Since the advent of property rights, people have built wealth through real estate. And it is still one of the best ways to do so.
Despite what you might see from infomercials, gurus, and whatever house-flipping show is fashionable at the time, however, real-estate investing is not easy money and much can and often does go wrong. Real estate can create passive income, but it is rarely passive from the start.
But if you are ready to roll up your sleeves, do your homework, and think creatively about risks and opportunities, real-estate investing could lead you to financial freedom.
If you want to learn more about the financial benefits of investing in real estate, keep reading.
Types of Real-Estate Investments
If you talk to a real-estate investor, he or she will probably tell you that whatever approach they are taking is the best way to make money in real estate. And it might be—for them.
What is great about real estate is that there are many entry points. Each offers different levels of risk, requirements for capital, and opportunities for pay off. Some approaches may work better than others depending upon your geographic market.
For example, some investors like to flip single-family homes, while others will buy and hold large apartment buildings. There are, in fact, other countless options for the real-estate investor as well—everything from triple net leases to mobile-home parks. You can read about our article about investing in vacation-rental real-estate here.
Each approach has its own learning curve and laws vary from jurisdiction to jurisdiction, so you have to do your homework. If you are interested in real-estate investing, I recommend that you begin reading the forums at Bigger Pockets, where you can read about every type of real-estate approach available. You can access Amazon’s Real-Estate Investing Books section here.
Benefits of Real-Estate Investing
Each real-estate-investment approach has its own advantages, but let’s discuss two of the more common types of investments.
Buy and Hold Real-Estate Investing
First, some investors start by buying buildings with 1-4 rental units. These are ideal entry investments because they can cash flow, but don’t usually require tons of capital.
You may have heard the term that you make your money when you buy. That means that you need to find a good price—a good deal. You might have to analyze tens or hundreds of opportunities before you find the right one. It takes some time looking before you understand the market well enough to spot the right opportunity. So be careful about jumping in with offers when you first begin searching for properties.
Here is what is great about this type of investing: After you purchase the property and fill it with tenants (or inherit tenants), the property should cash flow. If it won’t, you shouldn’t buy it. Depending upon your market and the number of units, the cash flow may start out small. But it should cash flow, so you have some income coming in every month. And, as rents go up over time, your cash flow should increase.
Then, if you have a mortgage, you are also paying down part of the mortgage each month by making principal payments, which for most mortgages increase at least slightly each month (while the corresponding interest payment decreases).
As time goes on, the property should appreciate as well. Of course, there may be periods of time—like the one we went through several years ago—where property may not appreciate. But over time, it is likely to increase in value, to at least keep up with inflation.
Finally, the tax benefits—as of now—are outstanding. You can usually deduct a certain amount each year for depreciation (but talk to your accountant). And the increase in the value of the property itself is tax-deferred. And if you do what is called a 1030 exchange, you may be able to defer the taxes further even when you sell the property, if you buy another one and meet certain requirements.
So, let’s review. Here are the potential benefits of buy-and-hold real-estate investing:
1.Cash flow, which should increase over time as rents increase.
2.Your tenants will pay down the principal of your mortgage (at an increasing rate).
4.Tax-deferral and depreciation and other deductions.
With these benefits, it is no surprise that real-estate is a popular and effective way to develop wealth and financial freedom.
House Flipping as a Real-Estate Investment
Second, other investors like to flip houses. This is not easy to do, but it can create cash quickly, which you might use to purchase buy-and-hold properties. This is by no means “passive” income, and it is easy to screw up and lose a lot of money.
House flipping is not as easy as it appears on television. And it is stressful. Even a successful flip will likely create times of panic (which the drama of television does document well).
But it can create a lump sum of cash in a short period of time, if you do it right. What does that mean? Well, first, you have to find a great deal. House flipping is definitely a situation where you make your money when you buy.
Typically, the worst shape the house is in, the better your opportunity for a good deal. That is based upon simple competition: The less attractive the asset, the fewer the competitors for any given price. So if you are really good at taking houses that need a lot of work, or fixing problems that many people don’t like to touch—like foundation issues—you have a better chance to obtain good deals. Of course, I don’t recommend that you tackle foundation and other extreme issues unless you know what you are doing.
Make sure that you purchase a property whose defects you can fix. If the house is at a reduced price because it is on a busy highway, there probably isn’t anything you can do about that. You will have to offer a discount yourself when you sell it. Ugly paint, wallpaper, carpeting—you can fix those things. If the property has a strange layout, you can fix it, but it will be costly, so be careful with that problem.
Make sure you have a good construction team that you can trust, and do the work. Time is of the essence because holding costs are expensive. The sooner you can fix it and sell it the better.
Finally, when you are ready to market the property, pricing is important. If you price it higher than the market, it will likely sit, no matter how well you did with the fixes. Instead, price it at a slight discount to the market, so it will move quickly. Unlike many occupant-sellers, there is a definite monthly financial cost to each extra day the house sits unsold.
Where to Begin with Real-Estate Investing
Be careful with gurus (who are everywhere) and infomercials. Most of their time is spent talking about lifestyle and how easy it is to make money in real estate, rather than showing you how to do it. You can create both cash and wealth with real estate, but you have to be smart about it and it isn’t easy (at least when you first begin).
I recommend that you start your journey by reading articles and forum discussions at Bigger Pockets.
If you are looking for books, I recommend two to start. The first is Rich Dad Poor Dad, by Robert T. Kiyosaki. This book isn’t about real estate exactly, but the principles he discusses will help you develop the financial mindset for real-estate investing, particularly buy-and-hold.
The second book is called The Millionaire Real Estate Investor, by Gary Keller, with Dave Jenks and Jay Papasan. This book not only explains the advantages of real-estate investing, but also delves into many of the practical issues that you will need to understand to succeed.
After you devour those two books, check back on Amazon’s Real-Estate Investing Books page, as there are many useful books out there right now.
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