Successful Real Estate Investing: The Ultimate Beginners Guide
For many years real estate investing was seen as the realm of the super-rich. After all, to make money in real estate, you have to have deep pockets, plenty of knowledge, years of experience, and the kind of business network you can only build over decades – right?
While it is by no means an easy way to make a quick buck, almost anyone can make a move into real estate investment. To be successful, you’ll need to do your homework, find yourself a reliable team of professionals with which to work, and, perhaps most importantly, find a mentor who is willing to share their experience to help you succeed.
I’ll cover all of these essential ingredients to a successful real estate investment portfolio, as well as breaking down the basics of real estate investing in general.
So, let’s not waste any time; after all, you have investing to do.
What Exactly Is Real Estate Investing?
This might seem like a no-brainer of a question. I mean, investing in real estate is all about buying a ton of property, isn’t it?
No, Not exactly.
While some people make money by purchasing large volumes of real estate, most rookie investors begin with a much more modest approach. Real estate investing has several different branches, usually referred to as niches. Each niche is quite different in the pros and cons of the investment, how much hands-on work you’ll need to do in order to make a profit, and how much money you need in order to be successful.
Luckily there are a number of real estate investment niches in which you can sink your teeth, even with limited experience and resources. In fact, I’ll also share with you the real estate investment niche in which you can make money, without spending a cent of your own.
The one thing all niches do have in common is that they all involve purchasing property to make money.
So, for the purposes of this guide, I’m going to define “real estate investing” as:
Purchasing real estate to make a profit.
This definition includes residential, commercial, and industrial real estate. Meanwhile, it also covers those niches in which you may earn a regular income, those in which you may make the occasional quick buck, and all of the possible money-making combinations in between.
How Do People Make Money With Real Estate Investments?
The majority of the money made in real estate investment is in one, or more of three categories:
- Rental Income: This is the most straightforward class of return on a real estate investment. The investor buys property, rents it out to a tenant, and the difference between the investors costs and the amount of rent is the investor’s income.
- Appreciation: Simply put, this is a case of selling a property at a higher cost than you paid to buy, improve and/or maintain it because the property has appreciated – or increased – in value. This can be a long term investment, such as owning a second home which you rent out to others or a quick turn around type of investment such as buying a property, renovating it and reselling in a short period.
- Interest: Private lenders, some REITs, and some Private Equity Funds make money through the interest charged on loans to other real estate investors.
Now we have our definition out of the way, and we know how real estate investors make money, let’s look at the most common real estate investment niches, how they work, and how suitable they may or may not be for rookie investors.
Real Estate Investment Niches
I have already published a detailed article about the various real estate investment niches, but it is important to run through them again here, so you have all of the information you need in one place.
To begin with, real estate investment niches can be split into two categories – Active investments and Passive investments. As you can probably guess, active investments require some kind of on-going work, research, management, or some other form of work in order for them to be successful. You do not necessarily have to do the work yourself, but the fact that you would still have to hire someone and oversee their work means that it would still be considered an active income investment.
Passive investments are the opposite. In these you can place your money and, hopefully, watch it grow with no additional work from you, except maybe reading the occasional report about how your money’s doing.
Let’s begin by looking at those investments which are classified as active.
Active Real Estate Investments
Active investments are, generally speaking, more accessible for novice investors to get into.
Buy And Hold
When real estate investors use a buy and hold strategy, they purchase properties with the intention of keeping them for a period of time.
How Investors Make Money With Buy And Hold
The properties are rented out, with the rent being enough to cover all of the investor’s costs plus a little more on top in order to make a profit. There is rarely a great deal of profit to be made in rents; the real benefits of buy and hold are seen in the longer term.
While you own your property, it will be, hopefully, increasing in value. This will be one way that you begin to make a profit, but, obviously, you only realize this benefit when you sell your investment.
While your tenants are effectively paying your mortgage, you are building equity in your real estate. The higher the percentage of your stake in the property, the more money will go into your pocket if you sell up and move on.
