Real estate investing is still unfamiliar territory for many. Unlike traditional assets such as stocks and bonds, real estate is considered an “alternative asset” that is more expensive and harder to access. Nonetheless, that doesn’t make it an investment opportunity that should be avoided. Real estate has been around for ages and it’s still a lucrative investment to this day! When approached correctly, it can provide generous returns (both over the short and long term) in addition to unique advantages like portfolio diversification, appreciation potential, and tax benefits. The trouble is, many first-time investors don’t know how to invest in real estate which makes it seem intimidating. But that doesn’t have to be the case. In this article, we’ll cover investing basics that every aspiring investor needs to know before getting started in real estate.
1) Educate Yourself on Real Estate Investing
Though many plan to start making money in real estate, property investments are not for everyone. Real estate is illiquid and expensive to buy and sell, which is why investing money in this industry is a big and long term commitment. To find out if this commitment is worth making, you need to understand it before diving in. As with any type of investment, you should never invest in something that you don’t understand in the first place. So, step #1 to become a real estate investor is to learn what real estate investing is all about to decide if it’s really right for you and worth the efforts it requires.
How much money do you need to start investing in real estate? What are the ways to invest in real estate? What are the risks of real estate investing? Is this type of investment reliable enough to be part of your retirement plan? You can do your research and find the answers online or, better yet, find a mentor. The best way to educate yourself is by learning from those who are already winning in the real estate investing game. Start by reading books by other investors who have failed and succeeded, attending real estate seminars, or by shadowing a mentor who’s willing to show you the ropes.
Learning what to do (and what not to do) before investing money can save you thousands. In our guide for how to invest in real estate, we’ve already laid down the most important investing basics. So by the time you’re done reading this, you’ll have completed this first step! Any questions you may have that were not covered here, you’ll surely find the answers on our real estate investment blog.
2) Get Your Financing in Order
The first question that pops up when learning how to invest in real estate is: How can I afford it? Besides time commitment, getting into real estate also requires cash. Because not everyone has bags of money ready to be invested, financing is the main obstacle that many first-time investors deal with. So, if you’re seriously considering buying real estate investments, one of the first steps to cover is getting your finances in order.
First, start saving for the down payment as early as possible. Unlike the 3% down payment on your primary residence, a down payment for an investment property is typically 20% of its purchase price and you need to have it in hand. This might seem out of reach but is definitely doable (depending on your strategy and the property price). To bump up your savings, you may want to contact a financial planner to help you create a budget.
Experts also advise first-time real estate investors to establish an emergency fund, pay off their debts, and automate their retirement savings. In addition, you should make sure to have a reserve to dip into if and when something needs fixing. When you have your finances in order, you show your lender that you have the financial discipline and are eligible to become a real estate investor.
FAQ: How Much Money Do I Need to Invest in Real Estate?
Perhaps nothing kills beginners’ ambitions more than the belief that they don’t have enough money to get started in real estate investing. However, just like many other real estate questions, how much money you need to start investing depends on you. Most importantly is your investment strategy. Buying a rental property naturally requires more money than buying in a REIT. Plus, there are ways to invest in real estate with no money.
Also, are you paying for the property fully in cash or with a loan? If you don’t already know, using leverage allows you to invest less money and make better returns! First-time real estate investors also tend to forget that property prices are not set in stone. Unless you’re in a very hot housing market, you have negotiating powers and can make a lower offer. A smart move to find out how much money you need to get started is to speak with a financial adviser.
3) Pick Your Real Estate Investment Strategy
As mentioned, your investment strategy is one factor that determines how much money you need to start real estate investing. In this industry, there are a variety of options to choose from, which might leave you feeling overwhelmed. So the next step of how to invest in real estate is to learn as much as you can about the different investment strategies and pick one to focus on. Some think that pursuing multiple ways at once allows them to make more money in real estate – this is not necessarily true. Experts recommend starting out with one strategy and then considering others as you grow your real estate investment portfolio.
