How to Make Money Investing in Real Estate
In this post, you will learn how to make money with real estate investing. If you’re afraid that you may have to break your bank to fulfill this dream of yours, wait till you hear what we have to say. People with poor credit and not much money saved can still invest in real estate. There are many methods to making money with real estate investment we will discuss.
What is Real Estate Investing?
Just like the words sound, real estate investment means putting your money into real estate properties to earn a profit in return. There are many things that you’ll have to consider before getting started in the real estate investing business. And we’ll cover them step by step. But first, let’s look at the major areas where you can make money in real estate.
#1: Rental Properties
Renting out a property is one of the most common and most effective ways of making money from real estate investment. In laymen’s terms, you either buy or already own a property that you will then rent out to people who are looking for a place to stay or renting for an event.
Between the rental fee you charge and your operating costs for owning the rental property, there will be a difference, either positive or negative. Ideally, you want a positive difference, meaning the rental income exceeded your expenses, and what remains as the difference is your profit from the rental business.
However, it’s not that simple. It never is, right?
It all starts with whether you already own a property or not. If you have a ready-to-go property that remains empty most of the time, you can easily rent it out. The rental income will help you turn this vacant property (costing you money) into an asset that starts paying you money (from the rental income).
On the other hand, if you buy a property for the sake of renting it out, many new variables are introduced. These include analyzing the home before buying it to assess the needed property repairs, determining management fees if hiring a property manager, what to account for as a vacancy allowance, and so on.
These are all considered ongoing expenses. We have a dedicated section coming up. Stay tuned!
Fixing and Flipping
Buying a property, fixing it up, and reselling it for a profit, is another great way to make money investing in real estate. That’s because unlike most other assets like cars or machinery, real estate appreciates (goes up) in value. And you can accelerate the process by improving the overall condition of the property.
The most common example of fixing and flipping would be you buying a beat-up house for cheap, fixing it to increase the value, and finally selling it for a higher price than you paid + fixer upper costs, leaving you with a profit.
It may take a little bit of work and upfront investment, but it’s worth the profit you make in the end. Some house flippers can make $100,000 or more off of one house flip deal!
Wholesaling Real Estate
This is one of those methods where you don’t need any initial investment. However, you need proper connections and the ability to convince people. A property wholesaler works as the middleman between a home seller and a buyer.
You would also need a realtor license and proper training before you go this route. You should only focus on becoming a wholesaler of properties when you are willing to make a career out of it.
When you become the wholesaler, you contract the house with a buyer for more than what you contract with the seller. The difference is your wholesale profit.
Distressed properties like those that need severe repairs or the sellers are in debt works perfectly for this scenario as they’ll be easier to bargain down the price with. The desperation of the seller allows you to make more profit.
It might seem unethical to capitalize on someone’s desperation, but it’s completely aligned with the real estate business. In most cases, you’re helping someone get out of a property they no longer want to own and is costing them money to own it. They’d be happier to sell cheaper and get rid of their problems with that property.
Why Should You Invest in Real Estate?
Now that you have somewhat an idea about what real estate investment is, you might be thinking about why would you want to invest money there instead of stocks, bonds, etc. There are many other areas for investments, right?
Well, the real estate space works differently than most other industries. You’ll know why when you look at the reasons to invest.
#1: Real Estate Appreciates in Value
One of the main reasons to invest in real estate is that it almost never depreciates in value. Even if you buy a property and give it out for rent, the property itself will keep appreciating. If you decide to sell the property after many years, you can sell it for way more than what you bought it with.
In the meantime, you get your rental fees that tend to rise over time as well. Real estate investment is mostly for the visionaries who have the patience to give it time to increase in value.
#2: Cash Flow
There is nothing in the world that brings in consistent cash than real estate. When you put your property for rental, you are generating a constant stream of revenue. It’s especially true when you have a good location and a property that suits the need of the majority.
For example, a single-family house in the middle of the city will go for higher and more consistent rental deals. But if you have a mansion in the middle of nowhere, it’s very unlikely that you’ll generate a profit from that. Because even if you manage to rent it to the millionaires on a weekend, the vacancy allowance will go over your profits.