While you are building equity, you are also building leverage. As your stake in the property grows, it also becomes a more significant asset, against which you can borrow money to make further investments. It works like this – although this is a little oversimplified.
- You buy a $500,000 property with an 80% mortgage.
- Your equity is 20% which in this case is $100,000
- Four years later you have paid down the mortgage to the point where you owe $200,000 on the mortgage.
- You now have equity of $300,00
- You could:
- Remortgage the property with a new 80% mortgage and have $200,000 with which to make further investments
- Sell the property and have a $200,000 profit
- Access private financing using your 60% stake in the property as collateral.
Longer-Term Rental Profits
When you are mortgage-free, you will still have some necessary running costs for the property, but a significantly larger proportion of the rent will become income for you.
How Investors Lose Money With Buy And Hold
First of all, real estate values can go down as well as up, and you can find yourself owning a property that is worth less than you paid for it. Secondly, neighborhoods can change, and you may not be able to continue charging enough rent to cover your costs. You might also discover that, for one reason or another, you have problems keeping tenants, in which case you will not have any money coming in with which to pay the mortgage and other bills.
Why Buy And Hold Is Not A Quick Ticket To Riches
It is a surprise to most people outside of the real estate industry that five years is the average amount of time you need to wait before you will be making a profit.
Why do you need to have a property for five years before making a profit, when the cost of properties can rise rather quickly?
When you purchase a property, it is not just the purchase price you pay. With home inspectors, assessors, other specialists involved in the process, real estate agents to pay, and various closing costs, you might see yourself paying around 10% of the purchase price, in buying costs. When you go to sell the property, you’ll also have selling costs.
Between all of these fees, you’ll encounter for the pleasure of buying or selling a property; five years is the average amount of time you’ll have to wait before selling is financially worthwhile.
Fix And Flip
Made to look deceptively simple by the people on TV, fix and flip investing is where you buy a property, make repairs and cosmetic changes and then resell it within a relatively short period of time.
This is an incredibly work-intensive investment, even if you hire other people to do the actual work. Not only that but the proliferation of flipping shows means that there are now many more and more flippers out there, chasing potential investment properties. Add to that the fact that property owners are also much more savvy, and therefore likely to demand a higher price for their home, and you have a situation where Fix & Flip has become an area in which it is significantly more challenging to make a profit than in previous times.
How Investors Make Money With Fix And Flip
With fix and flip real estate investing, you make money when you sell the post flip property. The amount you make in profit varies according to what it cost you to hold the property and for how much you sell the finished product.
How Investors Lose Money With Fix And Flip
You can lose money through a fix and flip when you over-improve a property and price it out of a neighborhood. In addition, failure to correctly estimate the costs of the project can result in paying out far more than you planned and seeing your profit disappear. There is also the possibility that you will encounter issues that increase the timeline for your fix and flip, causing the holding costs to rise beyond the point where you can make any money and last, but by no means least, is the situation where you find yourself the owner of a property which does not sell.
Wholesaling in real estate is not the same as wholesale in retail. In real estate, wholesaling is not the practice of buying property in bulk and then selling it off again piece by piece for profit. Instead, property wholesaling goes like this, although this is somewhat simplified and there is a lot of work behind it.
- The investor identifies a property which would be difficult for the owner to sell. This might be because it needs more repairs than the owner can afford or because it is generally run down and the householder is not in a position to revamp it.
- The investor then makes a deal with the owner that says the owner will receive X amount of dollars for the property, and the closing date will be on an agreed date.
- Then the investor goes to their contacts with the intention of selling the property to them at a price, which is higher than the amount they have agreed with the homeowner.
- The deal closes on the agreed date, the homeowner gets the agreed price for the property, and the investor keeps the difference between the homeowner’s price and the price the contact paid.
How Investors Make Money With Wholesaling
A slightly oversimplified example would go like this:
- An investor makes a deal with a homeowner. The homeowner will receive $300,000 in exchange for their house on March 1st.
- The investor finds someone who is willing to pay $350,000 for the house.
- On March 1st, the homeowner receives $300,000 for their house.
- The investor keeps the $50,000 difference.
