Depending on the level of involvement you desire, investing in real estate can be as demanding as managing multiple properties and tenants or as simple as taking 10 minutes to create an online portfolio on a crowdfunding site.
When the market’s up, many aspiring investors may try their hand at making a buck, but the reality is that it’s a business with a high risk of failure. An appreciating asset, people often think real estate is a safe bet; however, it’s also illiquid and requires a longer time frame to see results than stocks, for example. So we talked to an array of real estate experts to investigate what kind of person is the right fit for real estate investing, and what kind of investing is best for beginners.
According to their experience, it’s not only about ranking in returns—the real estate investor is a specific kind of spender. Before you tie up your finances in property to rent or flip, here are five essential questions to ask.
1. Are you the right personality fit?
You can read all the blogs on the ins and outs of real estate investing that the internet has to offer, but if your personality isn’t a good fit for this type of investment you’ll still be facing an uphill battle.
“A common misconception is that you have to know how to do all the work yourself. That you have to be handy or that you have to be a ‘jack of all trades’ type, which is not true at all,” explains real estate agent and investor Jeremy Rynders. Based in Milwaukee, Rynders is an experienced flipper, as well as rental property owner.
Rather, whether going into flipping or rental investment, Rynders says the appetite for risk is necessary.
When Rynders reflects on his success in real estate investing, it’s often because he was willing to purchase a property when no one else was: “I didn’t have a special inside deal on them, they were on the market. It’s just the market was worse then, so people weren’t as willing to buy them.”
If the thought of going door to door to find leads for your next flip, or confronting a tenant about a late rent check makes you nervous, then hands-on real estate might not be for you.
“The hardest part about flipping a house right now is finding the house to buy,” Rynders explains. You’ve got to be willing and good at scouring court records, networking with agents and developers, or even knocking on doors in areas for lead generation. That, and a real estate agent knowledgeable in flips or rentals, is your key to that initial property hunt.
While you’re at it, consider what personality skills might help your edge out the competition in your area, advises full-time flipper, Uriah Dortch. You might be investing in real estate as a side hustle, but you’ll “need a competitive advantage to beat out someone like us that does this full time, has a team of people and lives and breathes this lifestyle.”
That might mean you thrive when networking, or already have a Rolodex full of contacts. Perhaps you love being part of the action, and your people skills make confrontations around late rent or property complaints no problem.
If people describe you as a risk-taking people person, flipping properties or investing in rentals might be a fit for you. But, if you see yourself more on the sidelines in other aspects of life, you might want to consider more passive real estate investment alternatives (more on that below).
2. How much initial capital do you have to work with?
Real estate investing comes in all shapes, sizes, and opportunities—especially when it comes to the depth of your pocket book. The type of investment route you decide to go down will not only depend on having the right personality, but also how much money you have to work with upfront.
Here’s how much you can expect to spend on these common types of real estate investments, from most expensive to least expensive:
Purchasing a house, renovating it, and selling it typically comes with the highest price tag.
In the Milwaukee market, Rynders reasons you’d need between $120,000 and $200,000 to successfully flip a home. That means purchasing a home for between $80,000 to $120,000, then investing $50,000 to $80,000—assuming you’re doing this all in cash.
The biggest barrier to entry for many when it comes to flipping is the 20% to 25% down payment on the property. Typically, you’ll need a higher down payment for an investment property than buying a property for yourself—you’re limited to financing the purchase of the property through conventional mortgage loans, or cash.
The rule of thumb when investing in a flip is researching the potential ARV (after-repair value) of the property in your market, then working backwards: cut that cost by 75%, then subtract the estimated cost of repairs to determine how much you should pay for a home you want to flip.
If you’re purchasing a rental property, you’ll still need the 20% to 25% down payment, and depending on the condition of your property, you might not need to allocate as much capital towards renovations.
When you’re factoring in the expenses around a rental property, it’s smart to keep the 1% Rule in mind. The 1% Rule means that if your property can rent for at least 1% of the cost it took to acquire it, then it’s a solid investment. Keep in mind acquisition costs isn’t just the market cost of the home, but remodeling or any other expenses you’d have to take on before bringing in tenants.
While a rental might not be as capital intensive upfront as a flip, you do have to consider the cost of monthly maintenance on the property. Remember, you’re not flipping and selling, you’re updating and occupying. The profits you collect in rent will have to factor in the cost of:
- Emergency repairs
- Taxes, insurance, and mortgage
- Routine maintenance and upkeep
- Garbage and recycling collection
- Rental vacancies
One of the ways to get started in real estate rentals is with an owner-occupied property. That could mean a duplex, triplex, or property with a carriage house where you intend to live in one of the units. If you occupy a portion of the property, “then you can buy it for as little as 3.5% down FHA or 5% down on a conventional loan,” Rynders reasons.
Since you’re living on the property, regardless of other occupants, you’re not limited to just conventional mortgage loans. If you don’t mind paying for mortgage insurance (PMI), you can sometimes get away with putting less than 20% down.