#3: Tax Deductions
When your money is in real estate, you get more flexibility for tax breaks and deductions. The value of the buildings will depreciate over time (27.5 years for residential properties and 39 years for commercial ones) and it helps to lower your taxed income. In the meantime, you get to deduct the costs of owning, managing, and operating the property.
#4: It Diversifies Your Portfolio
If you’re on the hunt to diversify your portfolio, there are very few assets that offer more opportunities than real estate. It has very little correlation with other asset classes. Hence, it returns a higher return against your per unit of risk.
#5: Inflation and Real Estate
If you’re not familiar with how inflation works, it’s when the government decides to print more money to increase the money supply and the price of limited supply goods increase.
Let’s understand the concept with an example. Suppose in a closed economy, there is only a $100 supply. And there are 10 houses for sale. No other factors are influencing the economy. Ideally, each house will be priced at $10 to cope with the money supply.
Now, inflation happens. The government injects more money into the system and now there is $200. But the number of houses remains the same. So, what would happen? The price of the houses will be $20. Inflation has increased the price of the property.
In the real world, the real estate economy works very similarly. But there are many other factors that influence the prices. One of them would be interest rates. If the interest rate is lower, people will feel the urge to buy their dream houses. With higher demand and the same supply of properties, the price will increase. It’s the simple law of supply and demand.
The effects of inflation are more prominent where the supply of land is limited. For example, the price of properties is higher in a city when compared to a suburb. Because suburbs offer more land availability, the effects of inflation are somewhat neutralized.
The opposite happens with deflation. If liquid money is scarce in the system, property prices are likely to drop. However, you shouldn’t worry about deflation because inflation is a more likely phenomenon than deflation any day.
So, if you purchase a property now, the price will automatically increase within a few years. And you will be able to maximize your profits by repairing and appreciating the value in the meantime.
#6: You Don’t ‘Have to’ Own Properties
If you’re interested in real estate investments but not sure whether you want to own and maintain properties, you can go with Real Estate Investment Trusts (REITs). You will be buying and selling REITs at the stock exchange.
It’s a great way to make some quick profits through your real estate investments. REITs are essentially companies that buy, fix, maintain, sell, real estate properties. But instead of one investor, they pool their funds from the public sector. Just like you, there are other people trading REITs. And all of you can enjoy a percentage of the profits.
The most common form of REIT is an equity REIT. It’s a company that focuses on commercial properties like apartment complexes, hotels, shopping malls, hospitals, etc. Annually, 90% of these REIT’s income must be distributed to investors.
A big reason to opt for REITs instead of regular stocks would be the tax policy. REITs are classified as pass-through entities. It means they don’t pay the higher corporate tax. Do you know what it means? It means a higher return for you as an investor!
Things to Know Before You Invest
The overall concept of real estate investment might look very simple, but some things don’t meet the naked eyes. We’ve seen many people come into the space with limited knowledge only to lose money over time.
We don’t want that for you. So, we’ve created a list of things that are crucial for you to know before you begin real estate investment.
Cash Purchase vs Debt Purchase
It’s one of the major areas where investors go wrong. The idea of getting a property for little to no down payment sounds amazing. And it’s a good place to start for investors who don’t have a lot of cash or bank balance lying around.
But the interest you pay on your mortgages will cut into the profits. You need to set a rental fee that covers mortgage fees, maintenance, repairs, utility bills, and your profit. If the location isn’t good enough or you fail to attract enough tenants, you might lose money.
It’s especially true during the vacancy periods. There’s no guarantee that someone will be around to rent your property. But the maintenance, utilities, and management costs will remain the same. So, you would be essentially paying for those out of your pocket!
A cash purchase, on the other hand, requires you to put more down payment upfront. But you are free from monthly mortgage fees. And when you own the property, the appreciation of value over the years will come directly into your pockets. You will also deduct taxes in the meantime from the depreciation of the buildings.