So what are the top real estate investment strategies for beginners? Typically, there are 2 main ways to invest in real estate, with a number of strategies falling under each category:
Active Real Estate Investing:
Investing in real estate actively means you’re actually buying a property that you’ll be responsible for managing and making sure it’s generating profits. These investment strategies require more money and they include:
#1. House Flipping
Flipping houses like you’re on HGTV is as active as you can get for real estate investments. You buy the property for cheap, put funds into fixing it up, and sell it for profits. If done correctly, this can be a quick way to make money in real estate. However, the fix and flip real estate strategy is a bit harder than it looks on TV. It requires deep financial and real estate knowledge and it comes with high investing risks. When flipping, time is your biggest asset – the investment property needs to be sold as fast as possible. House flipping is a short-term investment strategy because the longer you hold a property that’s not generating income, the less money you make. It’s also crucial to find deal-breakers, set a budget, and have a team of inspectors, contractors, and appraisers that’ll help you avoid losing time and money.
#2. Rental Properties
This is one of the most obvious ways of how to invest in real estate for the long-term. Any type of property (residential, commercial, or industrial) can be a rental. As a landlord, you can have a steady, reliable source of rental income and monthly cash flow. But, owning traditional rental property also requires a lot of work to ensure that it’s running smoothly. You’ll be responsible for finding tenants, performing background screenings, rent collection, property maintenance, repairs, evictions, record-keeping, and more. Depending on the size and number of rental properties you own, this can be a full-time job. Of course, you can hire property management to handle all these tasks for a fixed fee. This takes some weight off your shoulders and turns the rental property into a passive real estate investment! But it would also mean you’ll lose a portion of your monthly income.
You can find and analyze the best rental properties in your city or neighborhood of choice on Mashvisor.
#3. Vacation Rental Properties
As opposed to long term rental properties, vacation rentals allow investors to rent out their properties on a nightly basis. Short-term rentals let you rent out either the entire property or just a portion and you’ll be responsible for handling tasks like furnishing and maintaining the home for guests. Depending on the demand for vacation rentals in your location of choice for real estate investing, this investment strategy can be very lucrative. However, because the best places to buy vacation homes are highly desirable, these properties can be expensive.
Before renting out a vacation home, make sure to check local short-term rental laws in your area. HOAs can ban these properties and in some cities, like New York and Los Angeles, there are restrictions against types of short-term rentals. Weigh the pros and cons of vacation rentals to see if they’re the right way for you to get into real estate investing.
#4. House Hacking
Want to know how to invest in real estate with no money? Here’s one of the best ways: house hacking. It essentially means you can make rental income from your personal residence. As a real estate investor, you can buy a multi-unit residential property and become eligible for conventional financing with as little as a 3% down payment. Then, you live in one unit and rent out the others – it’s really that simple! So, you put less money down, get better interest rates, and have tenants paying your mortgage, insurance, and taxes. Another reason why this is a great investment strategy for beginners is that it helps you learn the ropes of becoming a landlord and cut down living expenses. Smart investors put any leftover money into savings to use for taking care of inevitable maintenance costs and to roll into their next real estate investment.
#5. Commercial Real Estate
An intriguing option for those interested in real estate investing beyond residential property is commercial real estate. These are properties or spaces that are rented out to businesses. Commercial real estate is classified as office space, retail space, land, and large multi-family homes. Some are interested in this way of real estate investing because there’s an opportunity to rent out to big businesses and get significant cash flow. However, commercial real estate costs much more than residential real estate and vacancies can last longer as well. Meaning, they are high-risk, high-reward real estate investments that you should only consider when you’re ready to grow your portfolio, not as a first-time investor.
Passive Real Estate Investing:
If buying property is too expensive for you, then we’ve got good news: That’s not the only way you can add real estate to your investment portfolio. Here’s how to invest in real estate without actually having to buy any property:
#1. Invest in REITs
A REIT, or real estate investment trust, is a company that either owns or finances income-producing real estate assets. Through these, you can invest in residential or commercial real estate and earn income from their shares, which are bought and sold like stocks and pay dividends. Some REITs invest in properties (like apartments, office buildings, warehouses or personal storage), some invest in mortgages, and some invest in a hybrid of mortgages and property. New investors should generally stick to publicly-traded REITs, which you can buy through brokerage firms. These are a good investment strategy to make money passively if you don’t have the funds to buy a property or want to diversify your real estate investments without adding more properties.
