How to Invest in Real Estate
If you talk to any wealthy person, chances are that real estate investing has contributed somewhat to their success in reaching their financial goals. Knowing how and when to invest in real estate is integral to growing your net worth over time.
I am a big believer that buying rental properties need to be a part of your long term investment portfolio. Besides the potential for capital appreciation and income, it also diversifies some risk away from the stock market.
Over the years, I have followed some general rules when it comes to investing in real estate.
Do Your Homework
Before investing in real estate, you need to do your homework. It’s important to have clear knowledge of the specific geographic market you are looking at. You should visit open houses in the interested area and talk to local real estate agents to gain insights into local housing activity.
Simply relying on real estate agents to tell you how much you should offer for a property is very limiting. Use web sites like Zillow and Redfin to research listings and perform your own comparable analysis.
I sign up for daily email alerts from these websites to get real time information on market activity so I don’t have to wait to hear about them from agents. It may not necessarily be the agents fault, but relying on someone else to pass on information may cost you precious opportunities.
Dealing Directly With the Listing Agent
Another tip is that if you find a property that you are interested in, go see the property yourself and speak directly to the listing agent. There certainly is value to working with your own agent, but sometimes dealing directly with the listing agent is more beneficial.
If you have sufficiently educated yourself with the geographic market and the home buying process, you can consider dealing with the listing agent. Having the same agent for the buyer and seller is referred to as dual agency.
Dual Agency, in my opinion, has two great benefits: one, you may have more negotiating power since the agent has a good understanding of what is important to the seller; and two, the agent is incentivized to work with you as they will get paid from both parties.
Having said that, there are certain pitfalls with dual agency if you are not careful. It would be difficult for a dual agent to be completely loyal to both parties (the seller and buyer), and so assuming that the seller and seller agent already have a relationship, your welfare may not be the first consideration of the agent.
Also, the home buying process is a stressful period. Having a buyer agent who you personally choose may help relieve that.
Regardless of whom you work with, just remember to be disciplined in your approach to buying and be knowledgeable about the market so you will not be swayed by opinions from any agent.
Cash Flow is King
Before you buy a property, assess how much repair and maintenance you may incur based on its age and condition. Property maintenance expenses can run from $150 to fix a faucet leak to over $4,000 to replace the entire A/C unit.
Never buy a property where you are cash flow negative every month. Be sure to put enough down payment so that that your financial model shows at least a break even cash flow.
I always build a financial model to calculate the monthly cash flow coming in and going out. This way, you’ll clearly see what your property is doing for you. In terms of expenses, don’t forget to include mortgage payments, property taxes, HOA dues, management fees and operating expenses.
Shows on HGTV make flipping homes seem easy; but in reality, it is not easy to buy a house for cheap, remodel, then sell for a nice profit. These shows make home flipping glamorous and entertaining, and gloss over the stressful, competitive side.
Besides investors and contractors who are looking for these projects, you are also competing with companies that are set up for the purpose of buying cheap homes and flipping them.
After the 2008 financial crisis, it was possible to buy homes from banks (REO), court auctions or through short sales at attractive prices. Due to the rebound in housing prices over the past 7-8 years, those opportunities are very rare nowadays.
So if you see a listing that says “Investor’s Dream” or “Fixer upper”, you should know that everyone else sees the same thing and I bet the sale price will likely end up not being much of a bargain.
Sticking to What You Know
I suggest investing in markets that are close to you or ones that you know. I know people who Google articles on the fastest growing housing markets in the United States and try to buy in those cities.
The problem with purchasing in an unknown market is that you don’t know anything about the local economy, school districts, commercial activity, etc. Whereas when you invest in areas that you do know, you can see if there are new retail/industrial developments, compare rankings of the local schools, and see where the jobs are moving to. All these are factors that will affect the current and future price of your property.
Buying a rental property out of state will force you to rely on real estate agents and management companies that you may not be familiar with. I have seen too many investors regret buying out of state due to issues with the property, management and/or tenants.
Things to Consider
– You should always have a long holding period when investing in real estate
– Do your homework before buying anything
– Build a detailed financial model so you can estimate the monthly cash flows
– Don’t be tempted to flip properties for quick profits
– Invest in geographic markets that you know and understand
It’s important to understand that real estate is cyclical. Having a long holding period ensures that you can ride out any bumps along the way.
These general rules have helped me throughout the years with purchasing real estate for investment and should help you along the path of achieving financial independence.