Real estate investing is one of the most effective and dependable ways for investors to generate income. In fact, According to a recent Gallup poll, real estate was rated the best long-term investment, ahead of stocks and bonds. Best of all, it’s possible to invest in real estate while spending far less time than you do at your full-time job.
Unfortunately, to the beginning investor, real estate can seem overwhelming. Isn’t investing in real estate expensive? Don’t you need to have a lot of investing experience before getting into real estate? And how can a beginner possibly get into the lucrative world of commercial real estate?
It all seems a little daunting. But it doesn’t have to be.
With just some basic information, you can start your journey into the profitable—and relatively low risk—world of real estate investing.
How Do You Make Money In Real Estate?
First, let’s talk about the most attractive part of real estate investing: the money. There are two fundamental ways to earn money through investing in real estate. This includes passive income from rental payments and equity in the property.
If you’re a homeowner, you already know that equity is the primary source of return on investment in real estate. Equity is defined as the ownership of a real estate asset after any liabilities associated with the asset are paid off.
For example, let’s say you buy a single family residence in Tupelo for $160,000. You place 20% down, or $32,000, and carry a mortgage for the remaining balance. After ten years, you decide to sell the house for $200,000.
Sales Price$200,000.00Remaining mortgage$(100,000.00)Original down payment$(32,000.00)EQUITY$68,000.00
Note that the original down payment goes back in your pocket, too – it’s simply not counted as equity (for tax and liability purposes).
In most cases, the greatest amount of equity comes from property value appreciation. National appreciation values average around 3.5 to 3.8 percent per year. This can vary greatly by region and with fluctuations in the economy, with some areas experiencing 10% or greater appreciation per year.
Generating Passive Income Through Rental Properties
The second way you can earn money through real estate investing is with rental income. Rent, of course, is the monthly amount your tenant pays to occupy your property. The best real estate investments are ones where the amount paid in rent covers all your monthly liabilities on that property and still puts money in your pocket.
What kind of liabilities? Mortgage payment, insurance, property taxes, utility costs (if not paid by the tenant), and maintenance are some of the biggest liabilities.
Let’s take our Tupelo property as an example. Having put $32,000 down, you carry a mortgage of $128,000. For rent, you charge $1,100 a month:
Mortgage payment $ (533.00)Insurance $ (70.00)Water & garbage $ (75.00)Property tax $ (120.00)Maintenance $ (100.00)Rent $ 1,100.00MONTHLY INCOME $ 202.00
In this scenario, rental income earns you about $2,400 a year. That’s a 7.6% annual return on your initial investment of $32,000.
The One Percent Rule
If you’re a beginner who is considering real estate investment because you’ve heard about the advantages of owning rental properties, then you need to know the One Percent Rule. This is a simple calculation that can help determine whether a rental property will actually be profitable.
First, you calculate one percent of the purchase price of the property. Then, you use a site like Zillow to find how much you can charge for rent on that property. If your rent is greater than one percent of the purchase price, chances are you’ll have some solid cash flow and the potential to generate a profit.
Keep in mind that the one percent rule is just a rule of thumb and is there to help you to avoid markets that aren’t worth your time.
For example, if you are looking at some high cost-of-living area where the homes sell for $1 million but rent for $3,500, you should avoid that area altogether.
How Safe Is Investing In Real Estate?
You’ve worked hard, you’ve build up a small savings, and now you’re ready to grow that savings a little more aggressively. At the same time, you don’t want to risk what you’ve worked so hard for. Is real estate really a safe investment?
Compared with almost any other form of investment, real estate investing one of the safest places you can put your money. This is primarily because your investment is secured by the asset itself — the building. Rarely will you see your investment lose value and if so, it’s usually only for a short period of time.
Unlike currencies like the dollar, real estate doesn’t lose value to inflation year after year — it performs better. Smart investors can even set themselves up well in down markets by buying under-valued homes, such as many did after the housing bubble burst in 2008.
Real Estate Is A Long Term Investment
Another big concern about the safety of real estate investing is holding a property over the long term. Will a house keep its value over 20, 30, or even 40 years?
The answer is yes. According to the National Association of Realtors, the price of existing homes increased by 5.4% annually from 1968 to 2009, on average. That’s 50 years of high-yielding investment.
