Real estate investing can be a lucrative way to build wealth and generate passive income. Whether you’re a beginner or an experienced investor, there are various strategies you can employ to achieve your financial goals. In this comprehensive guide, we’ll explore the different types of real estate investments and provide practical tips to help you get started.
Types of Real Estate Investments
- Residential Properties
- Single-family homes. The advantage of single family homes is that they tend to be in higher demand than apartments within multifamily properties. Vacancy rates may be lower. Also, tenants are typically responsible for all utilities, lawn care, and snow removal. Increases in rates for utilities do not mean higher expenses for the landlord, unless the landlord decides to pay for such utilities (not recommended).
- Multifamily properties (duplexes, triplexes, etc.). Some say that an advantage to such properties is that when you have one vacancy, you have other units providing cash flow. A vacancy does not hurt as much.
- Vacation rentals. A downside risk to vacation rentals is that short term rentals are losing favor with tourists. Popular platforms are charging more and more fees, and tourists are getting tired of rules and needing to perform some cleaning in addition to paying a cleaning fee. Many cities are banning or restricting short term rentals due to a shortage in housing for regular people. I’ve said it before–if the numbers don’t work with long term rentals, the numbers don’t work at all. It is too easy to underestimate vacancies and overestimate income. Don’t trust automated cap rate calculators, they often don’t account for HOA fees or properly estimate vacancy rates, repairs, and utilities associated with short term rentals.
- Commercial Properties
- Office buildings. These are high risk, particularly with more and more people working remotely these days. There may be government loans available for such conversions. There may be potential to convert office buildings into apartment buildings if you understand the regulatory framework, including zoning rules and number of parking stall requirements. Many office buildings have limited numbers of large bathrooms and would require substantial replumbing to convert into apartments.
- Retail spaces. These may sometimes require substantial remodelling between tenants and may also experience long vacancies between tenants.
- Industrial properties. These must typically be located in industrial parks or areas that are appropriately zoned. Be aware of risks of liability for environmental damage caused by your tenants. Talk to an environmental lawyer before considering such a property.
- Apartment complexes. These require a different type of financing than 1-4 unit buildings, at less favorable terms. Most loans are adjustable rate, meaning that some owners are in for a shock when rates adjust from previous low rates to current high rates. Once cash-flowing properties may soon become negative cash flow. If you have cash, there may be opportunities for bargains. Or, if you are patient, you may see foreclosures soon.
- Real Estate Investment Trusts (REITs)
- Publicly traded companies that own and operate income-producing real estate. You don’t get the same leverage advantage and possibility of buying below market value that you do with traditional real estate.
- REITs do off exposure to real estate without the need to directly manage properties. They are fine if you don’t have time to be a traditional real estate investor, but so are stocks.
Real Estate Crowdfunding
- Online platforms that allow investors to pool funds for real estate projects. Again, these are fine if you don’t have time to be a traditional real estate investor, but so are stocks. Beware of funds that are not liquid. You may not be able to access your principal if you need it suddenly. These platforms are not always insured like stock market accounts and may fail.
- They do provide access to a range of investment opportunities, such as pools of notes. They are often not much different than REITs.
Strategies for Investing in Real Estate
Buy and Hold
- Purchase properties and hold them for the long term. This is what I like to do. Please review my article on how to calculate cap rate. That will help you decide on which property to buy. Also review the links at the top of the page. They provide access to very useful tools to help you choose where to buy.
- When you buy and hold, you benefit from rental income and appreciation in property value. You also benefit from a tax deduction for fictional depreciation while you hold, and an advantageous long term capital gains tax rate when you sell (or deferred tax if using a 1031 exchange).
