Getting Started in Residential Real Estate Investing

Residential real estate investing is a business activity that has waxed and waned in popularity dramatically over the last few years. Ironically, there always seem to be a lot of people jumping on board with investments like stock, gold, and real estate when the market’s going up, and jumping OFF the wagon and pursuing other activities once the market’s slumping. In a way that’s human nature, but it also means a lot of real estate investors are leaving money on the table.By understanding the dynamics of your residential real estate investment marketplace, and acting in opposition to the rest of the market, you can often make more money, as long as you also stick to the real estate investing fundamentals.Real estate investing, whether you’re buying residential or commercial property, is not a get-rich-quick scenario. Sure you can make some fast cash flipping houses, if that’s your bag, but that is a full time business activity, not a passive, long term investment. The word “investment” implies that you are committed to the activity for the long haul. Often, that’s just what it takes to make money in real estate.So, while the pundits are crying about the residential real estate market slump, and the speculators are wondering if this is the bottom, let us return to the fundamentals of residential real estate investing, and learn how to make money investing in real estate for the long term, in good markets, as well as bad.A Return To The Fundamentals of Residential Real Estate Investing When real estate is going up, up, up, investing in real estate can seem easy. All ships rise with a rising tide, and even if you’ve bought a deal with no equity and no cash flow, you can still make money if you’re in the right place at the right time.However, it’s hard to time the market without a lot of research and market knowledge. A better strategy is to make sure you understand the four profit centers for residential real estate investing, and make sure your next residential real estate investment deal takes ALL of these into account.

Cash Flow – How much money does the residential income property bring in every month, after expenses are paid? This seems like it should be easy to calculate if you know how much the rental income is and how much the mortgage payment is. However, once you factor in everything else that goes into taking care of a rental property – things like vacancy, expenses, repairs and maintenance, advertising, bookkeeping, legal fees and the like, it begins to really add up. I like to use a factor of about 40% of the NOI to estimate my property expenses. I use 50% of the NOI as my ballpark goal for debt service. That leaves 10% of the NOI as profit to me. If the deal doesn’t meet those parameters, I am wary.

Appreciation – Having the property go up in value while you own it has historically been the most profitable part about owning real estate. However, as we’ve seen recently, real estate can also go DOWN in value, too. Leverage (your bank loan in this case) is a double-edged sword. It can increase your rate of return if you buy in an appreciating area, but it can also increase your rate of loss when your property goes down in value. For a realistic, low-risk property investment, plan to hold your residential real estate investment property for at least 5 years. This should give you the ability to weather the ups and downs in the market so you can see at a time when it makes sense, from a profit standpoint.

Debt Pay down – Each month when you make that mortgage payment to the bank, a tiny portion of it is going to reduce the balance of your loan. Because of the way mortgages are structured, a normally amortizing loan has a very small amount of debt pay down at the beginning, but if you do manage to keep the loan in place for a number of years, you’ll see that as you get closer to the end of the loan term, more and more of your principle is being used to retire the debt. Of course, all this assumes that you have an amortizing loan in the first place. If you have an interest-only loan, your payments will be lower, but you won’t benefit from any loan pay down. I find that if you are planning to hold the property for 5-7 years or less, it makes sense to look at an interest-only loan, since the debt pay down you’d accrue during this time is minimal, and it can help your cash flow to have an interest-only loan, as long as interest rate adjustments upward don’t increase your payments sooner than you were expecting and ruin your cash flow. If you plan to hold onto the property long term, and/or you have a great interest rate, it makes sense to get an accruing loan that will eventually reduce the balance of your investment loan and make it go away. Make sure you run the numbers on your real estate investing strategy to see if it makes sense for you to get a fixed rate loan or an interest only loan. In some cases, it may make sense to refinance your property to increase your cash flow or your rate of return, rather than selling it.

Tax Write-Offs – For the right person, tax write-offs can be a big benefit of real estate investing. But they’re not the panacea that they’re sometimes made out to be. Individuals who are hit with the AMT (Alternative Minimum Tax), who have a lot of properties but are not real estate professionals, or who are not actively involved in their real estate investments may find that they are cut off from some of the sweetest tax breaks provided by the IRS. Even worse, investors who focus on short-term real estate deals like flips, rehabs, etc. have their income treated like EARNED INCOME. The short term capital gains tax rate that they pay is just the same (high) they’d pay if they earned the income in a W-2 job. After a lot of investors got burned in the 1980′s by the Tax Reform Act, a lot of people decided it was a bad idea to invest in real estate just for the tax breaks. If you qualify, they can be a great profit center, but in general, you should consider them the frosting on the cake, not the cake itself.
Any residential real estate investing deal that stands up under the scrutiny of this fundamentals-oriented lens, should keep your real estate portfolio and your pocketbook healthy, whether the residential real estate investing market goes up, down or sideways. However, if you can use the real estate market trends to give you a boost, that’s fair, too. The key is not to rely on any one “strategy” to try to give you outsized gains. Be realistic with your expectations and stick to the fundamentals. Buy property you can afford and plan to stay invested for the long haul.

