If your goal is to master any subject it is vital to to start with the foundational knowledge and principles on that topic. Building knowledge is a little like building a pyramid, take a minute and visualize a pyramid in your head, wide at the bottom, pointy at the top right? Well, if knowledge is built like a pyramid and you tried to start building it with the pointy top then it would topple right over wouldn’t it? Of course it would, it’s silly to even think about building a pyramid that way. To get to the top of a pyramid, whether a real one or a knowledge pyramid in your head, you absolutely must start with a strong foundation.
This is episode 1 of the foundation series. You can listen to all of these episodes in a row for a broad view of real estate investing or you can start with this episode and then jump to the topics that interest you most. If you are just getting started I highly recommend listening in order because, to be quite candid, it is hard to know which investing strategies will interest or suit you the most until you know what is out there. This is especially true if what you know, or what you think you know, comes from social media influencers or tv shows. Often, those types of sources have a vested interest in showing you only the exciting or dramatic parts and don’t give you a realistic picture of what is happening in real life. I assume that, like me, you operate in real life and that you’ll go through the entire experience and not just the parts that make it on tv or your social media feed.
I’m going to do my level best to bring you the truth on real estate investing whether it’s pretty or not.
Our topic for today is a highly personal one. Not personal to me per se but personal to each and every person that listens to or watches this episode. That topic is: Why invest in real estate?
With all of the different types and strategies of real estate investing you can bet that there is something to suit almost every investor and that there are many practical and concrete answers to the question “Why should I invest in real estate” and while I will certainly get to those but it’s absolutely vital that you start with YOUR own personal reasons for investing in real estate. If your investing strategy, no matter the benefits of that particular strategy, doesn’t align with your personal goals and resources then you are much much more likely to fail in the long run.
I’ll start with my reason for investing in real estate. I invest in real estate for security. Personally, my goal is to be financially independent. I want to be in control of my life and my time. Real estate investing is my retirement plan and my goal is to be able to retire early should I choose to do so. Practically that means that I’m not investing for funds to use today, I can choose strategies with a long time horizon that pay off over time or at a later date. Someone needing to use the money immediately would probably choose to invest differently than how I personally invest.
Just a handful of possible goals for other people include: the need to replace the income of a spouse that wants to stay home with the kids, or to fund college expenses, pay off student loans, or to generate money to support a loved one that needs full time care due to health or a disability. It could be that you hate your job and want to replace that income or at least set up enough of a safety net to quit and look for something else. Maybe you are investing in real estate to offset taxes from a high income career, as a store of value, or to finance hobbies like sailing, owning a race car or traveling the world. Whatever the reason that you are investing - take a moment and write it down - this will help you figure out what is best for you, personally, as we review investment strategies in future episodes.
Next: Let’s take a few minutes to take a personal inventory of your skills and available resources.
Do you have great carpentry, electrical or plumbing skills. Whether you do or do not have the skills, are you interested in being hands on and doing that type of work yourself? Will you hire it out? Do you have good management skills to oversee contractors or trade people? Do you have the time to visit the job site, meet with contractors or pick up materials? Would you rather avoid projects that need a lot of work all together? These are important things to consider at the outset as they will determine the criteria you set and what kind of projects that you are willing to take on.
How will you finance your projects? Do you have a large savings or brokerage account that you will use to fund your real estate investing? Do you have friends, relatives or potential investors that will help you financially? Will you partner with other investors? Do you have good credit? Can you live in an investment property while you fix it up or do you prefer to avoid that? Do you have no credit, no money and no outside sources for money? The answer to any one of these questions isn’t what’s important. What IS important is answering the questions so that you know where you stand and what strategies that you are most likely to be successful with.
Time. Time is one of the most important resources that we have and it’s really important that you are honest with yourself about how much time you have available to dedicate to your real estate endeavors. The strategy that you might choose if you have 2-3 hours per day to work on real estate is likely different from the strategy that you would pick if you have only 2-3 hours per week to work on real estate and drastically different from the strategy that you will want to choose if you only have 2-3 hours per month to work on real estate.
Ok, let’s do a quick summary before jumping into the real estate component of real estate investing. First, define your reason for investing in real estate. Second, make a quick inventory of your skills, financial resources and the time available for you to dedicate to real estate investing.
Got it? Great let’s move on to some of the benefits of investing in real estate.
Relatively low barrier to entry: It’s possible to buy real estate with no money down either through a VA loan, FHA loan plus grant money, a special loan program from a specific lender or through creative financing. If you will occupy the property you can often utilize an FHA loan with 3.5% down or a conventional loan with as little as 5% down. In many situations, you can even have the seller pay your closing costs to help reduce your out of pocket expenses to get into a property.
Leverage: To have control of $150k in stocks you need $150k, to have control of $150k real estate asset you can get in with as little as $0 but even if you had to put 20% down you’d have control of that asset for just $30k compared to the $150k it is actually valued at. Leverage is a strong tool when used correctly.
