The following is a guest post by Money Choices.
One of the most effective ways to build wealth is to invest in real estate. For the person just starting out, there are many ways to become a life-long real estate investor who eventually earns an additional income from properties in various locations. Properties of every imaginable type and purpose exist everywhere, and the wise investor sees real possibilities for profit with the right investment of money and hard work. Evaluate each of these ten techniques and determine which one is the most suited for your lifestyle and desired level of involvement.
[Kevin] If you’re looking at a depressed market like some parts of the U.S., then a rental could make a lot of sense! Rents tend to rise with inflation, and there is less downside risk if you’re already buying in at a lower price.
1. Single-family rental – Many real estate investors start with their own home that is kept when a move is required to follow a career move to another location. The home is rented to a tenant and maintained over the distance. Rental income is used to pay the expenses to maintain the property.
2. Multi-family rental units – Duplex and four-plex housing units are purchased for rental income that is used to pay-off the property and maintain the condition. As property values increase, the units are updated or the entire building is sold for a profit that will be used in the next venture.
[Kevin] Downside of this is that you have to manage the tenants, and from some of the stories I’ve read as well as personal experiences, this isn’t always fun!
3. Conversion property – Zoning laws within a city will often change the purpose of a property from residential to commercial. The investor can purchase a property within the reclassified zone and remodel the interior to serve a commercial purpose. Old homes with appealing exteriors become fascinating office spaces and the rental income can be substantially higher than simply renting the home as a residential property.
[Kevin] I’ve seen this happen to small homes near busy roads. Some of these can become quite nice offices for accountants or notaries.
4. Passive landlord – When a buyer purchases a commercial or residential property and hires a property manager, the owner is considered passive. All maintenance and tenant interaction is handled by the manager. Properties that are owned in distant places are often managed professionally.
5. REITs (Real Estate Investment Trust) – A fund created by a corporation that uses investors’ money to purchase and then manage investment real estate properties. To avoid federal income taxes, the corporation must pay out 90% of the annual profits in dividends to the investors every year. REITs are bought and sold on major financial exchanges in the same manner as stocks and bonds.
6. Real Estate Investment Group – A smaller fund where investors can participate in multi-unit ventures and the company manages the units. Each investor owns whole units that are then managed to collect rent and find tenants. The company retains a portion of the rent as payment for services. One advantage to this approach is the protection against income loss when the unit is vacant. Each investor contributes a certain amount of their monthly income to a fund to pay fellow investors when their units are vacant.
7. Leverage – Investors with an excellent personal credit rating can qualify for a second mortgage on their primary residence and invest only a fraction of the price of the rental property as a down payment. As long as the property is rented, the mortgage is covered and the property will gain value prior to a future date when it is sold. The loan payments are maintained, but the other property is leveraged as collateral on the loan for the rental property. Veterans can also compare VA home loan rates.
[Kevin] This is a way that many have expanded their real estate holdings, but it only works well when prices are rising and rates are not too high. Such a strategy can crush you if you go overboard and leverage 5-6+ homes, and then prices fall.
8. Flipping property – Homes that have fallen into disrepair or commercial properties that are standing idle can often be purchased in auctions or bank sales. Money invested in improving the property can ultimately become profit in the sale of the property. You can see more of Than Merrill here, to see how a professional house flipper does it. Keep in mind, many properties bought with the intention of flipping are never inhabited prior to the sale.
9. Appreciation of property – Rental properties that are held for a number of years will earn rental income and increase in market value. When the property is sold and a profit is realised, many real estate investors will take the entire yield from the sale and purchase two properties to expand their holdings. Location is the primary factor in the rate of property appreciation.
10. Buy below market – Real estate markets that fluctuate radically can be prime markets for investors with a keen sight for the upward turns. Every market will eventually recover from large drops in value, so the smart investor watches the area and buys at the lowest price. As the area recovers, the property is sold while the prices are still rising.
[Kevin] I agree with this, and another tip is also to look for those looking to leave an area quickly or those that are fed-up with the property management game. They will often sell at a better price than those that are willing to wait for the best offer.
