As an individual investor, real estate investing is a great way to increase not only wealth but create a well-diversified portfolio. Whether you are just starting or are an experienced investor, understanding the basics can help you in making the right decisions about things like if you should invest in commercial real estate, what’s the best way to manage properties or even the basics of how to get started in investing. Let’s take a look at some of the basic steps for beginners who are thinking of investing in real estate.
Investment Strategies for Real Estate Investors
When it comes to investing in the real estate market, there are different strategies you can use. Ultimately, these strategies depend on your goals and financial situation, so considering all of your options before choosing one is important. Three popular strategies include flipping houses, buying rental properties, and wholesaling. Keep in mind each strategy has its risks and rewards.
1. Flipping Houses
Flipping houses is when you buy a property to renovate it and resell it for a profit. This strategy requires substantial capital up front as well as expertise in remodeling and staging homes for sale. You also need to be knowledgeable about local real estate markets so you can accurately determine which renovations will yield the highest return on investment. If done correctly, flipping houses can be profitable. However, this strategy does come with considerable financial risk. One of those risks can be the volatility of the real estate market. If the market is a seller’s market, you may see a house that’s easily sold and have a chance at seeing higher profits meaning a higher return on your investment. If the market is a buyer’s market, however, there’s a chance you won’t sell the house as easily or for not as much as you hope for.
2 Buying Rental Properties
Another popular real estate investment strategy is buying rental properties. With this strategy, you purchase residential or commercial real estate to rent it out either long-term or short-term (i.e., Airbnb). This strategy requires more time than money since you’ll need to find tenants who meet your criteria as well as manage the property on an ongoing basis.
It can also be challenging to stay ahead of maintenance needs while ensuring that rent payments are made on time each month. Some investors hire contractors or companies to ensure their properties are professionally managed and one less thing they have to worry about. The downside to that approach is it is an added expense. Overall, rental properties offer steady income streams that often rise over time due to inflation or increased demand for rental units in certain areas.
One of the last primary real estate investment strategies is wholesaling. Wholesaling involves buying a property below market value to sell it as quickly as possible without making any renovations The difference between this and flipping a house is you make no updates or renovations to the property. Instead, you source a buyer for the property. The downfall to this approach is the profit margins aren’t always as high as those with flipping a house. And, as with the flipping game, you must rely on a real estate market that can be volatile.
What Steps Should I Take to Start Investing in Real Estate?
Now that you have an overview of the different real estate investment strategies, understanding the different steps in investing in real estate is critical before taking the plunge. Let’s take a look at five steps you should consider as you prepare to invest in real estate.
1. Establish Your Goals
The first step is to establish your goals. Do you want to generate a rental income? Are you hoping to flip properties? Or are you looking for long-term investments? Do you prefer residential properties or commercial real estate investments? Knowing what kind of return on investment (ROI) you want and how much money you’ll be able to continue to invest in a property (from property taxes to maintenance) over time is something you’ll also want to consider. Having a sound understanding of your investments and your financial health is a big part of this step and will help determine which type of property you should or can invest in.
2. Research the Market
After establishing your goals, research the market. Take a look at local listings, research local neighborhoods, and cities, and visit potential properties if possible. Some factors you may want to consider include the school district, neighborhood safety, access to public transportation, and other factors. Many of these influence buyer/renter demand as well as the future property value.
3. Understand Financing Options
Having an understanding of financing options when investing in real estate can be helpful. Some investors use mortgages or loans from banks or other lenders when purchasing properties. Others buy houses with cash. If you’re an investor who needs to start with a loan, understanding all of the details around financing options, such as interest rates, loan terms, repayment schedules, etc., can help you decide whether this is a good investment for your situation.
4. Analyze Profitability Potential
When considering a specific property for investment purposes, smart investors analyze profitability potential, as well as risks and benefits, before making any decisions. Consider factors such as potential rental income, repair costs, maintenance fees, taxes, and insurance premiums, etc. Knowing the cost of these things can help you accurately assess whether a particular property is worth investing in or not or which investment strategy is correct for you.
