Real estate investment is a very attractive avenue for wealth building, as there are few other business opportunities where the potential for income is so high. However, it can be a very risky endeavor to step out on your own and jump into a volatile market. Navigating the financial and legal issues surrounding real estate investment can be an incredible hassle. Still, thousands of people are doing it every day and the smart ones are coming out on top.
Here are a few of the things these successful investors consider before jumping into the fray:
Flipping or Long Haul Investing?
The first step to real estate investment is to decide what type of investor you’ll be – a house flipper or somebody who’s in it for the long haul.
Flipping houses has become something of a hot button issue. Televisions show across the networks have capitalized on the trend and popularized this quick-return type of property investing. However, it’s not all glitz and glamour…
Flipping involves buying fixer-upper homes, slapping on some “quick fixes” to increase the value, and then selling for a profit. Usually the whole process takes a month or two and profits can range from several thousand to several hundred thousand dollars, depending on the market, the investment, and how quickly the property actually flips.
But often, first-time flippers wind up sinking money into properties that won’t sell quickly enough for them to realize a profit. They may spend too much on renovations, fail to understand the particular market, or get hooked into high-cost loan arrangements that were supposed to last for 30 or 90 days, but end up lasting years.
Long-haul investment (usually in multiple unit residential properties) offers a different type of financial opportunity. Generally, these properties are purchased because they offer rental income and require little renovation up front. While these business opportunities are more stable, it may take some time before profits are ever realized. The idea of residual income is great, but when that actual amount earned is levied against mortgage payments, first-time landlords are often lucky to break even.
When considering which type of property to invest in, consider the wise words of Adam Baker – the popular Man vs Debt blogger who detailed his experiences as a real estate investor on the Get Rich Slowly website:
“A property or purchase can be a fantastic deal for one person and a horrible mistake for another. Crunching the numbers is essential, but you’ve got to take the steps to ensure it fits into your portfolio and life plans.”
Unless you’re independently wealthy, you’re going to have to find a way to pay for your investment properties. Any of the following options – or some combination of different techniques – may be right for you.
Though zero-down opportunities do exist, they carry a high level of risk if you can’t secure income relatively quickly from a property. Still, it’s a good idea to tie up as little of your own money in the process as possible. The good news is that these are competitive times and lending agents are aggressively looking for your dollar. Some offer down payments as low as 5% for real estate investment properties, so it’s worth the extra effort to apply with several lenders in order to find the best loan terms.
On the other hand, finding a wealthy partner might be the best option, as it is for many first-time investors. That said, if you take this approach, it’s important to always have an exit strategy to get out of such a relationship if you want to take your business in a different direction.
Another tip: always secure more than you need. This extra capital will allow you to do the necessary refurbishments to a property to either increase the value at sale or to increase your monthly rental prices. Either one of these options will help to boost your profits and do more than break even.
You can buy properties in your name and go from there, but that’s just asking for financial failure! You should always create your business as a business. There are several options available, based on the tax status you’re willing to accept – but generally, most real estate investment businesses are setup as LLCs. This option allows owners to legally separate themselves from liability in order to protect personal property and finances in the event of a catastrophic failure (such as a lawsuit).
It’s generally quite easy to create an LLC. The two main requirements are filing articles of incorporation with state agencies and maintaining a business of “good standing.”
However, even when setting up simple LLCs, it’s a good idea to seek the advice of a real estate attorney who’s experienced with real estate matters (or you can post a job with UpCounsel to save 30-50% off your legal fees). Additionally, you may want to ask a financial advisor before doing the actual paperwork to see if any other incorporation options suit your needs better.
Incorporation doesn’t protect your business from litigation due to unsafe conditions or accidents. Insurance does. Long-term rental property investors will want to have iron-clad insurance policies in place that include stipulations about what’s covered by the insurance and what is the responsibility of the renter.
Short-term investment properties must be covered by short-term insurance policies. You simply can’t afford to go without, but – at the same time – there’s no reason to lock yourself into a long-term contract if you’re going to offload the property as soon as possible.
Whatever type of insurance you choose be aware that there will always be exclusions. These eventualities are not covered by the policy and are one of the reasons why you should always incorporate your business to protect yourself. For instance, black mold is almost never covered by insurance policies, but is a common problem for property owners.
Work with a Realtor
When setting up your property investment business, you may be tempted to skimp as much as possible to reap the lion’s share of the profits for yourself. However, it’s not a good idea to go it alone during the property search on your first couple of go rounds. No matter how much market research you do, you’re not going to be an expert the first time or two you purchase income properties.
In addition, realtors understand the market within a given geographic area better than you ever could. Your goal should be to find the worst houses in the best neighborhoods and spruce them up to reap the biggest rewards. You don’t want to get hung with a mediocre property in a neighborhood that’s on the decline. This may mean sacrificing some of your predicted profit, but it’s a valuable learning experience that will help you cut the cord in the future.
Be Cautious of Starting Small
It seems wise, at least on the surface, to start small and grow bigger in the real estate business, but this may not always be the best option. Generally, single unit rental properties and small single family homes are the most attractive to newbie investors, as they usually cost less to purchase. However, the profit from these properties is often swallowed up by the mortgage, renovation budget, and maintenance on the properties.
As a result, it may be a better idea to partner with a wealthier individual or to secure more financing in order to purchase a more profitable property. This isn’t to say that you should ever over-extend yourself, but beware that properties requiring small initial investments often offer small profit potential. Take this – and all of the other factors described above – into consideration before signing on the dotted line of your first investment property.