Real estate is a popular investment aside from stocks and bonds, and most people who tend to take part in becoming investment property owners are interested in doing so to diversify their current holdings beyond stocks and bonds. There are different goals that you can set for yourself in regards to property investing — flipping and reselling or renting out.
Property Investing for Flipping
It’s becoming increasingly popular to flip homes thanks to the many shows we see that make it seem all too easy to do. If they can do it, why can’t you? But before diving straight into buying real estate to flip, it’s important to truly understand what you’re getting yourself into; that way you educate yourself well enough to make the right decisions with better pay off.
An investment is something that can yield a financial return (profit) and possibly provide an additional source of income. Flipping homes, although it can be profitable, is a one time deal—you buy a house and put money into it to increase its value and sell for a higher price. But once it’s sold and you make profit, that’s it with that home. To keep it going you’d have to purchase another house and do the same thing over again. So while it’s an investment, it’s not necessarily an income stream.
Learn the local housing market when flipping houses
Although some may be making an incredible profit from a home they purchased, flipped, then sold, it doesn’t mean that the local housing market will perform as well, or guarantee the same kind of return as it did for your inspirational flippers on TV. You also have to keep in mind that you have to truly search for that hidden gem at a deep discount to make the flip profitable.
The price of the home plus all the costs associated with the renovations would have to provide enough of an increase in selling price that there’s still profit left over.
It requires a lot of work and project management to flip
If you’re doing all the work yourself, then you could potentially make a lot of profit, but it might not be as quick as you’d like unless it’s your full-time job. If you’re not doing it yourself and hiring contractors, then you have to consider the extra costs associated with paying them. That money would come out of the profit you’d make from your flips.
Another thing to consider with flipping is the fact that you will also need to budget for loan payments on your property until you can flip it, list it, and resell it.
From the time you close until your first payment is due, you’ll have about 30-45 days. While television makes it look possible to flip and resell in that time period, the reality is that you may not. So, if you have a mortgage on your own home and a mortgage on your investment property, you may have a few months where you’ll need to tighten the budget. Especially if this is your first flip and you don’t have any money in the bank from a previous flip.
Steer away from making emotional decisions
Unlike buying a house for your family, you should lean away from flipping for your own tastes. It’s a business; therefore, it’s important to flip in a way that would make the house profitable and appealing to homebuyers. You should also keep in mind of costs associated with typical repairs. A house can look great, but if it doesn’t function properly, it won’t be worth it. And if you’re only able to fix the repairs and not put anything into the renovation, then it also won’t pay off in the end.
Property Investing for Renting
Unlike with flipping for profit, becoming a property investor for renting is a much more long-term investment. It takes a lot of commitment and a lot of research to know and understand the current and future local housing market.
Think long-term when choosing to rent out
Investing in a property to rent out could be a great way to have additional income for retirement. And rent typically goes up each year to meet local market demands. It’s a great way to have a steady stream of income, but there are also potential downfalls of renting out.
For example, what if no one is living in your rental? That means you’ll have to pay for the property during those months without making a profit. Or, sometimes tenants aren’t always on top of their payments, or can potentially damage the home with wear-and-tear. It’s a potential risk, but then again, most investments are.
Research the number of renters in different neighborhoods
In regards to tenants and demand of rental properties, it’s crucial to research the local neighborhoods. If you live in a college town, there’s a lot of chances of finding tenants while having competitive rent prices. And in college towns, you also often times experience co-signers on leases that understand that they’ll be held responsible in the case that the primary tenant misses rent or causes damages that they don’t pay for. Having co-signers can serve to be a good insurance against defaults and damages to your rental.
You’ll need to be handy
When your tenant leaves, it’s your responsibility to make the space look new all over again to put back on the market for renting. Labor costs can be high with maintenance; therefore, where you can do the work yourself, you’ll save on all the additional costs associated with repairs.