5. Calculate Your Investment Budget
Once you determine which property might be worth investing in calculate your budget so you know exactly how much money needs to be allocated towards this venture. In this step, consider how much you will need for renovations of the property, along with any down payments, etc. In this step, if you’re flipping a house, add the cost of listing the home with a real estate agent or if you’re wholesaling, the cost of sourcing a buyer.
Are There Alternative Real Estate Investment Strategies?
If the strategies above don’t sound appealing, there are alternatives to traditional real estate investing. Let’s explore two alternative real estate investment strategies and how they can help you build wealth.
1. Real Estate Investment Trusts (REITs)
One of the most popular alternative real estate investment strategies is via publicly-traded REITs, or Real Estate Investment Trusts. A REIT is a company that owns and manages income-producing real estate assets, like office buildings, shopping malls, hotels, apartments, and more. When you invest in a real estate investment trust, you are essentially purchasing shares in that company rather than buying actual property.
The benefit of this type of alternative real estate investing is it allows investors to gain exposure to a wide range of properties without having to manage them directly. Plus, because REITs are required by law to distribute 90% of their taxable income as dividends each year, they often offer investors steady dividend payments and potential capital appreciation over time.
2. Real Estate Crowdfunding
Real estate crowdfunding platforms allow smaller investors to pool their money together and invest in larger projects that typically require more capital than what an individual investor would be able to afford on their own. With real estate crowdfunding sites like Fundrise and RealtyMogul, investors can browse through different projects and choose those they feel have the most significant return potential. The platform then handles all of the paperwork, so investors don’t have to worry about managing the project themselves.
Don’t Forget About Real Estate Taxes
As a property owner or someone interested in investing in real estate, real estate taxes will impact you. Working with a financial professional can help provide clarity. Here are a few ways taxes will impact your investing.
Property taxes are paid annually by owners of real estate, such as homes and commercial holdings. The amount of tax due is based on the value of the property as determined by local assessors who review data such as market values, home improvements made over the years, and more. Because these assessments vary from year to year, homeowners should prepare to pay more or less than in previous years, depending on the current assessment. Even if you plan to flip a property quickly, you will be responsible for the taxes due between the time of purchase and the time of sale.
Capital Gains Tax
If you sell property, the income generated could be subject to capital gains tax. The capital gains tax is a federal income tax on any profits made from selling an asset such as real estate. This applies even if the property was inherited or gifted. Generally speaking, the amount of taxes owed depends on how long you owned the property and your total annual income. If you own a property for more than one year, it is subject to regulations associated with long-term capital gains taxes. On the other hand, if you own a rental property for less than one year, it will be subject to regulations associated with short-term capital gains taxes.
Are There Tax Exemptions with Capital Gains Tax?
There are certain exemptions to consider when it comes to real estate capital gains tax. One exemption applies to those who have lived in their home for two out of the last five years before its sale. This means that if you sell your home after living in it for two years or more, then up to $250,000 of your profits (if single) or up to $500,000 (if married and filing jointly) will not be subject to taxation. In addition, there are special exemptions available for people with disabilities or those who need to move due to changing job locations or health conditions.
The Bottom Line
Investing in real estate is no small endeavor, but it can help build wealth and add to your overall net worth. Learning about various strategies can help inform the approach you take to investing. However, as with any investment, don’t forget to consider the tax implications of owning or selling the asset.
If you’re a beginner investor, knowing the basics is the key to successfully navigating the world of real estate investments.
Tips to Being a Successful Real Estate Investor
- Work with your financial professionals (your financial advisor and your tax professional) to find the right strategy for you. They’ll also be able to work with you on the tax side of things and ensure you have the funds for the investments you plan to make.
- If you’re a beginner in real estate investing, become a member of Planning Made Simple. You’ll have access to a community of like-minded investors who can help to answer your questions, share best practices, and help to guide you in the right direction. You’ll also have access to resources like this one and content from experts in their field, from taxes to real estate, to help you take the investing process into your own hands.