#2. Real Estate Crowdfunding
When you participate in crowdfunding, you’re a part of a group of investors who pool together their assets. Real estate crowdfunding sites are platforms that connect investors to developers who are looking to fund private projects (they could be both residential and commercial). So, this is a way to invest money in real estate without having to buy or own an investment property- your workload and responsibilities will be minimized. The great thing about this option is that it gives you a way to get into real estate despite your level of experience in the industry! As an investor, you simply choose which real estate opportunities to pursue and then enjoy their return on investment.
#3. Opportunity Funds
An Opportunity Fund is an investment model where investors pool their money together to invest in a Qualified Opportunity Zone. Opportunity Zones are census tracts of low-income communities that have been nominated by state governors and certified by the US Department of Treasury. Opportunity Zones and Opportunity Funds were created to encourage investments in the development of these communities across the US. As an investor in an Opportunity Fund, you can get substantial capital gains tax incentives – you get to defer taxes on those capital gains until December 31, 2026. Keep in mind that Opportunity Funds are illiquid, long-term investments. As such, you should consider this way of how to invest in real estate if you can afford to tie up your money in investments for long periods of time.
#4. Mutual Funds
These are also investment vehicles structured as a company, which pool money from clients and invest on behalf of them. So, rather than owning real estate properties directly, investors own shares of a mutual fund that owns the investments. Real estate investors can earn returns in the form of dividends during ownership and appreciation upon the sale of mutual fund shares. Unlike other funds, mutual funds typically invest in publicly traded assets, which offer high liquidity. However, because of this, the net asset value of shares can be highly correlated to the stock market. As a result, mutual funds are a volatile real estate investment option. Nevertheless, it’s still an option to get started in passive real estate investing.
The final way of how to invest in real estate with little money or passively is through a partnership. Experts always say that real estate investing doesn’t have to be a one-man show. Partnerships are a common way to get into real estate, with each person taking over different responsibilities. Say you’ve found a good real estate property for sale but you’re tight on cash. Your partner can pay the down payment while you take on the responsibilities of managing the investment. Or it can be the other way around – you invest your money while your partner does the work and, this way, you’ll turn it into a passive investment. So if you’re looking to invest in real estate, don’t hesitate to suggest a partnership with another investor who makes up for what you lack.
4) Consider Your Financing Options
As many first-time property investors, you’re most likely considering taking out a loan to finance your first investment property. There are many types of loans available to real estate investors. Choosing the wrong type can impact your success, which is why it’s crucial that you understand and compare how the different alternatives work before approaching a lender. Some of the most common types of loans for real estate investors to consider include conventional mortgage loans, hard money and private money loans, fix-and-flip loans, home equity or line of credit loans, interest-only loans, and more. When comparing investment property loans, you need to look closely at the following factors:
- Rates: Rates have a big influence on your repayment size.
- Investor benefits: Ensure your loan has features that can maximize tax benefits or cash flow.
- Eligibility: The loan has to fit your investment strategy – not every loan is available for buying commercial property, for example.
- Fees: Ensure the fees you’ll be paying for will save you money or reduce your loan costs over the life of your loan.
5) Understand the Tax Implications of Real Estate Investing
The tax consequences for real estate investments are very individualized and can be complicated. Several factors impact the exact timing and amount for each investor including investment type, vehicle, amount of ROI, the lifetime of the investment, and the investor’s total income, among others. That’s why you should talk to a tax professional when learning how to invest in real estate. They’ll help you understand all you need to know about real estate taxes and keep you up-to-date on tax code changes. In general, these are the most common tax implications you’ll encounter when it comes to investing in real estate:
#1. Long-Term Capital Gains Tax
If you own investment property and sell it after more than a year, you’ll pay capital gains tax on the profit. Say you buy a property for $100,000 and sell it years later for $160,000 – that’s a gross profit of $60,000. How is that profit taxed? It depends on your tax bracket for your ordinary income. If you’re in the
- 10% or 12% tax bracket, you’ll pay 0% capital gains tax.