10 Ways to Maximize Your Performance As a Real Estate Investor

Now, this is not a scientific study. I did not go out and survey 5,000 real estate investors and determine who were successful and who were not and then look at the characteristics that shape their success (or lack thereof). This is based on years of personal investing experience and what we have learned from other successful real estate investors.If you lack these traits (or characteristics), there is a good chance you will under-perform as a real estate investor. You don’t have to have ALL of these, but the more you have, the more likely you will be highly successful.Passion – I feel strongly that if you have passion, real passion about real estate (and investing in it), you will perform better than if you don’t. We know quite a few investors that are not passionate about real estate that have been successful but they feel worn out and want to leave the business. The only reason they don’t leave is because it’s making them money… but they aren’t having fun and they aren’t making as much money as they would (I think) if they were passionate about it. Besides, why spend so much time, energy, focus, and money on something you don’t love? Life is too short!
Mental strength – There are so many times where you may want to just give up because you’re doing so much heavy lifting mentally. Challenges like insurance issues, and property financing troubles, and tenant challenges are part of the business of real estate investing – be strong and you’ll do well. And by the way – the more physically fit you are – the better you’ll perform mentally. That’s a fact that has been proven by scientific study.
Belief – No one, and I mean no one will (or should) believe in you as much as you do. If you don’t really believe that you can be a successful real estate investor, then you may as well stop trying. There will be times when it seems like you are the only one that believes in what you’re trying to do so you have to be there for yourself! You should also surround yourself with folks that believe in and support you… but that’s a different point.
Guts – You have to be willing to go the opposite direction from the rest of the people you know. You have to be able to make your own decisions and have the guts to take action on them. This is not an easy thing to do especially when you first start out. And, to continue and advance as an investor you will still need guts to try new real estate strategies and techniques.
Integrity – Sadly, I have met many folks who have become successful without integrity but I believe that their success is likely only financial. I am confident they don’t have the relationships nor the personal satisfaction that comes with doing business with integrity. Doing business in a way that treats everyone with respect in turn makes you easier to respect and like… and makes it easier to attract the folks that will help you grow your business.
Focus – This is probably the most underrated trait or action for becoming successful. If you lack focus, it is still possible to become successful. Heck, over the years I have had trouble staying focused but I have still performed fairly well in the REI game. But, my lack of focus has certainly played an important role in keeping me from reaching my full potential. And, the best part about focus, along with most of these other traits is you can learn it/them!
Communication – If you dislike talking to people, emailing, or just all around don’t communicate well with others, good luck performing and being successful with real estate. You have to communicate constantly with realtors, mortgage brokers, banks, accountants, lawyers, vendors, buyers, tenants, appraisers, inspectors, contractors, the list goes on and on. If you aren’t at least somewhat effective at not only getting your point across but also being a good listener and understanding others, forget about being in the REI game.
Hustle – Lining up your joint venture partners, obtaining financing, managing all the appraisers, inspectors, realtors, placing and showing tenants the property all require a large amount of hustle. Sure, you don’t need to hustle 365 days a year to perform well, but you sure better be able to hustle every time a deal starts to come together!
Commitment – Are you committed? Really committed to being an amazing investor? Are you making it a priority everyday that you do something that will move you towards your goal of being a real estate millionaire? Now, you don’t have to do something everyday, but your level of commitment is directly related to becoming better, stronger, faster, smarter, and wealthier. No commitment = Little to no payoff.
Persistent – In my humble opinion, this is absolutely the most critical reason why some real estate investors under-perform. If you want to succeed in this business, you HAVE to be persistent. You will find the best deals by continuously following up on opportunities. You will secure the best financing by continuously trying to find a better option. If your partner backs out at the last minute you have to pick up that phone again and again until you find a new partner. Keep trying, keep pushing, keep being persistent. Do not give up.Sure, there are likely several more traits that you need to have to rise to the top of the real estate investing pile, but if you have most (or all) of the above, you have a very good chance… in fact I would say you’re darn near guaranteed… to become a successful real estate investor.