Owning real estate is one of the main keys to financial freedom in this country. It's been that way for the last century. In fact, it's estimated that over 90% of millionaires obtain their wealth by investing in real estate. Why is this? Because real estate offers so many benefits and opportunities that investing in the stock market and other avenues simply can't provide. Unfortunately, not everyone possesses the ability to own or invest in real estate, nor want to, but I hope after reading this blog that their perspective will change. I understand real estate investing (REI) may not be for everyone, but I will surely advocate for why it should be.
First, is the power of leverage. Leverage applies to any home purchase. When it comes to buying a home, you are able to buy a home by placing a down payment, and then obtaining a loan for the remaining amount. This is called leverage. Down payments vary, based upon the type of financing received. For instance, VA loans for military members and veterans require no down payment at all. FHA loans require 3.5% down. Both of which must be used on a primary residence where one lives. Investment properties usually require 20% or more down.
Leverage is not typically available with stocks, unless you trade on margin, but that is a lot more risky. Generally, if you want to buy a stock, you have to present the full amount of the stock at the time of purchase. For example, if you want to buy 5 shares of Amazon at $120/share, you will need to pay the entire $600. You can't place a down payment of $50 and borrow the other $550 like you can with real estate. Now, I'm not discouraging stock investing. Actually, I'm a firm believer in diversification of income, including stocks. I simply place a higher value on REI, and I believe that it should consume a larger portion of one's investing portfolio.
Another benefit of REI is depreciation. Depreciation is the process of deducting the loss in value of a rental property from one's taxes. Depreciation is not deductible on one's primary residence. As a property ages, its useful life decreases and costs to be maintained. Thus, this cost is deducted over the useful life of the property, which is 27.5 years for a residential property, and 39 years for a commercial property. This amounts to a 3.64% of depreciation from the original purchase price for residential properties, and 2.56% for commercial. Example: John owns a single family investment property that he purchased for $500,000. Because it is a residential property, its useful life is 27.5 years. $500,000/27.5 = $18,181 depreciation/year.
The next real estate advantage is appreciation. Real estate appreciates at an average of 3% per year. This is not a given and home values can decrease over time, but a gradual 3% increase can be expected. Appreciation is just an added perk, as most homeowners don't buy or invest simply because of appreciation.
Taxes are an additional benefit. Property taxes are tax deductible up to $10,000. This is an added benefit over renting because you cannot deduct rent payments from your taxes. Moreover, the tax benefits amplify for a rental property. Not only are the property taxes deductible, but so are operating and owner's expenses such as maintenance and repairs, on top of depreciation.
Equity is also a fine perk. Equity is the difference between the balance you owe on a home, verse whats is worth. Although equity is usually acquired over time, it doesn't have to be. That's where the importance of buying a quality property comes in. If you are able to secure a property for less than the market value, you can walk right into equity. This usually transpires by way of foreclosure, a motivated seller who needs to sell quickly for one reason or another, or because the property needs work, and can be rehabilitated for a profit, also known as flipping. The beauty of equity is that you can continue to let it build, or you can tap into it by way of a cash out refinance. This cash can then be used for home repairs, large purchases, to pay off debt, or even to purchase another property.
There are several methods to invest in real estate. The four primary ways are: buy and hold (rental properties), wholesaling, flipping, and Real Estate Investing Trusts (REITs). Buying holding involves the purchase of a property and then renting it out for monthly income, known as cash flow. The key here is to ensure that you include expenses such as vacancy, capital expenditures, repairs, maintenance, utilities (including gas and sewer), and landscaping, in addition to the mortgage payment, insurance, and taxes. Some new real estate investors make the mistake of only calculating monthly income by the difference between the mortgage payment and the rental income. This is a huge oversight, and gives the investor a false sense of actual income. Rental properties are so successful because not only do you obtain monthly rental income, but you also gain all of the aforementioned benefits I discussed. Moreover, all the while, your mortgage is being paid down by the tenant, and you're incurring equity.
The average amount of cash flow you can expect on a rental property is around $300, depending on where you invest. This may sound modest, but consider owning 10 rental properties for a total cash flow is $3,000. Now we're talking. The blueprint for rental properties is volume. Once you've built a sizable portfolio of rental properties, combined cash flow from numerous units becomes extremely profitable.
In general terms, location is vital, and one of the most important aspects of real estate. In some markets, you can see cash flows of $500 or more, but in others you may even lose money. The main factor is the rental income to expense ratio. Hence, investing in a good location is critical. One more expense to be mindful of with rental properties, especially when investing out of state, is property management. Performing landlord duties can be difficult, especially for a property in a different state, so a property manager can be a significant help. The average cost of a property manager is about 10% of the monthly rental income, in addition to an acquisition fee, which is usually half of the first month's rent.
For those who don't have the ability to purchase a property and rent it out, there are alternatives. The first is to buy a home as a primary residence, live it in it for at least a year, and then rent it out. This scheme allows for one to save money during that year to potentially put towards a rental property. It also works really well for veterans because it doesn't require any money down. Another tactic is a fairly new, yet popular concept known as house hacking. House hacking calls for the purchase of a duplex, whereby you live in one of the units and then rent the other one out. Correct forecasting will prescribe your mortgage payment being paid for by your tenant, meaning that you live free. Another strategy is to partner with an investor who does have the capital, while you handle the property acquisition and transactions, and then split the rental income down the middle.