The bottom line is, both cash purchases and debt purchases can work in different scenarios. But you must evaluate your scenario before you go either way. You surely wouldn’t want to lose money over something you invested so much to make money.
One of the mainstream ways to generate profit from real estate investment is lease contracts. However, many new investors don’t think about leasing out their property. A lease contract is generally long-term where the tenant or the lessee uses the property in exchange for a fee throughout the duration of the agreement.
For example, if you lease your property to a party for three years, you will generate a steady stream of income for those three years. Also, with inflation rates in place, your property will appreciate in value over these years as well.
Depending on the type of your property, you can go for the gross lease or the net lease. A gross lease is where you pay for the maintenance, insurance, utility, and so on. But you charge higher. It’s good if your property is in good shape and may not require large repairs during the lease.
A net lease is where the tenants pay a lower fee, but pays for all the expenses. There are various types of net leases. If you’re interested in leasing out your property, do the proper research beforehand.
Moreover, you can go the other way where you can lease properties with a pre-set value if you decide to purchase. This way, if you concrete your decision to make the purchase, you get the property at a discount. Because during your lease period, the value will appreciate. As long as you put enough attention on the contract and not sign any ‘must buy after lease ends’ clause, you are on very good terms to make some profit.
You’ll be amazed to know how many rookie investors completely forget about the closing costs. In general, it’s a fee that you pay when a real estate transaction closes. It’s a very important aspect of real estate investment because very few people actually go for cash purchases.
Whether you finance your property purchase through a bank or a non-bank organization, you need to pay the closing fee. It ranges somewhere between 3%-6% on top of the purchase price. For example, if you buy a house for $100,000, you need to pay $3,000 to $6000 in closing fee when you settle your debt.
The fee varies on the state you make the purchase, the type of loan, the lender, and so on. But there’s nothing to worry about. Closing costs must be disclosed by the lender before you proceed. If both parties don’t agree on the fee, the transaction won’t go through.
Credit is Not as Important as You Think
There is a misconception outside the real estate bubble that you need an extraordinary credit score to get started with investments. But that’s not entirely true. Even with poor credit, you can start your journey to become a successful investor.
Ongoing Expenses for Real Estate Properties
After you’re done with your first real estate purchase, whether with cash or debt, a lot of other ongoing expenses will be waiting for you. It’s the premium you pay to keep the property in the best shape to make it more appealing to potential buyers or tenants.
This is going to eat into your profits the most. When you buy a property against a mortgage, you need to gradually repay the lender. Fixed-rate loans are generally the way to go for mortgages because they eliminate the risk of change in interest rates. It’s particularly important if you expect a reduction in your income or have plans to start a family in the long run.
On the contrary, if you have sufficient savings, you can go for an offset loan. It will keep your interest lower for the duration of the mortgage.
Just like with any other assets, you need to pay insurance. It won’t be as big as your loan payments, but it’s something you need to keep in mind. The insurance cost will vary from vendor to vendor and from location to location as well.
In general, there are three types of insurance when it comes to real estate investment. You pay for the building insurance, the landlord insurance, and the contents insurance.
- Building Insurance: Building insurance is for your building and its safety. It doesn’t cover anything else like the contents inside or the life of the tenants. Fire, water damage, or failing trees are the general coverage area for building insurance.
- Landlord Insurance: It’s your protective suit against bad tenants who may vandalize your property. Or, simply, not pay the rent. It’s part of the delinquency you must adopt as a property owner.
- Contents Insurance: It comes into play when you rent out furnished properties to tenants on Airbnb or Roofstock. This insurance covers any damage done or theft to the contents of your property.
If the property you buy is in good shape, you don’t have to break your bank over repairs. But if you buy a dead cheap property, you can expect to spend a lot of money to fix it up and get it ready for rental or flipping.
Apart from the one-time repair costs, there are multiple regular maintenance tasks that you must perform. For example, if the property has a lawn or a yard, you may need to cut the grass periodically.
A great way to increase property value is to use cash surplus for home improvement projects. For example, if your property is in a colder region, carpeting or better insulation will increase overall property value.
