How to Invest in Real Estate – 6 of the Most Common and Popular Strategies
Real estate investing is one of the most popular ways to grow wealth. It has provided investors with solid returns for decades and keeps new investors lining up to learn the ropes.
Real estate is generally much more stable than most other investment vehicles. Although crashes do occur, they are typically much more sluggish than a stock market crash.
Also, real estate introduces a beautiful tool investors have used for years to maximize their returns – leverage. The ability to leverage other people’s money in real estate is unmatched by any other investing strategy.
Although these benefits of real estate investing can be enticing, deciding how to invest in real estate and get started can be overwhelming. After all, there are countless strategies that gurus tout as the best, and new methods are being invented every year.
This article breaks down the most common strategies real estate investors use to grow wealth and build their portfolios. If you are excited about real estate investing but not sure which method is right for you, continue reading to better understand each one.
The Fundamental Task of Real Estate – Finding Profitable Deals
No matter which strategy you choose, success in real estate investing hinges on your ability to find profitable deals. This is especially true for active investing strategies such as flipping and long-term rentals.
If there were an abundance of great deals in plain view, everyone would be successful. However, finding the deals that will truly grow your wealth requires hard work and discipline. The most successful real estate investors have perfected lead generation techniques such as direct mail, cold calling, and SEO.
If you plan to pursue one or more of the active investing methods below, you should consider how you plan to source deals in tandem with learning the strategy itself. But if you can consistently locate stellar deals and know the nuances of the strategies you intend to use, you can make some serious money in real estate investing!
Fix & Flipping
Flipping houses is one of the first strategies people think about when considering real estate investing. Not only have people become fascinated with home renovations from TV shows and social media, but flipping follows the common investing philosophy of “buy low, sell high.”
One of the primary benefits of flipping houses is that it provides large chunks of capital. It is not unheard of for a flipper to make $60,000 on a flip. Fill your pipeline with a few of these each year, and you’ll be doing well!
We’ve already discussed finding houses to buy at a discount, which will be extremely important when flipping. However, a couple more parts of the process must be managed successfully to secure a profit.
First, you must successfully navigate the renovation process. Some flippers do the bulk of the improvements themselves, while some use contractors for everything. You should evaluate your skill set and time availability before deciding how much work you plan to do yourself. Needless to say, if you’ve never used a saw in your life, you should probably not attempt to renovate an entire house on your own. Instead, you should focus your effort on building a team of contractors.
Once you finish fixing a house, your next task is selling it for top dollar. Because most home sales take place on the Multiple Listing Service (MLS), you’ll likely want to find a real estate agent that is experienced in your area.
If you buy a home at a low enough price to account for repairs and your profit, successfully renovate it, and sell it for the highest price possible, you will likely be walking away with a large chunk of capital to reinvest!
Long-Term Rental Properties
While flip houses provide large amounts of capital in lump sums, rental properties generate consistent cash flow month after month. Not only that, but since a portion of each rent check pays the mortgage on the property, the loan principal is paid down over time.
The most common formula for evaluating a rental property is the 1% Rule. This rule says that for a house to be a profitable rental, the monthly rent needs to be at least one percent of the home’s all-in cost, including the purchase price and repair costs.
The most common reservation people have about becoming a landlord is dealing with troublesome tenants that don’t pay rent and abuse the property. Although this isn’t as common of an occurrence as people might think, it certainly can happen when owning rental property.
If you want the benefits of owning rental properties but don’t want to deal with the headaches of managing tenants, you can hire a property manager to do that work for you. They will find tenants for the house, collect payments, and respond to maintenance requests. Most property managers charge 10% of the monthly rent for their services.
On top of making monthly cash flow and having your mortgage paid down, Rental properties will generally appreciate over time. Although housing markets experience dips in prices every once in a while, the trend is always upward.
Creative Financing
Many real estate investors get started building a portfolio of properties only to find out they are hamstrung by funding. Whether they are limited by banks cutting them off or simply not having enough money for down payments, it can be frustrating when trying to scale.
To combat these issues, many investors turn to creative financing. This is a very broad term, but it generally entails using strategies to limit the amount of your own money required when buying real estate.
BRRRR Method
“BRRRR” stands for Buy, Renovate, Rent, Refinance, and Repeat. This is a great way to recycle money and buy multiple rental houses with the same capital repeatedly. Here are the general steps of the BRRRR Method:
1. Locate a property that needs some work
2. Buy it at a discount
3. Renovate it to raise its value
4. Rent out the house
5. Refinance the house based on new value
6. Repeat the process on a new property
In many cases, the refinance loan can replenish all of the money invested into the property. Even if there is still some money left in the deal, the resulting cash-on-cash return will be much higher.
Owner Financing
This may sound crazy, but it is possible to buy a house from someone and leave their loan in place. This is a strategy that many investors use to limit their involvement with banks and creating new loans.