How Investors Lose Money With Wholesaling
If an investor has not done their homework, they may find they have overpaid for the property and are unable to sell it at a profit. There is also a risk that the investor is unable to sell the property at all, before the agreed closing date and they will be left buying and holding a property that requires them to make ongoing payments.
The original intention of Airbnb was to provide a platform where homeowners could rent out rooms in their homes, or rent out entire homes for short periods of time, in order to make some additional income. As with many good ideas, entrepreneurs recognized an opportunity and while there are still plenty of homeowners on the site, there are also plenty of investors who purchase properties with the sole intention of providing short-term rentals.
How Investors Make Money With Airbnb
In a similar way to buy and hold, investors make money by renting out their properties for more than they need to cover their costs.
How Investors Lose Money With Airbnb
If an investor fails to ensure their property is in a location that will attract short-term renters year-round, they are in danger of having a property which frequently stands empty. This can result in the rental income being insufficient to cover the investor’s costs of buying, maintaining, and running the property as a year-round Airbnb.
Passive investments are those in which you place your money, and someone else does all of the work – at no extra cost to you in time, money, or effort.
While, as with most investments, there is still the requirement for the investor to carry out due diligence and research before investing their money, the ongoing, day to day management of the money, or the project in which the money is invested, is down to someone else.
REIT stands for Real Estate Investment Trust, and this is a specific type of corporation, trust, or association which owns, and in most cases operates, an extensive portfolio of properties. The profits from the ownership and management of these properties are then distributed to shareholders.
Investors can buy publicly traded shares in a REIT through a broker or shares in a non-traded REIT through a broker or financial advisor.
There are strict rules around how an organization must be structured and operated in order for it to be able to claim REIT status under U.S. tax rules. The company must:
- Be structured as a corporation, trust, or association which is managed by a board of directors or trustees.
- Have shares or certificates of interest which can be transferred from one owner to another.
- Be jointly owned by at least 100 people.
- Make at least 75% of its gross income from rents or mortgage interest.
- Have at least 95% of its income come from dividends, rental income, or mortgage interest.
- Payout at least 90% of the REITs taxable income in dividends.
- Have at least 75% of its assets invested in real estate.
A REIT cannot:
- Be a financial institution or an insurance company.
- Have more than 50% of the shares held by five or fewer individuals during the last half of the tax year.
- Have more than 25% of the REIT assets invested in taxable REIT subsidiaries.
How An Investor Makes Money With REITs
Assuming the REIT is well managed, investors make money through dividends from their shares in the REIT.
How An Investor Might Lose Money With REITs
No investments are 100% safe, and real estate investments are no different. A sudden crash on the broader economy can lead to a loss, as can investing in a poorly managed REIT.
Private Equity Funds
Private equity funds are typically limited partnerships. This structure means that each partner is only liable for company debts up to the limit of their investment. So, if the partner had invested $1 million, they would be liable for up to $1 million of the companies debts.
Each real estate private equity fund has its own rules about who can become part of the fund but, generally speaking, they require that an investor has:
- Either personal or joint assets which amount to $1 million, excluding the value of their primary residence.
- An annual income of at least $200,000 for an individual
- A joint income, with their partner, of at least $300,000 for the last two years PLUS a reasonable expectation that this level of income will continue.
To invest in a real estate private equity fund, you need to find a firm which specializes in this kind of investment or have a personal or business connection through whom you can access the investment.
When you join the private equity fund, you become a limited partner. This means that, as well as your liability being restricted to the amount of your investment; you do not have any power of veto over management decisions affecting the fund. So, for example, you cannot prevent the funds’ managers investing the funds’ assets in a particular property or class of properties.
The investors who set up the fund are the general partners, and they make the day-to-day decisions over the management of the fund. There are no legislative controls over how real estate equity funds must report to their investors, and while many funds provide regular updates and are transparent in their operations, this is not required.
How Investors In Private Equity Funds Make Money
Private equity fund investors make money in much the same way as those who invest in a REIT. However, the structure and requirements of both investments are very different. While you can buy or sell your stake in a REIT whenever you like, private equity funds are long-term investments and are frequently structured to have a decade long commitment – with no option to withdraw your money.
