7 essential steps to success for new real estate investors
Seven steps for real estate success
- Pick an investment strategy
- Decide how involved you want to be
- Choose what kind of property to invest in
- Save up a down payment
- Understand the costs
- Consider cash flow
- Keep cash on reserve
Real estate investing is a tried-and-true way to build wealth. But real estate can be a complicated world to navigate, particularly if you have no experience.
To get started in the real estate game, you need a solid foundation. To that end, here are seven essential tips new investors can follow for success.
1. Pick an investment strategy
There are many ways to invest in real estate. New investors should evaluate their options and pick the ones that best fit their goals and abilities. Your options include:
Buy and hold
If you’re aiming for a long-term investment strategy, buy-and-hold real estate investing is for you. With this, you purchase a property and make money through monthly rental income and (hopefully) the appreciation of the property’s value over time.
Buy and sell/fix-and-flip
The buy-and-sell strategy is to purchase a house and sell it at a profit. This most commonly takes the form of a fix-and-flip, where you buy a property that needs work, fix it up, and then sell it at a profit after its value has risen.
REITs and crowdfunding
For truly passive real estate investing, investors can look into Real Estate Investment Trusts (REITs) and real estate crowdfunding. REITs are companies that own or operate income-producing real estate, such as apartment buildings, hotels, office buildings or retail buildings, and allow investors to pool their money together for an investment that is a fraction of the cost of purchasing real estate themselves. Real estate crowdfunding is more akin to Kickstarter or Indiegogo, with a group of investors coming together to fund a real estate deal. Whereas Kickstarter backers are usually rewarded with some kind of product or service, real estate crowdfunding backers are rewarded with a share of the property’s profits.
2. Decide how involved you want to be
Real estate investing can be as active or passive as you want.
If you go with a buy-and-hold investment strategy, for example, you may find that it takes a lot of work to be a landlord. You can transfer that responsibility by hiring a property management company to take care of the property for you, but expect the company to take a percentage of your monthly rental income — perhaps up to 10 percent. REITs and crowdfunding are other viable ways to passively invest in real estate.
3. Choose what kind of property to invest in
Consider what kind of property you want to invest in. Your options include:
Single family residences
Single family homes are the easiest investment properties to acquire, as borrowers can use conventional financing from a bank to purchase them.
Multiunit properties, two to four units
Properties with two to four units are still considered residential properties, meaning borrowers can use conventional mortgages to purchase the property, rather than a commercial mortgage.
Multifamily properties, five or more units
Multifamily properties with five or more units are considered commercial properties. You’ll need to take out a commercial mortgage to purchase such properties; you should expect to pay higher interest rates and make a larger down payment (at least 25 percent).
Commercial real estate properties
Investing in commercial real estate can be rewarding; it offers high cash flow and the value of commercial properties can appreciate significantly. Commercial properties typically require a larger capital investment, however, so they may not be the best option for first-time investors.
4. Save up a down payment
How much money do you need to put down to purchase an investment property?
For an investment property, you’ll almost certainly need a down payment of 20 percent. Offering a larger down payment can get you a better interest rate. Depending on your circumstances, however, there are some opportunities for low-down payment investment mortgages. But such low-down-payment strategies are limited to very specific scenarios and require you to live in the residence; generally speaking, if you’re not going to live in the place, plan on a down payment of at least 20 percent.
5. Understand the costs
Investing in real estate comes with ample costs, especially with a buy-and-hold strategy. Such costs can include:
Maintenance and repairs
When you first purchase a property, you may need to make repairs before you can rent it out. And you’ll have ongoing maintenance expenses as long as you own the property. Take these expenses into account before you buy, and keep the condition of the property in mind. An older property is going to have higher maintenance costs than a newly built home, for example.
Though tenants are often responsible for paying some utilities — electricity and gas, for example — landlords may be responsible for paying utilities such as water, sewer or garbage. Ask to see utility bills for the prior year. You may also be able to contact the utility directly to request historical data on the property.
If a property is located in a homeowners association (or a condo association), you’ll need to pay monthly HOA dues. Don’t just look at the current dues — ask to see historical records so you get a sense of how often the dues increase, and by how much.
The only certain things in life, they say, are death and taxes. Property taxes on real estate investments are a certainty, so plan for them ahead of time — and anticipate that they will go up over time.
This expense is entirely optional. If you’re ready to be a fulltime landlord, there’s no need to bring in a property management company. But if your goal is creating a passive source of income, you may find a property management company well worth the expense. Expect to pay as much as 10 percent of the monthly rental income to a property management company. The company may charge additional fees for the initial work of filling vacancies.
Capital expenditures (CapEx)
Capital expenditures, commonly abbreviated as CapEx, are major expenses you’ll only have to pay for every once in a while. For an investment property, capital expenditures could include replacing a roof or major appliances.
6. Consider cash flow
A real estate investment is essentially a business, and when you own a business, you must consider its cash flow — that is, the amount of net cash flowing in or out of the business.
If you’ve bought an investment property with an appreciation strategy — you intend to wait for it to increase in value and sell it at a profit — cash flow isn’t as much of a concern. But if you intend to rent the property out, you should evaluate a property’s potential cash flow before you purchase it. You don’t want to get stuck with a property that has negative cash flow and ends up costing you money.
To help determine whether a property will have positive cash flow, you’ll need to rely on historical data, such as what the property has rented for in the past and how much the previous landlord typically spent on repairs. You’ll also need to have an idea of your monthly mortgage payment, homeowners insurance and other monthly costs.
7. Keep cash on reserve
Depending on the circumstances, lenders may also require you to have a certain amount of cash in reserve, to ensure you can continue making mortgage payments even if, for example, the property remains vacant. The exact amount you must have on hand can vary, depending on such factors as the number of units, the property’s occupancy status, and the number of other financed properties the borrower owns.