While tenants live there, you’ll also have to keep in mind of possible immediate repairs that would be needed in case of emergencies. Sometimes the repairs may be too immediate for you to try to fix yourself; therefore, having money saved away for those situations where professionals are called in would be necessary.
Get an income-approach method for your appraisal
Most people aren’t aware that there are different methods for your property appraisal. When you’re buying a home for personal use, you get an appraisal that compares the house to other houses just like it that have recently sold to establish a value.
There’s another method of appraisal called the income-approach, which determines the value of your property based on its income-producing ability.
Basically, this method helps you determine your net operating income of the property. First you calculate the annual income for the property and then subtract a vacancy factor that fits your market. If your market has a transient population of people who move in and out a lot or have short-term leases (think military), you may have a month here and there during the year where the property is vacant.
Property and income taxes can affect you
So if you plan on investing into a rental, keep in mind that it gets taxed as investment income.
Financing for Property Investing
Getting a mortgage loan is probably the first thing that comes to mind for property investing, and it’s definitely what we know about and encourage, but we want you to also know about other ways people pay for investment properties.
Get approved for a mortgage
You’ll most likely need a conventional mortgage loan for your investment property. Other loan types such as FHA, USDA, and VA may offer low down payment and low closing cost options, but typically aren’t approved for investment properties. I say “typically” because FHA does have some exceptions for multiple-unit property purchases.
Traditional conventional loans require a down payment of at least 20% of the purchase price to avoid private mortgage insurance.
You may be able to find conventional loans with lower down payments. You may also have renovation loan and energy efficiency loan options available to help offset the cost of the flip.
This seems too obvious and it’s not the most feasible for most people, but it’s still an option. If you have access to retirement funds, savings accounts, or other investments (like stocks, bonds, CDs, etc.), you may be able to liquidate some of them to free up cash for a property purchase.
If you’re flipping, there’s a good chance you can repay yourself within a few months. If you’re renting, repaying yourself may take longer.
You can also combine cash and a mortgage. If you can come up with a larger down payment for the mortgage loan, the amount you have to repay is less and the monthly mortgage payment you may have to carry until the house sells or rents out will be smaller.
Example: Our aspiring investor has $100,000 to invest. They can choose to use that $100,000 to buy a house that will produce $1,000 per month in income or $12,000 per year. Once they recoup their initial investment, this will equate to a 12% return-on-investment.
Or, they could instead use that $100,000 as a 20% down payment on five similar homes, each listed at $100,000. With an $80,000 mortgage on each, the cash flow would be approximately $300 each month per house, which is $1,500 per month each or $18,000 per year. Once they recoup their initial investment, this will equate to a 18% return-on-investment, which is 50% better than buying just one home. This is also much better than placing the funds in a savings account or risky stock that may only yield a fraction of a percent ROI each month, if that.
Find a private investor or lender
This is different than getting a mortgage loan. You find someone else who is interested in real estate who will either lend you the money to purchase the property, and you pay them back with interest out of the proceeds of your flip. Investors tend to not want to invest in rental income because it takes them too long to see a return on their investment.
Loans made by private investors are usually called “hard money loans” because they have short repayment terms, higher than normal interest rates, and no loan limit caps. They’re designed to motivate the borrower to pay them back quickly. Your lender is not investing in your property, but are investing in you. So it’s important for you to prove to them that you’re a good risk.
Form a relationship with other property investors
You could also look for other people who want to invest in properties and pool your resources to purchase properties. This may require each person to obtain loans or use their own cash. Profits are split depending on how much each investor places into the property. In some states, these investors may even be able to sell the home to someone who wants to carry a loan and pay them back, just like they were working with a bank or mortgage company.
One of the most important parts of real estate investing is making sure you have a specific goal in mind before you start. How long do you want to do it? How soon do you want to see a profit? Your goal(s) will help guide you to the kind of investments you want to do and the kind of financing that works best for you. Speak with a mortgage banker to find out if investment properties are an option for you.