How Investors In Private Equity Funds Lose Money
Again, as with REITs, private equity funds can lose money through mismanagement, bad decision making, or a general downturn in the economy affecting the entire real estate market.
Private Lending Real Estate Investment is exactly as it sounds. The investor takes their money and lends it to someone else, in order for that borrower to take on a real estate project. The majority of private lending agreements are of the shorter term variety, although there is nothing to say they cannot be longer-term commitments.
Private lending is a passive investment in as much as the investors only role is to bankroll the project. However, this still requires a certain amount of due diligence on behalf of the investor to ensure their money is likely to be safe, as well as a certain amount of checking in to ensure a project is on-track.
The rules around private lending vary from state to state. In some parts of the country, anyone can make a loan to anyone else, should they wish to do so. In others, there are rules that require a person to register as a lender once they have made a particular number of loans.
How Investors Make Money With Private Lending
The majority of the money made through private lending is from the interest the lender charges on the loan. Some private lenders also negotiate a percentage of the profit made by the finished project.
How Investors Lose Money With Private Lending
If a borrower defaults on a loan or the finished project does not make a profit, then the private lender will fail to make the money they had expected.
Why You Should Consider Investing In Real Estate
One of the reasons many people give for investing in real estate is that they are looking to achieve financial freedom. This freedom takes on many forms for different people with some investors wanting to have additional ongoing income streams and others looking to make a series of profitable transactions.
The reason why many people turn to real estate investment to meet their financial goals is that real estate has the potential for higher returns than that of other financial growth strategies, such as investing in the stock market.
In fact, since 1970, real estate investing as a whole has had an average annual return of 11.42% compared to an average yearly performance of 10.31% for the S&P 500. Now although trying to compare real estate investment directly to investing in the S&P 500 is a bit like comparing apples to oranges; this statistic does demonstrate that there is the potentiality of higher returns from real estate investments.
How Do I begin Investing In Real Estate?
If you have made it this far and you feel that real estate investment could be right for you, there are a series of steps to take before placing your money.
1. Choose Your Niche
My article How To Pick Your Real Estate Investment Niche details the process through which you can work out the best niche for your lifestyle and needs.
The best real estate investment niche for you will depend on:
- Whether you want to or are able to, make a passive or active investment.
- How much money you have to invest.
- The amount of return you are aiming to get from your investment.
- How much risk you are able to sustain.
- For how long you want to make the investment.
- How quickly you may need access to your money.
It is essential to begin by establishing yourself in one niche and sticking to it. Each type of real estate investment requires a slightly different knowledge base as well as having its own actions and processes. Trying to learn the intricacies of multiple niches will significantly reduce your potential for success.
2. Get Your Finances In Order
Don’t try to invest in real estate as a strategy to get yourself out of a bad financial situation. There is plenty of potential for real estate investments to go wrong or to require additional injections of cash above and beyond the amount you originally planned. For this reason, before you embark on your first investment, ensure that you:
- Pay off consumer debt: While you do not have to be mortgage-free before making your first real estate investments, it is sensible to eliminate any credit card debt as well as any car loans or other similar interest incurring debts.
- Save Your Living Expenses: Once you have paid off your consumer debt, you should try to save three months worth of mortgage and other living expenses. This will ensure you can still afford to live if your investment hits some temporary bumps in the road or if there is an unexpected interruption to your employment.
- Establish An Emergency Fund: Separate from your living expenses, establish an emergency fund that will cover your costs for any unexpected expenses such as car repairs or the replacement of a home appliance.
Only when you have these financial safeguards in place should you consider moving forward and investing your money.
There is nothing to stop you moving along through the next steps while you create your financial safety net. In fact, it is actually an excellent idea to move forward with these as soon as practically possible.
3. Find A Mentor
A mentor is an invaluable asset in most areas of life, and real estate investment is no exception. By establishing a relationship with a mentor, you will be able to learn from their practical experiences, and hopefully avoid the mistakes they have made, as well as learning about what has brought them success.
