Learning about debt and residential real estate financing options is one of the keys to building wealth in an accelerated manner.
Robert Kiyosaki famously states that learning about debt, financing, and taxes are how the rich become wealthy and is the biggest difference between them and the middle class. It helps turn around you working for money to money working for you.
With all of that said, let’s get into whether or not real estate is a good investment and different options for financing your first rental.
Is Real Estate Investing a Good Idea?
There are several benefits that investors may see from entering the real estate market. Investing in real estate can have many benefits, but these benefits are not always present and can depend on market conditions. Nevertheless, the benefits may be attractive enough to start investing in real estate. Here are some of the reasons real estate investing might be a good idea:
Rental real estate is a popular strategy to keep up with inflation because it provides a hedge against inflation.
Diversifying your investments by including real estate may provide stability to your portfolio. Diversifying your investment portfolio by investing in a home in addition to stocks may reduce the overall volatility of your portfolio because home prices increase and decrease more slowly than stock prices.
The prices of real estate and stocks may sometimes be inversely related.
Although it may seem daunting at first, real estate investing could be a good idea because it is easy to get into.
4 Types of Real Estate Investing Strategies
There are many different types of real estate investments to choose from. There are pros and cons to every type of real estate investment, like how much time and money you need to put in. So that we can begin to see which real estate route would best fit you, let’s explore some of your options.
Flipping houses is the art of buying a property for a below-market price and selling it for a higher price. The practice has become increasingly popular in recent years as a way to make a quick profit, but it is not without its risks. In most cases, real estate investors purchase a property that is in poor condition and then renovate it before selling it to someone else. A distressed property is a property that requires repairs in order to return it to its original value. The repairs necessary may vary from something as small as putting in new carpets to something as big as replacing an entire roof.
You could make money flipping homes by understanding the future value of a property after you have repaired it. The value of a property after renovations and upgrades are completed is known as the after-repair value or ARV.
Your profit is calculated by subtracting your selling costs, purchase price, repair costs, and carrying costs from the new sales price. Carrying costs include utilities and insurance. Before you commit to an investment, do some math to figure out if it is a wise decision.
Buy, Rehab, Rent, Refinance, Repeat (BRRRR)
The BRRRR method of real estate investing is all about rental properties. Investors look for properties that are in bad condition and underpriced so that they can fix them up and sell them for a higher price. Properties that are being sold for less than the market value might be available at a discount. The home you’re looking at is selling for $120,000, which is less than neighboring homes because the owner is going through a divorce and needs to sell quickly.
After the property is finished being renovated, the investor lists it for rent. An investor could refinance a property after a tenant has occupied it, using the after-repair market value as a basis. A refinancing loan may allow the investor to start the BRRRR process again with another property.
Money is made with the BRRRR method in three ways:
- The price of a property often increases once it’s repaired and rehabilitated. The increase in price, also known as capital appreciation, is money you could potentially make for fixing up a property.
- You might earn money from the rent collected, even after accounting for your expenses. Some of the expenses you might have include insurance, property taxes, property manager, and others.
- The property price might increase over time, but this depends on the economy and local market conditions. Home values typically go up over time in line with increasing consumer prices, but changes in the economy, such as a recession, may affect home prices. Additionally, local conditions, such as a factory shutting down or a new major employer opening up in your town, might affect your home’s value.
Wholesale real estate involves buying property from someone who wants to sell and then selling it to someone who wants to buy, with the intention of making a profit.
Wholesalers are not required to have a license, as opposed to real estate agents. The reason for this is that wholesalers technically own the pieces they are selling.
Real estate wholesaling often falls into one of the following categories:
- Land wholesaling: The wholesale process for undeveloped land that often has no structures built on it. It could be cheap for the investor to purchase and maintain land since their property taxes might be minimal when there are no structures.
- Residential wholesaling: This wholesale process focuses on single-family homes, condos, townhomes, or multi-family homes (up to four units). The targeted homes might be distressed or undervalued compared to other homes in the area. The wholesaler may sign a purchase contract with the seller, then locate a buyer who would buy the contract for a fee. This buyer would insert themselves into the contract with the wholesaler, meaning that residential wholesalers might not take possession of the properties. Instead, they may back out of the deal before losing their deposit if they are unable to locate a buyer.
- Commercial wholesaling: This type of wholesale involves commercial buildings, strip malls, apartment buildings (of five units or more), office buildings, and similar properties. Wholesaling a commercial property generally follows the same path as residential wholesaling, but instead of finding an undervalued house, you’re looking for buildings that have low occupancy or below-market rents. The real estate developer or company that buys from you may see these properties as an opportunity to create value.
REITs and Other Investment Opportunities
A real estate investment trust is a company that owns real estate or finances real estate developments, which typically produce passive income.
There are many REITs that focus on a specific type of property, such as healthcare facilities, commercial buildings, or apartments. The main advantage of investing in a REIT is that individuals can start with a small amount of money and then gradually invest more as their finances allow.
Publicly-traded REITs, REIT mutual funds, and real estate crowdfunding platforms are all options that investors could choose from. Several crowdfunding platforms have launched in recent years, including:
There are different investment opportunities available for different types of investors.
