So you want to be a real estate investor? The process of creating wealth through real estate investing is truly simple but does take faith, faith in the process. Let’s explore the concept together and then we can begin breaking down this fabled process as we complete this series.
Read these two short stories and think about which path you would prefer to take, or at least which outcome you desire. This is a comparison of a straightforward buy and hold strategy. You could choose to flip a property (buy, fix up, and immediately sell) to help create cash reserves. We are focusing on simply keeping and renting for simplicity.
There are literally hundreds of variables in every real estate transaction, and even more in traditional investment strategies. For purposes of this concept introduction we will focus on average results. We can dive into the particulars in later posts. There is a reason that most wealthy people have significant real estate holdings. Real estate investments are an extremely powerful way to turn a little money into a lot.
I have taken two assumptions for this exercise, 401K investments will provide a 6% return, and homes will appreciate at 2%. Again, we will explore the other variables later in this series.
The American Dream Path
Michael and Jessica were just married at 25 years old and have chosen to move into their favorite suburb. They both have corporate jobs bringing in a combined $76,000. They are really doing very well! Everyone tells them to start investing into their 401K’s and buy a house, stop renting! By watching their budget and keeping up with their credit card and car payments they keep their credit score up. They qualify for a mortgage of $200,000 and can afford the payments that are just under $1,400 with taxes and insurance. Somehow at the end of every month there is simply no money left no matter how hard they try. Still, they are able to save $400 and put into their 401K. At least at the end of thirty years this house will be theirs free and clear!
After a short 12 months their dream home was worth $204,000 the mortgage balance was $176,830 giving them an equity position of $27,170. They had also managed to save $4,954 as well!
Fast forward to thirty years of saving $400 per month by contributing to their 401K and realizing an average return of 6% annually it will be worth nearly $400,000! Their house has appreciated at nearly 2% per year over the thirty years and is now worth $362,000! At just 55 years old they have managed to save almost $762,000. With another ten years before retirement they should easily hit $1,000,000! Now that’s the American Dream!
The Wealthy Road Path
Michael and Jessica have just gotten married at 25 years old. They both work in corporate jobs and bring in a combined $76,000 per year. After attending a local real estate investors meeting they have decided to follow the BRRRR strategy that they just learned about, putting to use the $20,000 wedding gift from their families. At the real estate meetings, they were taught the basics of how to Buy, Rehab, Rent, Refinance and Repeat (BRRRR) properties to create real estate equity and cash flow. First, they visited their local bank and were pre-approved for a $200,000 mortgage with just 10% down at 4% interest. With this information, they consulted their friend and realtor and quickly found a duplex near the area they desired. Not exactly where they wanted to live but close enough, they were determined to build wealth. They moved in the next month and immediately rented out the other side of their duplex for $1,100 per month. This not only meant they were able to live there for only $300 per month but they could save $1,200 per month for a down payment on the next property!
After 12 months their new duplex was worth $204,000, the mortgage balance was $176,830 giving them an equity position of $27,170. They had also managed to save $14,400 towards their next property as well!
Michael and Jessica continued to focus on buying single family homes for rentals one each over the next ten years. Single family homes, 6% Interest on 30 year loans, 10% down and using the same assumptions as above these properties put them in great financial condition after this short time. They were able to retire at 55 years old with plenty of financial security.
After thirty years of saving $1,400 per month; using a small portion of it the first ten years to place a down payment on another property, they accumulated $1,030,931 dollars! Their 10 properties appreciated at nearly 2% per year over the thirty years and are now worth $1,584,940! At just 55 years old they have managed to save almost $2,615,871. With another ten years before retirement they should easily hit $3,000,000! Now that’s the American Dream!
BRRRR – Buy, Rehab, Rent, Refinance, Repeat
Buy a property.
It does not matter if it is a Single Family Home (SFH), a duplex, or an apartment complex. Multiple units have a more difficult learning curve so if you are just beginning start with a SFH. If the property can produce a positive cash flow then you are in the ballpark. Your goal is to give less than 70% of market value, including the rehab costs noted below if there are any. Oh, did I mention to buy a property now? Time is your greatest ally.
Rehab the property. You may find a property that we investors call turnkey. A turnkey property can be purchased and put into your rental pool immediately. Literally creating cash flow the first month you own it. However, these types of properties can be difficult to find in a hot market. Properties that need a lot of work are typically cheaper to purchase, you just have to be ready to put the additional work into them.
Rent the property.
Do your research in the area you want to purchase and determine the local rental rates. As you continue to farm an area you will know these rates before even making an offer to purchase. Farming an area is the idea of knowing everything you can about an area. Know what is for sale, what has sold, how much. How much rents are, how long are rentals sitting empty? Drive the streets, stop and talk to people. Get to know your market.
If you have no idea what the rates are simply drive around and call on the properties for rent. Check Craigslist, the internet, local ads, anywhere you find houses for rent. A great resource that I use to check local rentals is www.rentometer.com. You simply put your property address and number of rooms into the website and voilà, you get a map with the areas rentals! Get moving, real estate investing is not an internet job. Boots on the ground pay big dividends when you are farming your area.
Refinance the property. If you purchased the property with cash now is the time to finance it. Take your cash out and use it to buy more, this is called leveraging. Many small banks will give a portfolio loan to investors, my experience is between 4.5 to 6% interest rate. Once you form a relationship with a local banker this becomes easier as they become more comfortable with your process.
For beginning real estate investors it will be easier to look for a turnkey property and obtain a traditional loan. The pros of a traditional loan are that you can finance for a longer period at a lower interest rate. However you can, get your cash out so that it can be used to obtain more properties. Another worthwhile avenue is to take a Home Equity Line of Credit (HELOC) out on an existing property.
The last option I would consider but can work is to deal with a Hard Money Lender (HML). Their interest rates with be much higher than a traditional or portfolio loan. They also charge fees up front and are typically short term loans. A positive is that a HML can help you close on a property in days, not weeks.
Leveraging must be done with respect to the property value. My typical rule is never leverage over 70% of a homes value. This helps protect against interest rate hikes, down housing markets, and rental rates dropping. If you borrow 100% of a property’s value and the market goes down it can put you in a very difficult financial spot.
Repeat the process.
Still interested? Yes this process can seem daunting, nothing great is ever easy. The point of this article is to show the power of real estate through hard work and natural appreciation. If you purchase a property in the right area, don’t overpay, and find good tenants, you can be putting cash in your pocket every month for years. And the bonus is that the tenants will pay the mortgage for you and you end up owning the house.
There will be difficult situations with tenants, with plumbing, with insurance or the properties neighbors. After a short time these lessons will come and go and your rentals can operate with little headache.
So we have finished with a very simple version of the HOW part of real estate. In the next part of the series I will discuss the WHY. Why I believe that real estate is the easiest path to wealth that I have found.
I hope you join me for my next post: There is no I in Team.
Happy Sunday – Curtis