Also, the down payment is negotiable when owner financing a house, as opposed to the 20% minimum when working with a traditional lender.
If the seller has a mortgage on the property, there are a couple of options for structuring an owner-financed deal. The simplest form is called buying the property subject to the existing loan, where the buyer simply takes over the mortgage payments and underlying balance. A second option is a wraparound mortgage, where a new loan is created that “wraps around” the existing loan. In this case, the new loan’s principal balance and monthly payment typically exceed the existing loan.
The process is even more straightforward if the seller does not have any loans on the property. Instead of them getting a lump sum at closing, they receive the down payment and a promissory note that describes the terms of how you will pay the remaining balance off.
Short-Term Rentals
With Airbnb’s becoming increasingly popular for vacationers and work travelers, many investors are beginning to capitalize on this trend by using their properties as short-term rentals. The primary benefit of this model over more traditional long-term rentals is the increased monthly cash flow.
The nightly rate for these short-term rentals is often comparable to nearby hotels and extended stay facilities. As a result, the monthly cash flow often well exceeds the fair market rent of the house if it were leased for a year. This allows investors to pay more for properties they intend to use as short-term rentals.
While long-term rentals are more of a “set it and forget it” approach to investing, short-term rentals require constant attention. First, bookings and communication with guests must be well-managed to avoid any issues. Also, because of the frequent turnover between guests, it is vital to have a dependable cleaner that can come in and clean between stays.
Although this strategy requires much more time and attention than others, it is undoubtedly one of the most profitable. If you have a property in an area that receives significant visitors, this is definitely an investment to look into!
Wholesaling
What if you want to get involved in real estate but don’t want to renovate houses or manage rental properties? Also, what if you don’t have much money saved up or don’t have the credit that banks are looking for?
The good news is that you can still invest in real estate!
The answer is called wholesaling. Wholesaling real estate involves finding a distressed property, negotiating a deal with the seller, getting the house under contract, and selling the deal to another investor for a fee. A wholesaler’s profit on a deal is usually between $5,000 and $10,000, but it can be much higher.
The key to success in wholesaling real estate is consistently finding profitable deals. The best wholesalers have honed their marketing strategies so that they can find motivated sellers when no one else can. On top of marketing, wholesalers must be able to evaluate property values and negotiate stellar deals. Since there must be profit for the end investor as well as the wholesale fee, the purchase price must be even lower than it would be if you were buying the property yourself.
There are two main options for structuring a wholesale deal. The first is using an assignment. First, you get the property under contract with the seller. Then, you find another investor wanting to buy the house, and you sign an assignment agreement with them, allowing them to step into your place as the buyer. This assignment agreement is what specifies the profit you will receive. Finally, the buyer closes on the property with the seller, and you receive your assignment fee.
The next option is called a double closing. Instead of the end buyer stepping into your place, you, as the wholesaler, will close with the seller and immediately turn around and sell the house to the end buyer for a slightly higher price. Your profit will be the difference in the purchase prices, minus closing costs. Depending on the title company you close with, you may need transactional funding to fund the first closing. However, some title companies will allow the money from the second closing to fund the first. This is a question to ask your title company before doing wholesale deals.
REITs
Perhaps you are drawn to real estate investing but don’t want to take such an active role that most strategies require. REITs, or Real Estate Investment Trusts, might be the right option for you.
REITs are large investment companies that purchase rental income-producing assets such as office buildings and retail spaces. Most of these companies are publicly traded and allow investors to buy shares. They use the money from shareholders and purchase properties that fit within their portfolio and then provide returns to the investors through dividends and capital appreciation.
One of the primary benefits of REITs is that they are entirely passive and provide relatively stable returns for investors. Because real estate is often decoupled from other asset classes, savvy investors often invest in REITs for portfolio diversification. Because shares in REITs can be bought and sold just like stocks, they are much more liquid than actual real estate properties.
Although REITs provide passive income backed by real estate, they are not capable of producing the types of returns that are achievable through more active forms of real estate investing. It all comes down to risk versus reward. Since REITs are professionally managed, they are less likely to buy properties that don’t produce returns. On the other hand, many inexperienced real estate investors have lost money by overpaying and getting in over their heads. However, with the proper knowledge and experience, active real estate investments will almost always outperform passive investment vehicles such as REITs.
How to Invest in Real Estate – Get Started!
As you can see, there are many options to get started investing in real estate. Hopefully, one or more of these strategies stood out to you. If so, you should spend some time investigating them and learning all of the ins and outs.
One key to success in real estate investing is being adaptive. Whether it be your marketing methods or investment strategies, you must track how your current approach is working and adapt based on what you see.
If you commit to finding profitable deals and learn the keys to success for your investing strategies, you will likely generate returns that are rarely possible with any other type of investment!