Where Do You Find A Real Estate Mentor?
You may be fortunate enough to know a successful real estate investor who is willing and able to mentor you. If not, there are a number of places you can find reliable real estate investment mentors who have the time and dedication to helping others, such as yourself, succeed.
Real Estate Investment Clubs / The National & Local Real Estate Investors Associations
It has been estimated that in 2018 there were in the region of 200 real estate investment clubs/associations in the US, with a total of somewhere in the region of 40,000 members. The structure of these meetings varies, but, in general, they are monthly events with a guest speaker and a portion of the event devoted to discussions and networking.
The NREIA’s website describes the association as follows:
“The National Real Estate Investors Association is a 501 (c) 6 trade association. We are a federation made up of local associations or investment clubs throughout the United States. We represent local investor associations, property owner associations, apartment associations, and landlord associations on a national scale. Together we represent the interests of approximately 40,000 members across the U.S. As such, we are the largest broad-based organization dedicated to the individual investor.”
Think of it as an umbrella group for the regional real estate investment associations across the country. An investor must join their regional group before joining the national association.
Local groups have a number of monthly meetings, often as a dinner meeting where you can eat and network with a smaller group. Guest speakers address different areas of and issues around real estate investments, and there is also a significant amount of deal-making going on.
Real Estate Investors Meet-Ups
Hosted on the Meet-ups website, real estate investor meet-ups are a little less formal than other types of groups with events such as “Real Estate Pitch Nights” where people turn up to pitch their current deals and hopefully find buyers, sellers, or investors and “Investment Expos” where there may be a large number of booths at which to meet a wide range of real estate professionals.
Other Local Business Networking Events
You can also attend local chamber of commerce or board of trade type meetings, especially if they have a real estate or investment focus. While these are an excellent opportunity to network generally, there is a much lower likelihood of finding an appropriate real estate investment mentor.
Ensure You Have The Right Mindset
When you begin to invest in real estate, you absolutely have to have the correct mindset. Never, under any circumstances, make decisions with your heart. This can be quite difficult for many people, especially if there is a sad story behind a property for sale. For example, if a homeowner is selling because they cannot afford to bring the house up to a standard where they could get more money for it, you have two options:
- Buy the home for a price the homeowner is willing to accept and yet will still allow you to make a profit.
- Give the homeowner more money for the property and take a smaller profit and a bigger chance of a loss.
Of course, this doesn’t mean you have to do your best to ring every last cent out of people or make a conscious effort to short-change them. There is no need to be greedy and unscrupulous.
There is a point between “so generous you make a loss yourself or do not make enough of a profit to make the entire endeavor worth your while” and “saying and doing anything to maximize your profit without any regard to anybody or anything else.”
It’s called being ethical.
So, within the context of working in such a way that you do not throw basic human decency out of the window, real estate investment should be about the numbers.
If you are unwilling or unable to make business decisions by balancing business success with ethical behavior, then real estate investment is probably not for you.
Choosing Your Strategy And Creating A Plan Of Action
When you have chosen your niche, have begun developing a relationship with a suitable mentor and you are well on your way to having your financial safety net in place you can start to fine-tune your strategy and begin to create a detailed plan of action.
The details will, to some degree, depend on the niche you have chosen but, at a general level, you now need to plan:
- How you will learn more about your chosen niche. Will you rely on reading websites and books? Do you expect to take a real estate or real estate investing course of some kind? Are you assuming you will learn everything you need to know at networking events and from your mentor? (spoiler alert – you won’t)
- How you are going to build an appropriate team of experts. Details about the people you will need on your team are below.
- From where are you going to get the money to invest?
- What is your timeframe to begin investing?
- Are you going to invest all of your money at once, or are you going to spend a proportion of it, to begin with?
- When do you expect to see a profit? How much profit?
- How are you going to choose a real estate market in which to begin investing? Do you want to invest locally so you can be hands-on, or are you willing to invest further afield?
