Today’s article is from Chad Carson, who writes about real estate investing (and other money matters) at Coach Carson. I’ve always been intrigued by real estate investing but overwhelmed by how much info available. I asked Chad if he’d be willing to write an article that would help me (and other GRS readers) understand the basics of real estate investing. This is the result.
I got started in real estate investing right after college. Because a young adult can basically sleep in a car if he has to (my 1998 Toyota Camry with cloth seats was comfortable), I had little to lose by launching a business. Unfortunately, as a Biology major, I also knew very little about business or real estate. But I did know how to hustle and to learn. That helped.
Slowly, I learned to find good deals and to resell them for a small markup of profit (a.k.a. wholesaling). I also learned to buy, fix, and flip houses for a bigger profit (a.k.a. retailing). After a few years, my business partner and I began keeping some rental properties because we knew that was the path to generating regular, passive income.
While my early business might sound like an exciting HGTV house-flipping show, it’s not for everyone. I experienced radical ups and downs of cash flow, and there were many unpredictable outcomes. I learned a lot being a full-time investor, but there are actually easier ways to get started.
Most investors I know started with a full-time job. They became valuable at their job, earned good money, lived frugally, and started boosting their saving rate. With their extra savings, they began buying rental properties on the side.
I’m not saying you shouldn’t begin as a real estate entrepreneur like I did — you’ll know if you’re called to make that leap — but if you currently have a non-real estate job and you’re saving money, you’re already going down the easiest path.
The next step is to learn how to invest that money profitably and safely. I personally think real estate investing is one of the best ways to do that. I’ll show you why that’s the case in the next section.
Why Real Estate Investing? Because It’s Ideal!
I’ve yet to find a better way to describe the benefits of real estate than this. All you need to remember is the acronym I.D.E.A.L:
- Income. The biggest benefit of real estate is rental income. Even the worst rentals I find produce more income than a portfolio of other assets like stocks or bonds. For example, I often see unleveraged (no debt) returns of 5-10% from rental income. And with reasonable leverage, it’s possible to see these returns jump to 10-15% or higher. The dividend rate of the S&P 500, on the other hand, is only 1.99% as of 1/24/17. And the yield on a broad basket of US bonds as of the same date was only 2.41%.
- Depreciation. Our government requires rental owners to spread out the cost of an asset over multiple years (27.5 years for residential real estate). This produces something called a yearly depreciation expense that can “shelter” or protect your income from taxes and reduce your tax bill. (For more about this, check my article The Incredible Tax Benefits of Real Estate Investing over at Mad Fientist.)
- Equity. If you borrow money to buy a rental property, your tenant basically pays off your mortgage for you with their monthly rent. Trust me: Having somebody else pay your mortgage is a beautiful thing! Like a forced savings account, your equity in the property gets bigger and bigger over time.
- Appreciation. Over the long run, real estate has gone up in value about the same rate as inflation, roughly three to four percent a year. Combined with the three benefits above, appreciation can produce a very solid long-term return. But this passive style of inflation is not the whole story. Active appreciation is even more profitable. You get active appreciation when you force the value higher by doing something to the property, like with a house remodel or changing the zoning.
- Leverage. Debt leverage is readily available to buy real estate. This means your $100,000 of savings can buy five properties at $20,000 down instead of just one property for $100,000. Interest on this debt is deductible, so you also save on your taxes. (While this can be helpful, keep in mind that leverage also magnifies your losses if things go bad.)
These IDEAL benefits are core reasons to invest in real estate. But as a Get Rich Slowly reader, I think you’ll appreciate another core real estate investing benefit: control!
Controlling Your Financial Destiny
I love J.D.’s message here at Get Rich Slowly: You are the boss of you! You can apply this lesson to so many parts of life, but it especially applies to your finances. Real estate investing fits very well with the GRS philosophy. Why? Because real estate gives you much more control than other more traditional investments.