Some investing platforms allow you to withdraw your money more easily, while others will be less liquid. Comparing Fundrise to REITs makes it clear how this crowdfunding platform differs from traditional REITs.
Real Estate Financing Options
Conventional Bank Loan
The most common form of financing for real estate. The financial institution will lend you money based on your income, credit history, down payment, and your overall ability to handle and pay off the loan on time. Your interest rate is determined by various factors, including credit score and the percentage of the total loan you’re willing to pay upfront. The more money you are able to put down, the more trustworthy the institution’s perception of you is.
Hard-money loans are best for flippers, not buy-and-hold investors. Hard-money loans are secured by the property itself, making it the hard asset. The lender in this situation provides funding only until the property is sold for a profit, or if the investor can manage to get traditional funding later on.
The big draw here is speed. A hard money loan is a quick way to get money. The lender is most concerned with your property as collateral rather than your credit score or other financial details.
You’ll get hammered by high interest rates. The lender would own the property and benefit from its resale if the borrower defaults.
Home Equity Loan
A home equity loan lets you borrow against your home’s equity. Lenders use your home equity to determine how much of a HELOC you can borrow. Home equity is the difference between your home’s current market value and the remaining balance on your mortgage. You can use your equity as collateral for the lender if you have a mortgage balance remaining on the property. For example, if you have a $100,000 mortgage balance remaining on a property worth $250,000, your equity would be $150,000.
You can usually borrow between 80 and 90% of the combined loan-to-value ratio, depending on the appraised value of your home. Your credit score and financial report card determine your borrowing limits and interest rates, just like with a traditional loan.
If you’re a borrower who is responsible with their loans, a home equity loan could be a great option for you. A second mortgage will have a higher interest rate than a first mortgage, but it will be lower than the rates on credit cards or unconventional loans. If you know how much money you need and what you want to spend it on, a home equity loan could be a good option for you.
While home equity loans are relatively easy to be approved for, this can create a situation where the borrower finds it hard to escape debt. Its common for borrowers to fall into a habit of constantly taking out new loans to pay off existing debts, which only leads to them accumulating more debts that they will eventually have trouble repaying.
If a company borrows money in a way that is not fully secured, this can lead to them having to make interest payments that are not tax-deductible.
Portfolio loans aren’t too different from conventional bank loans. The primary difference between a portfolio lender and other lenders is that the former does not sell its loans on the secondary market. This allows lenders to set their own terms rather than sticking to strict guidelines set by secondary buyers.
In the absence of newrules from the secondary market, lenders are free to offer more favorable terms to borrowers, making it easier for them to get financing, especially investors and the self-employed.
Typically, lenders who offer portfolio loans don’t advertise it. This type of financing can be difficult to obtain without a strong network or positive relationship with lenders. To increase your chances of obtaining this type of financing, reach out to your network or contact lenders directly. Besides the interest rate, you may have to pay a fee upfront, which compensates the lender for taking on extra risk.
The gist of it is that you can put your IRA into all sorts of investments, including real estate, that you couldn’t otherwise invest in with a traditional IRA. SDIRA investing is complex, but it allows you to invest in things like real estate that you couldn’t with a traditional IRA. This is a “self-directed” individual retirement account. The traditional IRA structure does not allow for investment in real estate, but this is allowed with a Roth IRA.
The person who owns an SDIRA account is responsible for making sure that the account is managed properly, even though someone else is responsible for administrating the account. There are two types of SDIRAs, a traditional IRA with tax-deductible contributions and a Roth IRA with tax-free contributions.
Home Equity Line of Credit (HELOC)
A HELOC is a loan that is secured by your home. This credit is often issued as a credit card or checkbook. This allows the user to make purchases without using cash. The amount of money you can borrow in a home equity loan is based on your home equity, or the difference between the estimated value of your house and the amount you still owe on it. If you have good credit, you may be able to borrow up to 85% of your home equity.
A HELOC is usually easier to get than refinancing. The “draw period” is the time when you can use the line of credit, and the “repayment period” is the time when you have to pay back what you’ve borrowed. The former only demands smaller interest-only payments. You will have to pay more money back over a longer period of time.
Even though interest rates on HELOCs are lower than credit cards and other loans, they are still higher than with a regular mortgage. The interest rates for these loans are often variable, which means you won’t be able to lock in a favorable interest rate. The risks of not being able to pay include losing your home.
Crowdfunding is the latest method of raising money for investing. It is more casual than other methods. Although you’re more likely to contribute to a crowdfunding campaign than to host one, the latter entails allowing investors to finance the investment project through small, incremental payments. You are investing in shares of a real estate company and receiving dividends from that investment.
After a project is completely funded, shareholders start to earn dividends. It is most advantageous for people who want to invest in real estate but do not have the money or expertise to take complete ownership.
Cash Value Life Insurance
Our own personal favorite way to finance real estate down payments is through cash value life insurance. Having your own policy like this allows you to pay the loan back when you want to, have a fairly low interest rate, plus keep your cash value compounding money over time.
Kurt has gone from the financial lows of the ’08 financial crisis to personal financial success. He is a professional real estate investor owning properties in multiple states.
One of his passions is financial education and the pursuit of financial freedom.
You can learn more about Kurt here.