Are you currently considering starting a real estate investing journey?
Real estate investing makes people wealthy. Of the 400 richest Americans, 24 made their money on real estate investments. At one time, they were like you--starting as a novice real estate investing professional. Below we have compiled some of the opportunities and challenges you may encounter so that you can hit the ground running.
Here are the things that you should know as a beginner on your real estate investing journey.
Real estate investing is not without risk. As a result, before you take this monumental step towards securing your financial freedom, you need to have rock-solid legal and financial structures in place. One way to ensure that you have the proper legal and economic systems is to create a Series LLC.
Take a moment to discover how Royal Legal Solutions can protect you with a Series LLC. This business structure will safeguard your investment and livelihood.
You must be financially prepared to start investing in real estate. Read on for six tips to start on a solid foundation.
As a new real estate investor, carrying debt is not ideal. Adding to your current expenses such as student loans, medical bills, or paying for essentials may put you in a challenging position. Ideally, you will want to have some money in savings to use as a safety net.
Depending on your investing goals, you will have to decide whether it would be better to purchase with cash or finance your real estate investment.
One benefit of a cash purchase is that you start accruing positive monthly cash flow. On the other hand, financing may generate a higher return on your investment.
For instance, you use cash to buy a property for $100,000. After collecting rent, deducting taxes, and other operating costs, you might see about a 10% return on your investment. A 10% return equates to a cash flow of $10,000 per year.
Another option is to finance the property with a 20% ($20,000) down payment and an annual 3.5% mortgage rate. After paying taxes, operating costs, and additional interest, your earnings will be about $6500 per year.
The cash flow is lower with financing, but the return on investment is much higher at 32.5%
Primary residence mortgages and rental property mortgages are similar. However, there are some critical differences.
First, people default much more often on rental property loans. That makes sense because a borrower who runs into financial trouble is more likely to focus on their primary home mortgage first.
In general, the additional risk associated with rental property loans results in lenders charging higher interest rates.
Second, rental property mortgages come with more stringent underwriting standards. The lenders closely inspect your credit score, down payment, debt-to-income ratio, and cash on hand.
In 2021, the interest rate is relatively low for a conventional mortgage. You should know that the interest rate on investment properties is higher than a traditional loan.
When you decide to become a professional real estate investor, you need to secure a low monthly mortgage payment so that your monthly payment does not disproportionately eat into your profits.
You should set a goal of a 10% return on your investment. When developing your expectations, you need to consider the following factors:
An easy way to estimate your monthly operating expenses is to follow the 50% rule. Simply put, you need to figure that about 50% of your operating income will go to operating expenses.
For instance, if you charge $1500 rent, you should expect to pay $750 in total expenses.
It would be best if you protected yourself with landlord insurance. Landlord insurance covers property damage, lost rental income, and liability protection from a tenant or visitor injury on your property.
You will want to avoid making a real estate investment in a dying area that may become a burden to you.
Instead, find a city or location where the population is growing or where a community revitalization plan is in place. A revitalization plan in a community increases the likelihood of employment, living wage jobs, and tenants.
Here are some things to look out for in profitable rental properties:
Each of these factors will likely contribute to a healthy set of potential renters.
Remember, the more expensive the home means higher operating expenses. An excellent place to start your real estate investing is finding a $150,000 to $200,000 home in a growing neighborhood.
You want to follow the Goldilocks Rule, "You are looking for something just right." Don't buy the best house in the neighborhood for sale, nor should you invest in the worst.
Part of finding a home that is just right is avoiding a fixer-upper. You might think you are getting a bargain and can flip a distressed property into a cash cow. If you are only beginning your real estate investing journey, that's a monumentally bad idea.
The price of building materials and a labor shortage make the house flipping industry an expensive and dangerous endeavor--ask Zillow.
Should you hire a manager or go at it alone?
Using a property manager is a significant consideration for you as an investor. As a landlord, you would be involved with vetting tenants, coordinating maintenance, collecting rents, and resolving disputes. You may prefer to offload those duties to someone else so you can focus on activities that grow your business.
Hiring a property manager can be a tough decision because it will cost a portion of your operating income. The cost can be a considerable chunk of your profits, typically between 8% and 12%.
That said, an experienced property manager might still be worth it to you. Realistically, a property manager eases the burden of being a landlord and brings lots of experience and expertise to the table.
Most property managers:
Consider the following to determine if a property manager is worth the cost:
As with any financial decision, you must decide if the benefits outweigh the costs. Real estate investing is a great way to increase your wealth, but it is not without risk.
See the table below to help you decide whether starting a real estate investing journey is right for you.
First, one way to mitigate some of the risks you will encounter in real estate investing involves forming an LLC. Read more to learn about the benefits of using a Series LLC to protect your assets.
Second, make sure your finances are in order before you embark on your real estate investing journey. You can reduce your debt which will help lower your debt-to-income ratio and improve your credit score. A higher credit score means better rates and terms and more cash in your pocket.
Third, find affordable housing in growing areas. Remember, the key is to get affordable housing without buying a money pit that needs a lot of work.
Fourth, consider hiring a property manager--the hassle and time saved might be worth it to you!
Before you decide to begin real estate investing, ensure that you have the appropriate asset protection and business structures in place. To discover how you can achieve bulletproof asset protection, check out our FREE, 5-part educational series for real estate investors. Request your access to the Royal Academy Asset Protection Vault today!
Scott Royal Smith is an asset protection attorney and long-time real estate investor. He's on a mission to help fellow investors free their time, protect their assets, and create lasting wealth.
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