Property Management Fees
It’s something that you generally don’t have to think about in your initial days. Management fees mostly refer to the manager’s salary if you decide to appoint one. Unless you’re investing in multiple properties at once, you may not need a manager.
But if you decide to nosedive into the world of real estate investment, it’s something you need to consider. And it will add to your expenses list.
It’s all of the expenses we already talked about minus a tenant or a buyer. When your property is vacant, you still need to pay for utilities and management services. It’s known as vacancy allowance.
Other Ways to Make Money with Real Estate Investments?
From what you’ve read so far, you should have a good grasp of what real estate investments are like. They aren’t as simple as they look, are they?
It might take some time and patience, but you will start to generate hefty profits from your investments. All you have to do is make smart decisions. How? Let’s find out.
Real Estate Limited Partnerships
Known as RELPs for short, it allows you to merge your funds with other investors to take in larger properties i.e. commercial ones. It’s a great way to buy, develop, lease, and flip properties without taking too many risks on your own shoulders.
RELPs are very similar to REITs, but instead of trading stocks, you’ll be investing with a pool of other investors. But unlike REITs, RELPs have a limited lifespan, usually 7 to 12 years. During this time, your RELP venture will acquire properties, develop them, sell them, and distribute profits to the investors. Once the acquired properties are settled, the partnership dissolves as well.
If you’re looking for long-term investment opportunities and have a high net worth, RELP is the way to go for you. You can buy your way into the pools with a fixed amount to enjoy profit shares from the ventures.
Short Term Rentals
If you’re familiar with Airbnb, you would know that you can rent an apartment or a house on a per night basis. It’s very similar to how hotels work. Instead of renting a room at the hotel, you rent the entire house.
You can list your residential properties on Airbnb to reek benefits. It’s a great way to make money quickly. If your property is located in a tourist-heavy state or city, you can make a lot of money from these short-term ventures.
Financing the Buyers
If you have enough cash lying around after your property purchase, you can lend money to the buyers and earn interest on the loan. It’s a win-win situation for both you and the buyer. They get to pay you in installments and you get to enjoy a monthly interest over a long period.
Keep Your Expenses in Check
To make the most out of your real estate ventures, you must keep your expenses tracked. Whether it’s mortgage repayment, repair costs, or other fees, keep it minimal. Don’t spend on repairs that you don’t need. For example, a stain on the carpet can benefit from a thorough wash instead of changing it entirely.
It’s especially necessary when you are maintaining multiple properties at once. If you’re not careful, the expenses can stack up pretty quickly.
It all starts with understanding your property. For example, commercial apartment complexes require an HOA fee or Homeowners Association fee. It’s something you must pay whether your apartment has a tenant or not.
You need to calculate all of your ongoing and upfront fees before you invest in a property. There’s nothing more effective than long-term planning when it comes to real estate investments.
Get Counseling from a Property Lawyer
Each state has different laws governing the real estate market. If you’re not aware, you may fall victim to legal trouble. To eliminate the possibility entirely, it’s best to talk with a property lawyer before you invest in certain properties.
Also, investing in REITs or RELPs is generally safer than owning properties directly. When you are the sole owner of a property, you may be held accused if something was to go wrong. You can even lose your property in a lawsuit!
Another important aspect to discuss with your lawyer would be the taxes. There are different ways to pay taxes on your properties and it varies dramatically. Your best bet is to devise a strategy with the lawyer even before you make a down payment.
Don’t Forget Your Own House
If you are fortunate enough to own a house, you’re already into real estate investment. And you should always focus on improving your property. It will increase your net worth over time and build credibility for your other ventures in the real estate world.
For example, by building a pool in your backyard, you are effectively increasing the value of your property. It’s a value-added service that you can provide if you ever decide to sell your house.
Real estate investments are an intimidating thought. Many people back out because they think it’s the rich people’s game. But in reality, anyone can become a real estate investor. All you have to do is research your properties properly and follow our guide to make money from real estate.