Real Estate Investment Funds (REITs)
REITs are a lower capital commitment in the real estate investing world. As an individual investor in the fund, you’ll buy shares in a portfolio of real estate properties. The rent the REIT collects on the space is distributed to investors as dividends.
Typically shares of REITs require low or no investment minimums, and are more liquid than buying an actual property.
Online investment platforms
In recent years, the online crowdfunding of real estate has boomed. Similar to services like Kickstarter or Indiegogo, these platforms make it easy for investors to contribute and buy shares in commercial and residential properties. With investment minimums as little as $10 on some platforms, these crowdfunded options might be the least capital intensive real estate investment.
3. How suitable is my market for investing?
Depending on how much money you’re willing to put down, and how much risk you’re willing to take, the ideal market looks different for each investor.
Location can make all the difference when it comes to yielding favorable returns on your real estate investments. When you’re starting out, an important question to ask is whether the area you currently live in has the right mix of conditions for investing. If not, are you willing to move, travel, or deal with the properties from afar?
Ideal market conditions for rentals
A rental property in a stable neighborhood with low rental inventory, good schools, and tenants that want to occupy the space for a long time would be perfect, but finding a home like that is hard, and cost prohibitive when you’re first starting out.
According to data from real estate technology company House Canary, the strongest markets to invest in are metropolitan areas with net population gains that will drive property price growth.
Live in an area where growth is slowed or stagnant? You might want to think twice about rental investments in the area. If you’re dead set on purchasing a rental property in this kind of market, you’d do best investing in a single-family home, which might have a smaller yield month over month, but maintains value and residents at a higher rate than condos or apartments.
Ideal market conditions for flipping
Remember how real estate investing is all about embracing risk? The best return on a flip will come from lower-priced properties where few are willing to buy, explains Rynders.
“The number one rule in flipping or making money in flipping is you make your money on the buy. So if you get it at a good enough price, you know you’re going to make money. If you overpay or stretch things thinking that you’ll like cut corners on the construction side, it’s never going to work out.”
Similar to finding a good rental market, you’ll want to flip a property in a neighborhood or market that’s growing, not stagnant. Indicators of growth include new construction, job growth, or population growth. However, you’ll want to hit that sweet spot between growth and inventory of distressed homes. Enter a market too late, and you’ll be overpaying for your property from the get-go.
Enter too early, and you’ll be hard pressed to find a buyer once the flip is complete. ATTOM Data Solutions, a real estate and property data provider, has a comprehensive index of home flipping profits by neighborhoods across the country.
4. How much time are you willing to commit to the endeavor?
As a first time real estate investor, you’ll need to have available time to commit to your property. If you’re flipping a home with the help of contractors, you’ll need ample time to check in and manage projects. If you’re in the rental game, you’ll need to have the time and flexibility to address tenant complaints, repairs, and chase down late payments.
If you have limited time to commit to a real estate investment, you’re more likely to lose out on profit. You might be hiring pros to tackle the large, complicated renovations, but if you can put in some sweat equity on easy to tackle projects, that means a faster turnaround and less contracted labor.
Similarly, Rynders cautions against relying completely on a management property company to oversee your rental investments: “Research property management companies and know how much they charge for things cause they will overcharge and take advantage, especially if you’re out of state or don’t know what you’re doing,” he advises.
Working with limited time, but still want to get involved in real estate investing? Checking online investments like REITs or investing platforms takes only seconds from an app or computer.
5. Should you dip your toes in the water before diving head first?
There’s no such thing as a sure thing when it comes to investing. Not ready to become a landlord or flipper? There are other, lower risk opportunities to dip your toes in the space:
ETFs, mutual funds, or REITs.
Investing in any of these means no sweat equity, with the stability that comes with real estate investing. Typically, this means a lower ROI, but it’s also not as risky as buying a property on your own. Unlike flipping or renting, these options are more liquid.
- A REIT (real estate investment fund) invests in real estate directly, but is bought and sold like stocks. Typically REITs invest in commercial buildings.
- A real estate exchange-traded fund (ETF) or REIT ETF invests in multiple real estate companies at once, a bundle of REITS, making it a low cost, low commitment alternative to flipping or renting out property.
- Real Estate Mutual Funds typically invest in not only REITs, but also real estate related stocks and companies.
Invest in online real estate opportunities.
With new e-companies like Fundrise, Small Change, and ArborCrowd, users pool funds to buy and develop housing. Unlike traditional crowdfunding platforms, you’d get a return on your investment, instead of perks.
Rent out a room or Airbnb.
If you’re considering investing in rental properties, renting out a spare bedroom in your primary residence, or listing your home on Airbnb can be a low-risk way to see if you’re cut out for property management. Keep in mind you’ll have to report this as taxable income.
As a whole, real estate investing can seem complicated and confusing to a beginner. Sure, the return on investment is exciting, and well-researched real estate investments can bring in a steady income and long term financial security, among other benefits. But before diving headfirst into investment properties, make sure to ask yourself the above essential questions to see if it’s a match made in heaven or recipe for failure.
Header Image Source: (Nguyen Khanh Ly/ Unsplash)