House Flipping
- Buy undervalued properties, renovate them, and sell at a higher price. This is a reasonable way to start if you have more time than money, and have some renovation skills. You could also partner with someone who has money, and provide labor in exchange for a share of the profits. Beware, though, that if you overpay, you could end up selling for a loss. If a house is in distressed condition cosmetically, it may also have hidden problems, like plumbing, electrical, or foundation problems. Make sure you look up and understand IRS “Dealer Status.” You will pay more tax with a flip than if you buy a distressed property, fix it up, then rent it out for long enough to be eligible for long term capital gains rates.
- House flipping thus requires a good understanding of the market and renovation costs.
Wholesaling
- Find properties at discounted prices and assign the contract to an investor. This is a good way to get started if you have no money.
- Earn a fee without taking ownership of the property and without much risk. Make sure your contacts don’t try to do an end run around you and do a deal directly with the owner. Tie up the property first with a contract.
Rent-to-Own
- Allows potential homeowners to rent a property with the option to purchase it later.
- A portion of the rent is credited towards the down payment. As a home owner, this is not something you want to offer. It is better to use a lease plus option. If you credit some rent towards down payment, the future buyer can potentially claim some amount of equity in your home, in a court of law.
BRRRR (Buy, Rehab, Rent, Refinance, Repeat)
- Buy undervalued properties, renovate them, rent them out, refinance, and repeat. I would recommend you add the step of hold for at least a year. This gets harder with each purchase unless cash flow is strong. Be aware that there are limits in the number of financed properties you can have, if you are using conventional 30 year fixed financing.
Land
- If you are young and have a long time horizon, buying a large tract of vacant land at the edge of a city (or between two expanding cities) can require little management time on your part. You just have to wait for the town to expand.
Tips for Successful Real Estate Investing
- Conduct thorough market research
- Understand the local market trends and demographics. You’ll find that cap rates are higher in dying towns and cities, high crime areas, and with very old properties. It is rarely worth trading leveraged appreciation for cash flow. Tech cities often appreciate quicker than other cities due to high salaries. But inventory rates and absorption rates are also important. Local Market Monitor performs very detailed analysis of multiple cities.
- Analyze comparable properties and rental rates. Zillow shows sold values but be sure to compare properties of similar age, design, and location. A real estate agent can also provide you with sold comps.
- Develop a solid business plan
- Set clear investment goals and timelines. I recommend planning to hold each property for at least a year, for the above mentioned long term capital gains tax treatment.
- Determine your target property type and investment strategy.
- Secure financing
- Explore various financing options, such as traditional mortgages, hard money loans, or private money. If you are doing a BRRRR strategy, look into DSCR loans for the refinance step. They are based primarily on the income of your rental property.
- Maintain a good credit score and have sufficient funds for a down payment.
- Build a strong team
- Work with experienced real estate professionals, such as agents, property managers, and contractors. Cheney Realty is on your side.
- Establish relationships with lenders, attorneys, and accountants.
- Manage properties effectively
- Screen tenants thoroughly. This is particularly important in jurisdictions with strong tenant protections. Make sure you read the landlord tenant laws of the state and city in which you are planning to buy. Look up the local tenant’s union and read what kind of advice is being given to tenants. Generally speaking (there are exceptions), it is quicker to evict non-paying tenants in red states. Red states often provide stronger private property rights than blue states like California and New York. Sometimes, cities provide additional landlord-tenant laws and restrictions on landlords. It may be better to buy in suburbs than cities to avoid this extra layer of laws.
- Maintain properties to keep them in good condition and attract quality tenants. Be aware that some property managers let properties deteriorate rather than suggest improvements, so as to provide good cash flow to their property owner clients.
- Stay informed and adapt to market changes
- Continuously educate yourself about the latest trends and regulations in the real estate industry.
- Be flexible and willing to adjust your strategies as the market evolves.
By following these tips and exploring the various investment strategies, you can take the first steps towards building a successful real estate portfolio. Remember, investing in real estate requires patience, diligence, and a long-term mindset. With the right approach and guidance from Cheney Realty, you can achieve your financial goals and create a stable source of passive income.