- What are your long-term goals? Do you want to build a portfolio of properties? Do you want a steady income? Are you willing to wait to see a return on your investment?
Other Questions You Should Ask Yourself When Developing Your Plan
Other questions to ask yourself include, but are not limited to:
- Do you have the resources you need? For example:
- Are you prepared to take a financial loss?
- How will you monitor your investment to minimize losses?
- How will you know if you need to revise your plan?
- Can you really take on the commitment of an active real estate investment?
- Does the market support your strategy? Is it a good time to buy and hold, or fix and flip, etc
- Have you defined your goals? In order to make it a worthwhile and achievable goal, you should have something specific written down. The goal needs to be:
- Measurable: “To make money” is not a goal
- Realistic: “I will become a multimillionaire in three months” is not a suitable goal.
- Not easily attainable: By setting easy goals you are not challenging yourself
- Time-specific: For example, “I will fix and flip a property by 1st June 2020.”
- Have you explored all of your options?
- Do you have the knowledge to make informed decisions?
- Are you looking for a long-term or short-term investment?
- How important to you is quick access to your money?
Building Your Team
The most successful people know their limitations and surround themselves with professionals who have the expertise they do not. Investing in real estate is no different, and the team of people you will have around you should include:
- Real Estate Broker or Agent: Developing a good quality professional relationship with local real estate brokers and agents will open the doors to information about listings before they hit the public domain, properties that could be ripe for wholesaling, etc. These relationships will also provide you with suitable outlets for the properties you are selling.
- Contractors: A general building contractor is worth their weight in gold when it comes to establishing if a real estate project has the potential for profit – or otherwise. For example, a contractor can tell you that the damp in the basement is superficial and can be addressed for a reasonable cost or that it is likely there is a significant problem, and you are looking at a considerable bill for remediation.
- Property Manager: If you plan to buy and hold, but you do not want to be particularly hands-on you’ll need a trustworthy and reliable property manager to take over the day to day running of your rental property or properties.
- Insurance Agent: If you are in a position where you may be in need of insurance quickly or for a particular period of time, an insurance agent who is familiar with you on a personal and professional level is better placed to give you the insurance you need, at an agreeable price, in an appropriate timescale.
- Traditional Lender: If you plan to buy more than one property, then, in the same way, you should develop a relationship with an insurance agent, you should develop a relationship with a traditional lender. While for some forms of real estate investment you may not be able to secure finance from a conventional lender, the fact that traditional lenders usually have lower interest rates means that whenever you have the option, they are often a better bet than private lenders.
- Private Lenders: On the other hand, private lenders have much more flexibility when it comes to the type of project on which they are willing to extend financing, and they are able to do so in a much shorter timeline. Your relationship with a private lender could make or break your real estate investment career.
- Hard Money Lenders: A subgroup of private lenders, Hard Money Lenders, offer to finance on the condition that the real estate in question is used as security against the loan. If you default on the loan, they take control of the property.
- Potential Partners: Don’t forget the possibility that other people in your network may be potential partners for your real estate investments. Perhaps you have a relative who would be willing to provide half of the capital needed for a project in return for half of the profit? Or maybe a friend who is willing to give their professional contractor skills for free in return for a slice of the proceeds when you sell your Fix & Flip? Remember, not every potential partner has money to contribute, but they may have other skills of great value.
Real estate investment is an exciting and challenging way to create wealth. You do not have to start out with a great deal of money, knowledge, or experience in order to be successful but you do need to be willing to learn, surround yourself with people who have the expertise you do not, and to create a meaningful plan of action to which you can stick.
Talk to your financial advisor prior to making any decision whether or not to invest.
About The Author
Geoff Southworth is the creator of RealEstateInfoGuide.com, the site that helps new homeowners, investors, and homeowners-to-be successfully navigate the complex world of property ownership. Geoff is a real estate investor of 8 years has had experience as a manager of a debt-free, private real estate equity fund, as well as a Registered Nurse in Emergency Trauma and Cardiac Cath Lab Care. As a result, he has developed a unique “people first, business second” approach to real estate.
Check out the Full Author Biography here.