Cash flow: Income generated over your operating expenses and necessary reserves can be taken home by you as free cash flow to fund your life, your goals or it can be reinvested to fund additional real estate investing.
Tangible asset: When you purchase a piece of real estate you own something that you can physically touch and use. A house can be used as shelter and an office as a place of business. You can’t live in your stock portfolio.
Appreciation: Historically real estate has gone up in value over time. Even better, leverage allows you to enjoy the appreciation of the entire property’s value, not just the portion that you own outright. The appreciation on a home that you have $5k invested in and the appreciation of a home that you have $150k invested in is the same.
Forced appreciation or sweat equity: You can sometimes force appreciation of your real estate investments by making improvements, increasing the income generated or changing zoning/use.
Ability to purchase below market value: You can search high and low, make connections, mail letters, put out signs and a whole host of other activities to find real estate that can be purchased below market value which creates immediate equity for you as the new owner!
Mortgage Paydown: With very few exceptions, you are paying down the mortgage every month with money that is generated by the property. This increases your equity and makes you wealthy over time.
Passive income: I and many many others got into real estate looking for passive income but I’ll be the first to admit that most investing strategies aren’t all that passive. Still there are very passive methods of investing and even the active investing methods usually offer a great return on your time. One popular strategy we’ll discuss, and the primary strategy that I use, is called the BRRRR strategy. It’s not very passive but the potential returns are great. Other strategies like buying turnkey properties or investing in real estate syndication can be very passive.
With some investing strategies, Real estate ca generate significant income quickly: Flipping houses and wholesaling offer great opportunities to make large amounts of money quickly. They also offer risks and they are on the active side of the investing scale but can be a great tool for generating money that you need in the near term.
Tax advantages: Of course you need to consult with your tax professional for your specific situation but some common tax benefits of real estate include: many expenses are tax deductible, the IRS allows you to reduce your taxable income by depreciating the structure, often you can defer taxes on the gain when selling a property by completing a 1031 exchange, if you have occupied the property for 2 of the last 5 years you may be able to avoid paying any taxes on the gain when you sell a property if the gain is under a certain threshold. There are other more complicated tax benefits and while we may dig into those in future episodes I’d recommend that you have a good tax professional at your disposal to avoid pitfalls and stay out of trouble.
Diversification: Real estate offers great diversification when mixed with a larger more comprehensive investment plan that includes stocks, bonds and other investment vehicles. You can also achieve a level of diversification inside your real estate portfolio by purchasing different types of property or in different areas.
You can use it: A popular investment strategy in today’s market is investing in short term rentals. If you own a property that you use for short term rentals at the beach or in a ski town you and your family can enjoy the use of that property from time to time. I can’t break out the beach chairs and umbrella drinks on my certificate of deposit at the bank but I can do those things at my beach house! There are of course other less sexy advantages like running your business out of a commercial property that you own and in which the other commercial tenants pay the mortgage. Maybe you have a storage building at one of your rentals that you utilize to store your tools or toys. You can use a short term rental near you to host visiting friends and family. The list goes on and on.
Borrowable: You can borrow against your equity: If you have equity in a real estate asset there is a great chance that someone will loan you money on that equity. I can pull out equity from one investment property to fund the purchase of another, to pay for college expenses, or just to live on that money. You can even borrow the equity in your personal residence, although I recommend taking great caution with that strategy. As of today, money borrowed against a property is not typically subject to income or capital gains taxes.
Potential for great returns: While not always the case, real estate purchased at a discount, financed at good terms and operated correctly can offer a return well above many other investments. There is ofcourse the potential for bad returns or even losing money so you must be diligent in your investments.
You can create a competitive advantage: It’s not likely that I’m going to have any advantage vs anyone else when investing in the stock market but by getting to know certain areas and asset classes inside and out, networking, building relationships and knowing my numbers I can have an advantage, at least in my investment area, when compared to most other investors.
Protection against inflation: Property values & rents generally go up over time which can be a great hedge against inflation.
Control of your investment: When you own a piece of real estate you have control over that asset. You can decide to make upgrades to a property for tax purposes or to increase it’s value, you can decide to buy or sell an asset, you can decide what to charge for rent, you can use the asset. There is control in owning real estate that many other investments do not offer.
Of Course, like any investment, real estate has it’s own unique risks. Because I want to do my best to bring you the full picture for each strategy, we’ll discuss some potential risks and downsides, along with the benefits, to each strategy as we dive into them individually.
While by no means a comprehensive look at real estate investing I hope that this discussion has been a helpful place to start and that you have better direction for your real estate investing career now than when we started.
In episode 2 of our foundation series on real estate investing I’ll be talking with you about the easiest way to get into real estate investing. Most people call it house hacking these days but it has been around for a long time and there are almost certainly more ways to use this strategy than you think. Join me for this and the rest of the foundation series as we discuss house hacking, flipping houses, short term rentals, long term rentals, wholesaling and more!
If you haven’t already, be sure to subscribe to the podcast or YouTube channel to be kept up to date with the latest REI Roadmap episodes!