Real Estate Investing 101
The first thing to decide when investing in real estate is what your goals are. While there are millions of possible goals, here’s a look at the main categories: Quick Profits or Buy and Hold. If you’re looking for quick profits, then you’ll want to look into flipping houses. Buy and Hold properties can provide monthly cash flow and they also offer the opportunity to make money down the road when the home is sold. Here’s what you need to know if you’re considering getting started with real estate investing.
Most beginning investors that I talk with love the idea of flipping homes. It’s exciting and you can build something that you can see. If done correctly, big profits can be earned in a relatively short amount of time. But, there are also big risks with flipping homes and there are considerable financial barriers to getting starting. The trick to flipping homes successfully is to buy the house at the right price, stay within budget for repairs and updates, and sell it for a reasonable profit. As a general rule, you’ll need to buy the home for about 1/3 of the value after repairs (ARV = After Repair Value), stick to a budget of about 1/3 of the ARV for repairs and updates, and use a portion of the final third for other things like taxes and real estate broker commissions.
The reality of house flipping is that few flippers make any money on their first flip so expect to do several before turning a profit. You’ll want to have substantial cash reserves available for the unknowns, as well. I can’t tell you how many homes for sale that I’ve seen that were ‘mid-flip’ where the flippers clearly ran out of money and had to sell the house.
The two biggest obstacles that potential investors face in getting started with flipping homes are finding homes that are cheap enough and coming up with the funds to purchase the home and make the necessary updates and renovations. Generally, at least in the Philadelphia area, it’s rare to find homes that are cheap enough for flipping listed for sale on the Multiple Listing Service (the database that real estate brokers use to share listings and syndicate them to portals like Zillow and Realtor.com). But, I’ve certainly seen them so it’s good to keep an eye out. More often than not, investors will find cheap homes by buying them through Sheriff’s Sales or by buying homes directly from the owners, often advertised as ‘We Buy Ugly Houses.’
These homes are usually sold for cash. If you have the cash on hand, great. Most would-be investors don’t have the funds available and getting a traditional mortgage for a home in major disrepair often is a possibility. Borrowing funds or getting a gift from family and friends is one way that people raise funds. Another common option is to get the funds through a hard-money lender. These private investors will lend money to home flippers through short-term high-interest loans. Hard-money loans can be a good option but be sure that you know what you’re getting into and have the contractors in place and ready to get the work done quickly. The longer it takes to remodel and sell the home, the more those interest rates will chip away profits.
Flipping homes can be exciting and it can bring big rewards in a short period of time, but there’s also a lot of risk. You’ll need to buy homes at the right price and also have a very good idea of the After Repair Value. There are plenty of cheap homes but buying a house for $20,000 that will be worth $60,000 after investing $80,000 isn’t a good deal. Buying a house for $80,000 and investing $80,000 into updates and repairs can be a good bet if you know that the After Repair Value will be $240,000 or more. Most first time flippers pay too much for the house, invest too much in improvements, and over-estimate the After Repair Value.
There are far fewer HGTV shows about rental properties than there are about flipping houses. Rental properties may not make for as good television as house flipping shows, but they can be a great investment with the potential for long-term rewards that you won’t get when flipping homes. Rental properties can also have fewer initial costs and it’s often easier to find these properties than it is to find homes to flip. What’s exciting about rental properties is having the ability for your tenants to pay down your mortgage leaving you with full ownership of the property.
Let’s look at why someone may want to invest in rental properties. Let’s say you buy a $200,000 home with a 20% down payment loan and monthly payments of $1200/month. With rent of $1600/month you’re monthly costs are covered and you can save some money for the inevitable vacancies, repairs, and maintenance. In 30 years, you own the property completely. If there was no change in the value of the home and you sell it for $200,000 then you’ve made $145,000. Or, you could continue to hold onto the property and have $1600/month of somewhat passive income coming in. In reality, the value of a dollar will change and, most likely, the value of the home will increase substantially in that time.
Of course, there will be costs for maintenance, repairs, and updates to consider but if the price of the home doubles in 30 years it’s certainly going to be a nice little profit. Do this with a few houses and you can sell a home when the kids go to college to help pay those expenses, have rental income from a few houses to fund your retirement, and leave something extremely valuable for your kids. All of these are things that really excite me about buying rental properties.
When searching for a Buy and Hold rental property there are plenty of factors to consider and also plenty of options. As a general rule, finding properties to rent is a lot easier than finding properties to flip. A home in generally good condition that can be improved with some paint and cosmetic updates can be a good option and far less daunting than a shell in need of a complete overhaul. Depending on your goals, you may prefer single-family homes, multi-family homes, or a combination. When assessing neighborhoods, you should look at the current rental rates and the general appreciation over the past few years to get an idea of what to expect before buying a home.
If you need more info or would like to talk about investment properties, call Jon Miller at 215-839-6034 or send me an email at email@example.com.