Reams have been written about each of these techniques for real estate investment. Careful research will provide all the information necessary for educated decisions about the best method of investing. Consult a financial advisor to determine the threshold of investment that is affordable within your portfolio. Many investors have been trapped with too much debt and had to start over when markets decreased in value. Beware of deals that appear too good to be true. Engage a set of trusted advisors with experience in real estate investing to prevent losing valuable funds in schemes that are destined to fail.
David is co-founder at Money Choices, a leading website based outside Sydney where users can compare home loans for real estate investors and new home buyers in Australia.
Interesting post. I’m thinking about recommending to people who are 5 years away from retirement or so that they pick up an inexpensive small house. In the U.S. a problem is that people are taxed on their IRA distributions as ordinary income so that a $1.0 million IRA is really $0.7 after tax. My thinking is to sell your main house for $450,000 or whatever and live in the down sized inexpensive house you picked up in today’s recession (which may have appreciated in value over the 5 years), and (here’s the kicker!) do a Roth conversion at low tax rates over the next 3 years. Except for the IRA withdrawal you might make it so that you have no other income!
Downsizing and perhaps getting a small duplex or other property on the side! Downside is that the keepup can prove to be a real headache.
I like to look at real estate the same way I’d look at a stock. I try to figure out what the renter’s yield would give me. If it exceeds the owner earnings yield of a stock, after all taxes and projected expenses, with a margin of safety for vacancies, then I consider it. With the owner earnings yield of nearly 7% for a great stalwart like JNJ, I’d want my property to have a renter’s yield of at least this. I’ve always figured that have multiple sources of revenue made sense, rather than going for a single family home. By that, I mean, it would be better to have a duplex or a triplex than a single. What do you guys think?
And to add, by “owner earnings yield” I’m suggesting something different to “dividend yield”
I also think they make more sense, but the more tenants the more possible bad apples land in your barrel.
I’m interested in hearing more about your owner’s earnings yield…
This is an interesting post. There are definitely some great moves to be made in real estate. Personally, we don’t use leverage in the same way, but I think smartly managing your leverage ratios is critical.
Yeah I remember the story of the guy who went on Oprah, or maybe it was another show, and at one point he had over 20 properties during the peak of the housing bubble, all highly leveraged. Of course he crashed and burned after then. He was trying to recoup some of his losses by creating a website about it…
Very interesting post 🙂 I agree that real estate as an investment should be looked at in the same way Andrew suggested.
I know some people who are very successful with flipping properties…
It’s also all about the timing too.
I personally would never want to get involved in flipping properties cause it feels risky to me, but I believe in properties as income-generating investments, and also when buying if you can buy near the bottom of a cycle rather than near the top, then that helps you out all the more…
As an alternative to flipping houses, I have a friend that specializes in flipping land. He will purchase large tracts, from 20 to 100 acres, and subdivide into 5 acre lots, the preferred size for people looking to buy land in the country.
Hmm, does he do some modifications to the land aside from dividing the lots? I guess one advantage is that if people don’t have the capital for a large lot, now they can just buy a smaller one.
Great list. I especially like REIT’s.
I thought about getting a duplex but after reading too many tenant horror stories I think I like REITs more!
I would like to comment about the real estate business whether its buying and selling homes fixing them up what have you. I do not have anything against real estate investing. But lets be clear this is a business just like if I own a used car lot a health food store a convenient store any variety of businesses. Each type of business has its own little little quirks of sorts real estate is no different. To many folks look upon real estate as an investment and that is why they fail to succeed in the real estate business’ when in fact it is clearly a business thats how one should look upon real estate. A good example of this is commercial real estate. When ever I drive around I see many almost empty or completely empty stripe shopping stripes. I don’t mean big box stores that are empty. I talking about a small commercial buildings that might house ten or at most fifthteen small mom and pop businesses along a major thoroughfare. I have seen dozens and dozens of partially or completly vacant stripe shopping stripes and I don’t live in detroit. I live in the suburbs of chicago and this is not something recent. I have seen this five ten fifthteen years ago so what does that tell you about investing in commercial real estate. Their must be many problems with these type of properties.
I definitely agree with you in your number 10 tip of buying below market. Many people are afraid of investing on real estate now because of the recession, but actually this is the time they should really start investing in the real estate, while the prices are still low. Like what you mentioned, every market will recover, and when it does, you can then sell the property you bought at a low price for a much higher rate.