As a sequel to my post on Achieving Financial Freedom through Real Estate, I have created this new post to get you started. Here you can bookmark practical tips on real estate investing and revisit anytime you need a refresher. I break down some of the basic concepts and terms: What is Cash Flow, Interest, Property Tax, Types of Real Estate Investments as well as Books to educate you in the process.
I recommend you start by investing in a single family house or 2 unit. Want a challenge? Go straight for a 3-4 unit, a challenge with more lucrative results! Build your experience while you start making Cash Flow, Equity and all the while earning even more money at the end of the year through a tax write-off on your mortgage interest or property depreciation. All of this will help make more money than your bank account accruing 0.1% interest.
“Cash flow” is the money you make AFTER all expenses are paid for. This includes your Mortgage (Principle + Interest), Property Tax (about 1.25%), Property Insurance + any expenses you cover such as gardening.
Practical Tips on Real Estate Investing
Misconception is that you need a lot of money to start. But with just a little savings, you can get an FHA Loan (as low as 3% down) as long as you live in the property, “Owner-Occupied Property”. That’s what I did in 2010 with my first property purchase. In 2013, when the value went up, I refinanced it into a “Conventional Loan” (20% loan to value) which meant I no longer paid Mortgage Insurance. You could also buy a 2-4 unit (with as low as 3% down) and live in one unit while the other renter(s) cover your portion of the mortgage.
- Keep in mind that with lower down payments, you will have higher monthly mortgage payments. Which means less cash flow.
- Mortgage Insurance “M.I.” will also be applied to any loans with less than 20% down which is calculated as 0.5-1% of your loan amount annually.
- Ie: $100k loan = $83 M.I. a month in addition to your mortgage and property tax.
Pros & Cons: Types of Real Estate Investments to Consider
Decide what type of Real Estate investment you are most comfortable with:
Condominiums
- PRO: May be the most affordable
- CON: Typically the least lucrative due to additional HOA cost and smaller margins for appreciation.
- While you do calculations on your monthly and annual Return on Investment “R.O.I.” similar to a Single Family House, you have to take into account the additional HOA (average of $200-500+).
- That’s extra monthly cost, unless you have extra Mello-Roos tax in certain newer developments. Values of Condos typically do not rise as high as SFR but it also depends on the area and when you bought it. If you bought a condo in a developing area such as Downtown LA in the early 2000’s, the prices have doubled or even tripled since.
Single Family Residence “SFR”
- Maybe the easiest to manage and better investment than a Condo.
- Good start as your first investment.
- Purchase to live in the property “Owner-Occupied” home.
- Discuss with your Accountant about Mortgage Interest write-off on your taxes
- Invest in an older, fixer-upper for less money. Put in repair money and either:
- Rent out at market rate after remodeling
- OR Re-sell as a “Flip”
Investing in Multi-Units
Typically more LUCRATIVE but more work
2-4 Unit Buildings
- Still considered a Residential property. This means you can get Residential Financing – typically easier to obtain with less down payment.
- PRO: Also a great starting point on your Real Estate Investment. A good way to get your feet wet right off the bat. The ROI will typically be higher than in SFR.
- PRO: You will likely make more money than if you had invested in a SFR.
- CON: If you manage it on your own, there will be more work since there are multiple tenants and depending on the area, you could be dealing with lower-income tenants.
- Alternative: Hire a Property Manager. It can cost you more money but worth relieving the headache.
5 Unit+ “Apartment Building”
- Investing in an Apartment building is typically for the more seasoned Investor. That’s not to deter you away if are motivated to start with it. You’ll need a good multi-family Real Estate Broker to help you find a good investment property.
- PRO: If you remodel the units and raise the rents to market level, you instantly increase cash flow. Property value automatically goes up based off calculations in CAP RATES & GRM.
1031 Exchange
Once you start selling your properties, you will have to pay Capital Gains Tax if your house sold for more than you bought it for. This is when you get into learning about “1031 Exchange”. This is a service that defers your taxes until you sell it at a later time. As long as you identify/purchase another ‘like’ property within 90 days.
6 Practical Steps on How to Start
Building Your Real Estate Portfolio
- Get Pre-Approved for a Loan to know what you can qualify for.
- Direct Banks: If you have straight forward tax-returns. As in you have w2 and consistent pay, a local bank will likely give you the best rates.
- Mortgage Bankers/Brokers: If you have more complicated tax-returns because you are self-employed or have changed jobs, a mortgage broker may be better for you. Sometimes they charge a point (1% of the loan amount) but not always. A mortgage broker acts as a middle man as they find out about your scenario, then shop at the best bank that fits your profile.
- There are also mortgage brokers that have been able to get better rates than a ‘direct bank’ have and without a point. I recommend talking to at least 3 different Mortgage Contacts to get started.
- Even if you are not ready to start investing, you should still get approved just to know what your capacity for investing is. And also if a good deal comes up and you want to submit an offer, it is more enticing to the Listing Agent when you present the offer with a Pre-Approval Letter from the Bank.
Identify Your Real Estate Appetite
- Come up with your top 3 scenarios on where and what you want to invest in. Here are examples in Southern California:
- Single Family house that you want to live in A, B, C city/area?
- 2 Unit Apartment Building in Long Beach?
- Single Family house you want to buy and rent out in Coachella Valley for AIRBNB?
- Large house in Lancaster that has room for remodeling to rent out to a family?
- Once you get an idea of what your appetite is, find a Realtor who is an EXPERTISE in that area. I think most of us know that the most successful, reliable professionals are those that have identified what they are best at -their NICHE. They are a master and are well-educated in that field.
- This applies to Doctors just as it applies to Realtors. The Realtor that tells you they can help you in every property in every area in the whole county likely isn’t as good as the realtor who can tell you exactly what property type they do in exactly what area.
- If you are looking to invest in an Apartment Building, hire a Multi-Family Real Estate Broker. It is so common for Residential Agents to say they do Commercial (not vice versa) and it’s a huge disservice to their client and the industry. Most Commercial brokers will not touch Residential Properties because they are not familiar with it.
- Therefore, true specialists will refer out deals they can’t do to another Professional that can.
- Drive and spend time in the area in which you want to buy. Go hang out at the local shopping center to see what type of people live in the neighborhood. This will give you a feeling of what type of renters you will have.
- Seasoned investors will also advise you to buy in areas that are within distance you don’t mind driving to once in awhile.
- Ask your realtor to put you on a weekly subscriber list of new listings that come up. This will get you familiar with the market you’re interested in. You start to study and notice the prices in the area and know when the right deal comes for you.
- Final step? Start putting in offers so that you can start this process already!
Recommended Books on Real Estate Investing
- Rich Dad Poor Dad – This is the quintessential book for everyone of all ages to train your mind to thinking that “Money works for you. Not you work for money”.
- Wealth Can’t Wait – Written by 2 of the largest Franchise Owners of Keller Williams. This book is targeted for those who want financial freedom and gets you into the mindset of investing in Real Estate. Highly recommend everyone to read.
- Investing in Apartment Buildings – A practical handbook on Investing in Apartment Buildings. Steps on how to calculate potential deals, ways of managing it, where to look and personal experiences from the author.
- Real Estate Investing for Dummies – I have not read this book but I can imagine that it has practical tips for anybody starting off in this new journey.
Read more practical tips on Real Estate Investing on my friend Ryan’s page: Freedom through Multiple Streams of Income.