Wholesaling is similar to playing the middleman. Wholesaling involves finding a discounted property for one of the reasons I mentioned earlier, and then getting it under contract. But instead of going through with the property purchase, you sell the contract to another buyer , typically an investor ,to buy the property. The fee you can charge for wholesaling (finder's fee) is commonly $10,000, but this number can vary. This REI option is best for those with little capital to start because it requires no money to execute
Flipping is probably the most polarized REI strategy because of the big pay day one can take home after a flip. A flip involves the purchase of a substandard home in need of repairs. These repairs can range from small fixes such as new paint and cabinets to large rehabs of a new roof and wiring. After these repairs are made, the home is then restored up to par with other homes in the market and will have a higher value, also known as After Repair Value (ARV). The purchase price, repair costs, and ARV should all be calculated up front. The most common mistakes flippers make are purchasing a property for too much, underestimating repair costs, and overestimating the ARV. Incorrect repair estimations can prove disastrous because this flaw has the highest chance of leading to a bad investment, and even losing money. Flippers should have good insight into the local markets, as well as reliable contractors to be perform the repairs. Dependable contractors are one of the hardest partners to obtain in REI due to their scarcity and high cost.
REITs provide another low barrier to entry option. REITs are trust funds developed by REI companies who invest in properties. These companies generally have massive portfolios of properties, primarily multi-family such as apartments. Some REITs allow you to invest for only $500. This is a good option for those who want to be hands off, but still want a nice return on their investment, as REITs have averaged more than a 10% annual return over the last 30 years.
I am such a big proponent of investing in rental properties because I've witnessed how successful they are. I've even seen people retire off them. The stability, consistency, and benefits rental properties provide are outstanding. I acquired my first rental property in 2020, after moving from Georgia to California. I had just refinanced my home, so it didn't make sense to sell. Thus, I conducted some research and discovered that I could rent it out instead. Because the home was new construction, I decided to forego a property manager because I did not anticipate any issues taking place. I took every photo, posted the home on Zillow, and handled every communication myself, including showings. I even handled credit checks and called references. So, I was able to digest a lot in the process. My diligence paid off, as my first tenant was a well-qualified daycare owner. In fact, the tenant paid his first six months of rent in advance. Although the gentlemen didn't possess the requisite credit to purchase a property, he did have the capital to do so.
The home itself was a new build that I purchased in 2018 after receiving military orders to Georgia. This was my first home purchase, and it couldn't have been in a better place because the homes were so cheap. I bought the 2,000 square foot home for $220,000. The home had 4 bedrooms, 3 bathrooms, a covered patio, an enormous backyard, granite countertops, hardwood flooring, and more! My decision not to use a property manager the first year worked out, but after the tenant moved out to purchase a property of his own a year later, I chose to hire a company now that I was on the other side of the country. The procurement of a new tenant was fairly seamless and hands off for me as the property management company handled everything. In fact, the tenant just renewed their annual lease in August, and things have been going well since.
The cash flow on my rental property is astounding. After refinancing twice, I landed at a 2.875% rate, for $1,353/month. The rent is $2,200, After subtracting the 10% property management fee of $220, that leaves me with $627 in cash flow per month, after taxes, insurance, and expenses. This rental property is truly a gold mine as it is located in a newer suburb subdivision, close to a military base. It is also in the best school district in the county. Because of my returns on this property and my familiarity with the market, I plan on obtaining more rental properties in this area. I am now in the process of saving more capital to acquire my next one.
Finally, I'm aware that like any investment, real estate has its risks. People may even be skeptical because of the 2008 housing crash. But that incident was more a matter of a perfect storm between poor lending practices and bad judgement from homebuyers. Many homeowners found themselves underwater, or owing more on their home than it was worth, forcing them to foreclose. I view this incident as more of a learning experience than a red flag. It brings home the importance of buying high-caliber homes that make sense from a numbers standpoint. Furthermore, from my experience, REI risk is much more calculated and controllable than any other investment.
For instance, if the stock market crashes today, the value of each stock generally decreases because investors are less bullish about the market. There aren't many ways to hedge yourself against this besides withdrawing your money before the crash, or investing in secure stocks like utilities or energy. But even then, you likely won't see much growth, just smaller losses, depending on the reason for the crash. But with real estate on the other hand, there are many ways to protect yourself if the real estate market crashes. The main reason behind that is people ALWAYS need somewhere to live, but people don't always HAVE to invest. If you have a rental property in a good location and the housing market crashes, you will probably be unaffected. Your property may not appreciate as much as it would under normal conditions, but it probably won't lose value either. If your tenant loses his job and has to break his lease early, well you're covered by the early termination clause in your lease agreement, plus you've been saving 5% of your rental income to account for vacancies such as this. Moreover, you shouldn't have a problem locating another qualified tenant with the prime location of your property. If you'd like to purchase a rental property during a housing market crash, then you will likely find great homes at discounted prices.
Of course, there are dozens of other circumstances that could take place such as poor tenants, a damaged rental property, etc., but hypothetical scenarios and risks are inherit in any investment. My point is that these risks, and external influences are less harmful when you've done your due diligence on the front end by obtaining a solid rental property. There is a lot of initial work you can do to be prepared for the worst. On the flip side, the positives are even more prevalent. Cash flow/monthly income, tax benefits, financial freedom; the advantages are evident. Lastly, real estate is a tangible and eternal asset that can be passed on to create generational wealth.
I hope this blog provided you with useful REI information and lights a fire for your financial freedom journey! For more on REI or if you would like to partner on a deal, please reach out! Also, don't forget to ask about Jamal's niche! God bless.