The Two Types Of Real Estate Investments
When a beginning real estate investor looks in the market for the right opportunity to start their first investment, the different types of properties for sale can seem overwhelming. Again, there’s no need for confusion here. There are basically just two types of real estate investments: residential and commercial.
Residential real estate transactions fall under different guidelines and regulations than commercial real estate transactions. Typically, commercial real estate sales & purchases are more complex than residential, but they can also offer significantly more upside opportunity.
Residential Real Estate
Residential properties are homes. They are also known as single family residences (SFRs) or detached homes.
Not all residential real estate consists of detached homes. Residential properties can also include town homes, condos and duets. Apartment buildings that are four units or fewer also fall in this category.
Commercial Real Estate
In essence, commercial real estate is everything else. Commercial real estate includes office buildings, stores, storage facilities, warehouses, and multi-unit apartment buildings. Often times, investment in a large commercial building is sold in the form of a real estate investment trust, or REIT.
Though the process of acquiring commercial properties is more complex, the important thing to remember is that the revenue model is basically the same between commercial and residential properties. Income is generated through rents and the appreciation of property value.
What Every Beginner Real Estate Investor Needs To Know About Taxes
They say nothing is inevitable in this life but death and taxes. And if you’re going to invest in real estate, you’re going to pay your fair share in taxes. Sometimes more than your fair share…
Before you get too spooked, we’re going to make this part easy on you. Yes, there are professionals who earn a substantial living by knowing all the ins and outs of real estate tax law, and yes, those laws are extensive. As a beginner, however, there are just a few important considerations to keep in mind about real estate taxes before you make the decision to start investing.
The Tax Benefits Of Residential Real Estate Investment
Let’s start with the good news: there are certain tax breaks and exemptions you receive when you invest in real estate. Here are ten of the best ones:
InterestDepreciationInsuranceLegal ServicesHome RepairsEmployees or ContractorsPersonal PropertyPass-Through Tax DeductionTravel ExpensesHome Office Usage
Some of these may seem too good to be true. For example, the payments you make to insure a rental property are tax deductible, as is the cost of home repairs. These two items alone can help significantly increase your passive rental income.
But perhaps the least known tax break is the Pass-Through Tax Deduction. Established in 2018, this tax write-off allows landlords to deduct either of the following depending on their income:
Up to 20% of Net Rental Income5% of Initial Property Cost + 25% of Amount Owners Pay Employees
Real Estate Tax Burdens To Consider
On the other side of the coin, there are certain taxes you have to pay as a real estate investor, some of which do not apply to other forms of investing. The two biggest ones are property taxes and capital gains taxes.
Residential real estate investors—especially those considering short term “fix & flip” properties—need to take a close look at their capital gains tax liability when calculating their return on an investment.
Calculating Capital Gains Tax
Capital Gains taxes can be especially cumbersome if you sell a property in the short term. If you sell a house or property in less than one year of owning it, the short-term capital gains is taxed as ordinary income, which could be as high as 37 percent.
However, long-term capital gains for properties you owned over one year are taxed at only 15 percent or 20 percent, depending on your income tax bracket.
In case of short-term capital gain, capital gain is calculated as the final sale price – (the cost of acquisition + house improvement cost + transfer cost).
In case of long-term capital gain, capital gain is calculated as final sale price – (transfer cost + indexed acquisition cost + indexed house improvement cost).
If you’re currently a homeowner, you already know a lot about property taxes. Whether you own your home in full or not, you are obligated to pay property taxes on every property you own.
The make-or-break factor to consider here is that property taxes are different from state-to-state. Nevada, for example, has zero property tax, making it one of the great real estate investment havens.
On the flip side, New Jersey holds the unenviable distinction of having the highest property taxes in America. The tax rate there is an astronomical 2.21%, the highest in the country. Since its average home value is painfully high as well, investing in property in New Jersey can be a difficult proposition at best.
Before investing in real estate, make sure you’re aware of property tax rates in the area you wish to invest, and how capital gains taxes will affect the return on your investment.
