Real Estate Investing for Beginners: 10 lessons from the veterans
One of the best strategies for building wealth is to develop multiple income streams, and there’s no better way to do that than investing in real estate. Real estate investing has four powerful trends working in its favor:
- Cash flow from rents
- Appreciation of the asset over time
- Mortgage paydown through rent payments
- Tax benefits such as depreciation
That said, starting out in real estate can be intimidating at first, especially if you don’t understand how real estate works. Here are 10 lessons from the veterans that every beginning real estate investor needs to know.
1. Start house hacking today
If you already have a place to live - even if you’re just renting - you can start investing in real estate by the time you finish reading this article. House hacking means taking a room in your house or apartment and renting it out to create an income stream.
You can also buy a small multifamily property using residential financing with a low down payment and low-interest rate, and live in one unit while you rent the other ones out to pay for your mortgage.
The most important thing to understand about house hacking is that you absolutely, positively have to save every penny of your extra income to save up for a down payment on another rental property.
2. Cash flow is king
Focus on cash flow and profits first, because there’s no point in investing in real estate if you can’t pay your bills and yourself.
Most beginning real estate investors do a pretty good job of forecasting income, but they’re not so good when it comes to operating expenses and CapEx (capital expenses). Factor in non-recurring expenses such as an unexpected roof repair, or lost rental income and the added cost on the off-chance you have to evict a tenant.
You can boost your cash-on-cash (CoC) return by using debt to your advantage. CoC compares the cash profits you earn after paying operating expenses and the mortgage to the actual cash you invested.
If your annual cash profit from a rental property is $2,500 and you used a down payment of $25,000, your cash-on-cash return is 10%, and that doesn’t even include potential appreciation when you buy and hold for the long term. Not bad when CDs are currently paying about 1% APY (annual percentage yield).
3. Avoid analysis paralysis
When you’re a beginning real estate investor, it’s incredibly easy to fall into the trap of analysis paralysis by looking for the perfect deal. The truth is there’s no such thing, and you’ll spend all of your time crunching the numbers – which is important – trying to find a deal that “makes sense”, whatever that means.
Instead, focus your efforts and analysis on finding a great deal with a specific return. For example, you could aim for a cash-on-cash return of at least 8% and discard deals that are below that threshold.
To be sure, in today’s real estate market even modest returns like these can be hard to find. But don’t be discouraged. Connect with a local real estate agent to scour the MLS each day, and monitor new listings online on sites such as Zillow, Roofstock, and Norada.
4. Know where you want to go
Before you buy your very first rental property, understand how the investment fits into your long-term plan. Maybe you want to retire by the age of 40, generate $100,000 in annual cash flow ten years from now, or trade-up several single-family homes for a larger apartment building.
The point is that if you don’t know where you want to be 5, 10, or even 20 years from now you’ll have no idea of how to get there. Beginning real estate investors who follow a plan and keep emotion out of the picture generate more consistent and measurable results throughout their real estate investing career.
5. Invest where people want to live
Look for rental property in middle-income and working-class areas with an average or above-average school district and neighborhood ranking. You can find places like these in every MSA in the country, where people take pride in themselves and their homes, even if they are renting.
You may have heard rental properties in lower-income areas referred to as “cash cow” properties because of the steady flow of rental income. While that may be true in some cases, tenants generally rent in these areas because they have no other choice.
Owning and managing homes for rent in less desirable areas can be extremely management intensive and come with a high level of hidden expenses, such as a damaged property or a high rate of evictions. Instead, look for a rental property in a solid middle-income neighborhood for your first investment.
6. Good tenants are like gold
Experienced real estate investors know that good tenants are worth their weight in gold.
Good tenants tend to stay put and renew their leases year after year, even with annual rent increases. They take better care of their home and your investment, pay the rent on time, and cooperate with routine inspections to help you keep the property well maintained.
Be sure to review our rent estimate guide to make sure you’re charging a fair and competitive rent that will make for happy and longer-staying tenants.
And don’t forget that professional communication and prompt response to repair issues will go a long way in maintaining a professional relationship that will encourage your tenants to stay.
7. Hire the right property manager
Oftentimes you’ll find the best real estate investments that aren’t in the same city where you live.
Remote real estate investing is a strategy investors use to boost ROI (return on investment) by buying in smaller cities where population growth and the economy is strong, and housing prices are still affordable.
To maximize your rental property returns you’ll need to have a property management solution in place. Look for a property manager, even if online, who has experience working with investors, has other property in the area similar to yours, with a network of cost-effective handymen, contractors, and suppliers to help keep your operating expenses under control.
8. Real estate is a team sport
The best property managers have a network, and so should you. Investing in real estate is a team sport, because at the end of the day building wealth through real estate is about who you know just as much as what you know.
In today’s competitive marketplace, your income depends on how much networking you do. The truth is that you can find deals almost anywhere, and people are more than happy to help in exchange for future business.
Your real estate team should include a real estate agent who knows what investors are looking for, home inspectors and appraisers, handymen and contractors, lenders and escrow officers, and even fellow real estate investors who are happy to help a beginner out.
9. Keep cash in reserve
The last thing any real estate investor wants to do is run out of cash and have to beg the bank for a high-interest emergency loan or run up a credit card.
Rental income and expenses never move in a straight line from month to month, so you’ll need to set some money aside to take care of unplanned expenses such as an air conditioning compressor that goes out in the middle of summer or a broken water pipe in the dead of winter.
As a rule of thumb, having a cash reserve equal to two to three months of operating expenses means you’ll have enough cash for a rainy day if and when you need it.
You can do this by putting away most or all of the cash flow for the first year of owning a rental property to generate a fund for these unexpected expenses. Or, you can set up a separate account where you deposit a percentage of all monthly cash flow to generate a ‘rainy day’ fund.
10. Remember that real estate investing is a business
Last, but definitely not least, is to remember that investing in real estate is a business and not a hobby.
Surround yourself with people who have skills and strengths that you don’t, enforce the terms and conditions of the lease with your tenant, and don’t be afraid to take a pass on deals that don’t help you reach your long-term real estate investing goals.
When investors get complacent with due diligence, best practices, and ongoing education, they tend to get into trouble more often.
Although everything has its ups and downs, following these 10 real estate investing rules can help keep your rental property business running smooth and on track, even when you’re just starting out.
Remember to focus on cash flow, know where you want to go, and take care of your tenants to keep returns high and property appreciation strong.