The housing market keeps sailing along. The only headwind that could take it off course is the lack of inventory for sale. The National Association of Realtors (NAR) reports that there&
Real Estate Investing 101
Dated: October 16 2019
So you’ve decided you want to invest in real estate. That’s great! It’s no secret that real estate is a great way to generate income without a whole lot of risk. As real estate agents, we work with many investors of different kinds and experience levels. We also receive numerous questions from others who are interested in investing in real estate for the first time. We’ve put together a simple list of tips and information to consider if real estate investing is on your mind, too.
First thing first, decide what kind of investment you’re wanting to purchase. There are several different ways to invest in real estate, each with their own unique risks and rewards. Are you looking for a distressed property that needs work to flip? Are you looking for a home to generate rental income? Are you planning to buy land and hold it long-term, while waiting for property values to increase? Or do you want to buy a large amount of land and develop it?
If you aren’t sure which route you’re wanting to pursue, consult a trusted and experienced Realtor to discuss the pros and cons of each. You’ll also need to consider available cash and financing options. There’s some amount of risk involved with any investment, but with the right guidance and education, the risks can be reduced. Here’s what you need to know before diving in.
Flipping or Rehabbing Real Estate
“Flipping” real estate has gained in popularity as several TV shows highlighting home flippers have hit the airwaves. Buy a distressed house, remodel it with all of the latest pretty finishes, hold an open house, and bam- make profit that equates to a year’s income for many people in just 30 minutes! They make it look so easy, but this type of real estate investing is far more challenging than it looks on TV.
Due to the popularity of these shows, combined with the current low inventory/high demand climate in real estate markets across the country, finding a distressed property at a low enough price to make it worthwhile can be half of the battle. Nationally, foreclosed homes made up just 2% of all sales in August, according to data from the National Association of Realtors. Of those 2%, not all were under-priced deals either. Banks have gotten a little more savvy as the market recovered. They aren’t just looking to get these properties off their books. Some of the foreclosure departments have learned that by putting in the funds to paint, recarpet, etc. they can sell for market value and recover some of their losses. When one is sold as-is for far less than market value, the competition is stiff. Those looking for a house to rehab must consider houses beyond foreclosures and get creative to find them. Consider traditional sales that need work, county auctions, estates, etc.
When considering properties to buy and flip, remember that your financing will be limited. Most government-insured loans are for owner-occupants only, and will require the home to meet certain condition standards. Conventional financing will usually require an appraisal, and the requirements for condition will vary by bank but are generally tolerant of more issues than a government-insured loan. Cash purchases are best, and usually will win in a multiple offer scenario because there are no condition or appraisal stipulations.
In addition to the purchase price, you’ll need to consider the rehab costs, carrying costs (like taxes and utilities), permit fees, and costs to sell in addition to your profits. Be sure to leave a contingency fund of at least 10% for unexpected repairs. You never know what’s lurking behind that wall you’re about to tear down, or when a pipe will burst and cause new damage, etc.
When planning your flip, be sure to enlist reputable contractors that are licensed and bonded (where required) and an expert, experienced real estate agents. It can be tempting to cut costs with cheap labor or inexperienced people just starting out, but that’s not the wisest move if you want to be successful. Flipping a home is a business pursuit, so be sure each person involved is a true professional, someone you want as a business partner because that’s essentially what they will become. Rookies in either department or shady characters can cost you a great deal, whether it be due to poor workmanship or poor marketing that results in a lower sales price and/or longer time on the market.
The same goes for your timeline. Have a project plan and deadline for each phase, with a little bit of wiggle room for unexpected setbacks like permit inspections and weather delays. Hold your partners accountable to the timeline, too. Be sure to discuss your timeline with your real estate expert, as some financing options for potential buyers may require that the house has been owned by the current owner (aka you) for a minimum amount of time. If this is a common type of financing used by buyers in the target area and price range, you’ll need to factor that in to your timeline as well.
Rental properties are great investments for long-term, passive income, and often won’t require as much up front investment as a house flip. Financing for rental properties is a little easier to obtain, since you won’t have to worry as much about condition. You can purchase a move-in ready home, or one that needs some updating, it’s up to you and your goals. You’ll also need to decide if you’re going to want your agent just to advertise for a tenant, or if you’ll want property management services as well. Some states require different licensing or training for an agent to become a property manager.
Consult an experienced real estate agent to begin your search, and be clear about your intentions. Your agent will consider the rental demand and rental prices in your target area as well as restrictions from HOAs or city ordinances that might be obstacles. Some HOAs limit the number of rental properties within the community, and others have strict rules and limitations that would need to be considered before purchasing. You’ll also need to take some time to educate yourself on local property codes, landlord responsibilities, and tenant rights to make sure your property complies with local regulations. Many states will also require you to hold the deposit in a separate account as well.
A home that needs some cosmetic work might be a good deal. You can put a little into up front, or improve some between each tenant and increase the rent with each improvement, as the home becomes more desirable to renters. Remember to have a repair and upgrade budget for your rental, as well as a financial cushion to cover costs in the event that the home is vacant for a couple of months between tenants. Repairs are your responsibility as the owner, or your property manager can handle them according to your management agreement. In addition, you’ll need to be prepared for repairs and cleaning expenses between tenants. If a tenant leaves the home in bad condition, you can charge them for damages but collecting any more than their deposit is another story. If they don’t have the funds, you may only get a judgement and will have to foot the bill on your own. If you plan for it, it won’t be as painful. If it never happens, great! You’re ahead of the game.
Buy and Hold
Some savvy investors use rental properties as buy and hold investments. They may hold the rentals and collect rent for 5 to 10 years while waiting for property values to increase, with the goal of selling them and cashing out instead of keeping them long term for passive income. The same can be done with land. Land speculation takes a little bit more research to learn what the long-term plans are for an area and when those plans are anticipated to be carried out. A well-connected and experienced agent can help you with this research. Land doesn’t require a whole lot of maintenance, and the taxes remain lower when it’s unimproved land. In Texas, if the land is used for certain county-approved agricultural purposes while it’s being held, the property taxes might be negligible. Maintain the land and pay the taxes over time and when development spreads to the area and demand increases, sell it for a profit.
Sounds pretty easy, and in the grand scheme of things it is relatively simple. Financing land can be challenging, and it’s a long-term strategy, but the payoffs can be great. Just ask Jerry Jones!
Buying land to develop into a new subdivision, shopping center, or office park is another type of real estate investment. This type requires a great deal of investment money that can come from loans, investment partners, and even bonds. You’ll need a very experienced land agent to help you find and acquire the property, ensure all environmental and soil tests are done, and to check for permitted uses in addition to market demand. This type of investment will also require you to consider city zoning and development requirements with the city and county, utility installation, and forming relationships with builders so it’s likely not a good investment idea for a beginner. The payoffs can be quite lucrative, but as with land speculation above, will be long-term payoffs. Consult an expert land agent for more information and guidance about developing.
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