I’m also a fan of low-cost index fund investing, for example, but do you have an impact on the returns of your stock portfolio? Not really. The 3500+ managers of the companies owned by the VTI total stock market index fund do impact your returns, but not you personally. You simply control when you buy, how much you buy, and when you sell.
But with a rental duplex, for example, your decisions directly affect its profitability (for better or worse!).
- You can buy in certain neighborhoods and ignore others.
- You can negotiate with your bank, with the seller, and with your vendors to get better prices.
- You can choose the property manager and the types of tenants who will ultimately produce the returns for your investment.
If this prospect of control excites you, then keep reading. But if your palms are clammy at the idea of hands-on investments, just focus on a different vehicle. That’s okay. There are options for everyone in this big investing universe!
To make things manageable, we’re going to break things down a little. As a baby, you learned to walk by taking tiny steps. You also fell down a lot, but with a diaper four inches from the ground, what’s the harm?!
Well, you’re no longer a baby. Financially you do have a lot to lose. Your family, your hard-earned savings, your plans for financial independence, and your pride would all suffer if you made bad investments.
I get that. And that’s why we still need to take safe, baby steps. There’ll be plenty of time to run and grow faster once you’re more confident. But in the beginning, just strive to move forward steadily.
The seven baby steps below provide a simple path to follow. I’ve taken each of these steps personally. You can use them as a blueprint to help you move forward with your own real estate investments.
Step 1: Create Financial Goals
Real estate is simply a financial vehicle. Before you begin to buy real estate, you have to have a clear picture financially where the vehicle will take you.
If you haven’t done it already, read J.D.’s Financial Independence in Plain English. You’ll learn that a solid financial independence goal is to achieve a net worth equal to your current annual expenses multiplied by 25. In other words, if you spend about $50,000 per year, your goal should be to achieve a net worth of around $1,250,000. With this level of wealth, you could likely withdraw 4% of your net worth each year without completely depleting your money.
While these assumptions are typically made for traditional portfolios of stocks and bonds, real estate works much the same. In fact, it’s much simpler.
Let’s say once again you spend about $50,000 per year. And let’s assume you can produce a cash-on-cash return of 6% with your real estate investments. (This return — or better — is achievable once you get going.) This would mean you need a net worth of $833,000 ($50,000 ÷ .06) to achieve financial independence. (For more details, check out my article How Many Rental Properties Do You Need to Retire.)
In case you didn’t notice, real estate’s income producing ability allows you to become financially independent with a much smaller net worth than alternative investments. In other words, you get to financial independence sooner!
Just another benefit of real estate investing! Now let’s pick a real estate investing strategy and niche.
Step 2: Focus on a Real Estate Investing Strategy and Niche
A niche is just a small segment of the larger real estate market. This could be a particular neighborhood, a certain kind of property (single family, duplex, commercial building), or a certain customer (like vacation rental tenants).
A strategy is a method of making money. In very basic terms, real estate strategies fall under two big umbrellas:
- Flipping properties (buying and quickly selling).
- Holding for rental income and growth.
Within each of these larger strategies, you’ll find a number of sub-strategies. I’ll give you my favorites below.
Many brand-new investors get overwhelmed because there are so many choices. This leads to analysis paralysis or ineffectiveness as they jump from one niche to another.
To help you avoid this, I’ll recommend a few of my favorite beginner combinations of strategies and niches within real estate investing.
The Live-In House Flip
My friends and bloggers at 1500 Days to Freedom built a large part of their wealth ($1.6 million +) using a simple real estate method. It’s called the Live-in House Flip. [J.D.’s note: I too am a fan of the folks at 1500 Days. They’re funny and informative.]
Just like it sounds, this strategy involves flipping a house. But unlike most flips, you live in the house for at least two years.
Why live in the house? Because this allows you to sell the house tax-free. This is one of the most profitable sections of the U.S. tax code! (In the U.S., when you sell your primary residence, up to $250,000 of capital gains for an individual — or $500,000 for a couple — can be excluded from your income.)
No, it’s not always fun to live with construction dust. But what if you could use this strategy for a short…
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