Getting Started In Real Estate Investing
Taking the first step in making a real estate investment can be both exciting and scary. Analyzing an opportunity to determine whether it’s a good investment can feel overwhelming. And as the saying goes, “you don’t know what you don’t know.”
So where’s a good place to start in real estate investment? The first step is to take a look at your finances and determine how much you want to invest. This is a decision you need to make on your own, based on you and your family’s needs and how real estate will fit into any existing investment portfolio you have.
Taking the First Step In Commercial Real Estate Investment
Not all forms of commercial real estate require a significant up-front investment. For instance, instead of trying to acquire an entire commercial building, you can buy into a real estate investment trust, or REIT.
Modeled after mutual funds, a REIT pools the capital of numerous investors. This makes it possible for individual investors to earn dividends from real estate investments without having to buy, manage, or finance any properties themselves.
Investing in a REIT only requires money to buy shares in the trust, much the same way you buy stock in a company. However, many REITs require you to be an accredited investor.
The Best Way To Get Started In Commercial Real Estate
If you’re fortunate enough to be an accredited investor, a great place to start your commercial real estate investing is with CrowdStreet. CrowdStreet is a marketplace for big-time investors with deeper pockets or public entities to make institutional-level investments.
But there’s good news for unaccredited investors who want to invest in the lucrative commercial real estate market. RealtyMogul is a crowdfunding platform that enables anyone to gain exposure to the commercial real estate sector. Investments are made exclusively from an online dashboard and are open to both accredited and non-accredited investors.
Another relatively inexpensive way to start in commercial real estate investment is through Fundrise. Fundrise is a crowdfunded real estate platform that makes it easier for individual investors to invest in commercial real estate.
Taking the First Step In Residential Real Estate Investment
If you’ve decided to move forward in residential real estate investment, you may find that it’s a lot simpler to do on your own than commercial real estate. That said, the more well-informed you are, the better.
A terrific resource for beginner real estate investors is Motley Fool’s MillionAcres. Brought to you by the same company that has revolutionized stock information, MillionAcres is a service that gives you lots of useful information in a format that isn’t overwhelming, and even includes exclusive investment opportunities in residential real estate.
The Pros And Cons Of Becoming A Landlord
One aspect of real estate investing that most beginners fail to consider is the idea of becoming a landlord once you purchase income-producing residential real estate. This is especially difficult if you want to purchase income property in a market in which you don’t personally live.
There are five basic responsibilities to being a landlord:
Provide habitable livingEnsure a quiet living environmentMaintain tenant safetyRespond to repair requests and perform repairsTrack unit condition and perform maintenance on routine wear and tear
These responsibilities are separate from the legal requirements specified by each state. In California, for example, the California Civil Code mandates that the landlord ensures proper electric, gas, and plumbing utilities, as well as installing proper locks and security systems.
Though this may fall under “provide habitable living” from the list above, it’s important that you, as a future landlord, get to know the specific legal requirements for landlords in the state where you’ll be purchasing properties.
Removing The Hassles Of Residential Property Investment
Most investors in residential income properties want the advantages of cash flow and appreciation without the hassles of ownership. That’s why most investors hire property managers.
But property managers cost money. Typically, they charge about 10% of the rental amount for their services. However, most investors believe they are worth every penny.
But where do you find property managers, especially if you live in a different market than the house you’re purchasing?
Real estate investment marketplaces such as Fundrise are made for investors with this concern. Fundrise will help you find a property management company, finance, and insurance all in one closing process. And there’s no need to work with a real estate agent, since properties can be bought and sold on the marketplace. They’ll even help you find a property manager to take care of all the details in your absence.
Ready to Start Investing in Real Estate?
Real estate investing can seem intimidating to start, but it doesn’t have to be. With the right approach and the right information, almost anyone can become a real estate investor.
Plus, if you aren’t comfortable handling all the responsibility on your own, there are plenty of ways to invest without doing everything yourself. You can use an investment marketplace, invest in a REIT, or participate in real estate crowdfunding.
Real estate is an excellent investment that everyone should consider. It adds diversity and strength to your portfolio that you won’t find anywhere else. Plus, it can help you earn passive income and grow your net worth.
If you’re looking for a way to build wealth, real estate will continue to be a great investment for years to come.