate investor, it’s often in your best interest to choose publicly traded REITs, which online brokerage firms sell.
2. Real Estate Crowdfunding Platforms
If you are familiar with crowdfunding platforms like Kickstarter and GoFundMe, this gives you an idea of how real estate crowdfunding platforms work. Real estate developers, or those with a specific rehab project in mind, create a profile and business plan and look to investors to fund their projects. Depending on the situation, you can make debt or equity arrangements with developers.
Debt financing is a loan in which the developer pays you back, plus interest. Equity financing includes receiving a percentage of the profits upon completion of the project. Crowdfunding real estate projects can be extremely risky. These investments are speculative, and getting your money out is not always easy. An important part of real estate investing for beginners is due diligence. New real estate investors need to thoroughly research projects and avoid putting all of their capital into one deal.
Making Money on Your Real Estate Investments
With an understanding of the risks and benefits of investing in real estate and the types of real estate investments available to you, now you need to know exactly how you make money on your real estate investments. Profits from real estate investing typically come from one or more of the following four ways:
1. Real Estate Appreciation
Any property you own or have an interest in might increase in value. Sometimes appreciation simply occurs over time as a result of inflation. Other times, new structures or homes shoot up around your property and increase its value — or businesses and residents move out and decrease its value.
This also includes fluctuations in rent. If an area builds up and has more shops and restaurants and an optimal location for tenants to use public transportation, you can expect to receive higher rents. Property upgrades can also increase the value of the real estate, which is how you use appreciation to make money when flipping a house. You can make money when your real estate investments appreciate, but it’s not dependable income.
2. Cash Flow Income
As a real estate investor, you can amass wealth by creating multiple streams of income with your properties. For most, cash flow income includes collecting rents from multiple properties. This might mean purchasing apartment buildings, storage units, office buildings, houses, and other commercial properties. As mentioned above, REITs can also provide regular income in some situations. Passive income associated with a real estate investment is especially favorable because you don’t have to actively participate to reap the benefits. Read more about passive income streams.
3. Real Estate Related Income
You do not have to own a property to receive real estate related income. This money comes from industry or industry-adjacent jobs. Some examples include real estate brokers and property managers. In fact, some people choose to start their own property management company and collect fees in exchange for managing houses or apartment buildings and their maintenance for clients.
4. Ancillary Real Estate Investment Income
Another way that real estate investors earn income from their properties is through ancillary things like laundry rooms and vending machines. These types of income opportunities function as small businesses within a larger real estate investment and allow you to make money from your tenants. Ancillary real estate investments can create semi-dependable income streams that allow you to pay for upgrades and invest the money into your properties in other ways.
How to Prepare to Start Investing in Real Estate
Once you understand the basics of real estate investing for beginners, including the types of investments you can make and the types of money you can bring in, you will be ready to jump in. But you need to take some important steps before you make any purchases. In no particular order:
Pay Down Your Debt
You do not want to have financial obligations when you invest in real estate, especially credit card debt. Pay off your vehicles, student loans, and any other large or burdensome debts to really help you amass wealth as you invest.
Save for a Down Payment
If you want to own a property, save the 20 percent down to help you avoid having to pay mortgage insurance (PMI). If you prefer to invest in real estate online, then you need to save for your minimum deposit into a trading account, which can be as little as $500.
Wait for the Best Opportunities
Don’t get so excited about the first property you see that you make a poor investment. Remember, another opportunity is always around the corner. If you are unsure, it’s best to wait.
Pro Tip: Always be learning.
Learn everything you can about real estate. This means reading books about real estate investing for beginners, listening to podcasts, and maybe even finding a mentor.
Funding Your First Real Estate Investment
The amount of money you need in real estate investing for beginners in real estate varies greatly depending on what type of investment you choose to make. You can start with as little as $500 if you are investing online. So, if you don’t have a large savings account or struggle with credit, this is a great way to get started.
If you want to flip houses or purchase rental properties, you can fund these properties or their down payments from your personal savings. However, you should consider keeping cash on hand for repairs, upgrades, and other expenses. So consider one of these funding options:
If you want to flip a house and you are willing to make it your primary residence, you should consider a loan from the Federal Housing Administration (FHA). The FHA insures the loan and offers low closing costs and down payments as low as 3.5 percent. The Veterans Administration (VA) offers similar loans with no down payment required, but they are only for United States military veterans.
The United States Department of Agriculture (USDA) offers no down payment direct loan programs for those who want to purchase multi-family units in rural areas as part of their rural development program.
Hard Money Loans
These loans come from private companies or individual investors. Hard money loans allow you to quickly secure funding without waiting weeks to close a traditional mortgage. You can negotiate terms to some extent, but the ease and flexibility come with a higher rate and a much shorter timeframe.
These are commonly referred to as traditional mortgages that fall under regulations set by Fannie Mae and Freddie Mac. Unlike FHA loans, you do not have to live in the property to get a conforming loan. However, expect to pay 20 percent down. You can find lower down payment requirement programs if you live in the property as you fix it up.
Tips for Real Estate Investing for Beginners
As you are learning how to invest in real estate or other income-generating assets, it’s important that you soak up as much valuable information as you can. This will help you avoid common beginner mistakes. The following tips include some of the most important considerations to keep in mind. They apply whether you’re buying rental properties, flipping houses, or investing in real estate online.
1. Treat Investing As a Business
If you aren’t house hacking, you should treat real estate investing as a business. This means getting an Employer Identification Number (EIN) and creating a limited liability corporation or partnership. An EIN is the business equivalent of your Social Security number. If you hold real estate through a business entity, you protect your personal assets if you make a bad investment or get sued.
2. Follow the 1% Rule When You Buy a House
You have to know the numbers when you make a real estate investment. But you might not have the time to crunch for hours or days. You can calculate the one percent rule in your head. Then, you’ll immediately know if you are paying the right price and if it has the potential to be a good investment. If you can rent a home for one percent of your cost of acquisition, it might be a good buy.
The acquisition cost of a house includes the purchase price as well as remodeling, upgrades, cleaning, and anything else you must spend to get the house ready for tenants. For example, imagine buying a condo for $130,000 and spending $20,000 on getting it move-in ready. Your total acquisition cost is $150,000. The one percent rule means you should be able to rent the condo for $1,500 per month; if that’s not what the market suggests is reasonable, it’s probably not a good investment.
Making this calculation is a good way to weed out houses and hone in on those that will give help you succeed.
3. Use the 50% Rule to Avoid Overestimating Your Profits
As you think about purchasing your first single-family home to rent out, keep in mind that about 50 percent of the rent you collect will go to expenses to maintain the property. Expenses vary but include taxes, insurance, repairs, property management fees, homeowners association (HOA) fees, and much more.
Your profit on a property is the net amount you receive after you make the mortgage payment and pay for expenses. Many new investors forget about expenses when thinking about or reporting cash flow. With the 50 percent rule in mind, you can negotiate to reduce your mortgage payment, try to get a lower purchase price, consider a higher rent, or choose to manage the property yourself.
4. Don’t Overextend Yourself
Real estate investing for beginners is all about being cautious. Excited new investors sometimes mortgage their first property so they can afford a more expensive house or building. Leverage is great, but if you financially overextend yourself, you can end up losing the property. Alternatively, you might have to sell it for less than you invested to get out from underneath it.
Invest responsibly and don’t buy into the hype about amassing as much debt as possible and using other people’s money. Instead, start your real estate investing for beginners journey from a place of financial stability. Then you can more easily achieve your income goals. Similarly, you should avoid buying into REITs on margin. You can expect your yield to be lower than your interest rate, and appreciation might not make up the difference.
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