- 22%, 24%, 32% or 35% tax bracket, you’ll pay 15% capital gains tax.
- 35% or 37% tax bracket, you’ll pay 20% capital gains tax.
Say you’re in the 22% tax bracket, so you’ll pay 15% capital gains. In this example, 15% of $60,000 means you’d pay $9,000 in taxes.
#2. Short-Term Capital Gains Tax
Returns earned on real estate investments bought and sold within less than one year (like house flips) are considered short-term capital gains. What’s the difference between long-term and short-term capital gains tax? Long-term capital gains use your tax bracket to determine the percentage of taxes you owe on those gains. Short-term capital gains tax, however, counts your profits as part of your annual income. For example, say your annual income is $50,000 and you made a $20,000 profit on a house flip. In this case, your taxable income is $70,000.
#3. Taxation on Rental Income
If you’re investing in rental properties, the money you make from rental income must be declared as income on your tax return. But you can also claim deductible expenses, like maintenance and repairs – be mindful that improvements won’t count. Say you’ve made $10,000 this year from rental income, but you also paid $1,500 for repairs on the investment property. You can deduct this $1,500, making your taxable rental income $8,500 which is also taxed as ordinary income. Paying the tax bill on investments can be confusing. Make sure to regularly meet with your tax professional to go over your financial information.
Top Tips for First-Time Investors
#1. Invest in the Best Locations
When learning how to invest in real estate, one of the first things you’ll pick up is that location is key to success in this industry. While some will tell you to invest locally when getting into real estate, you should always explore other housing markets too. You want to invest in a place where you can find profitable properties for sale that promise a good ROI. Do not pick convenience over profitability! When talking about location, we don’t mean just your city, but also the neighborhood of choice. You need to run a real estate market analysis, neighborhood analysis, and study trends concerning property prices, population, employment, etc. In short: Do your research to find a profitable location for real estate investing!
#2. Hire a Real Estate Agent
This may seem like a no brainer, but many beginners think they’re able to get started in real estate alone. However, as mentioned, real estate investing doesn’t have to (and shouldn’t) be a one-man show! One of the first people you need to work with is a dedicated real estate agent. Agents give you access to a lot of properties and help you navigate the waters of buying. Not to mention, a buyer’s agent costs you nothing as it’s the seller who typically pays this agent’s commission. Make sure you interview several agents and settle on one who is well connected, knowledgeable, and has experience in investing.
#3. Build a Real Estate Network
Successful real estate investing is as much about what you know as who you know. So if you want to learn how to invest in real estate, you need to focus on networking and building relationships with others in the business. Ask your family and friends and you might find out that they know an investor to connect you with. You can also attend local Real Estate Investor Associations (REIAs) where you’ll find plenty of investors and other professionals like agents, property managers, contractors, attorneys, and accountants. Surrounding yourself with these individuals is a great way to learn more about the real estate market, smoothly run your investments, and guide you to the path of success.
#4. Learn the Basic Real Estate Numbers
Real estate investing is a numbers game. In order to find good real estate deals, you need to learn how to analyze them by running the numbers. If you overlook even one item, it’ll affect everything else with the deal. Some important numbers you need to learn how to calculate include the cap rate, cash on cash return, price to rent ratio, occupancy rate, and after repair value, among others. Trust that these numbers will guide you to real estate investments that are worth your time and money. When analyzing properties, don’t let your emotions get involved – this is the easiest way to fail in real estate.
#5. Use Real Estate Investment Tools
Today’s first-time investors should take advantage of the tools available to them that help in making smart decisions and give them the ability to compete with existing investors. Some of the best tools can be found here on Mashvisor. You have the Property Finder that turns 3 months of rental property research into 15 minutes. There’s also the Investment Property Calculator which analyzes the profitability of properties for sale using predictive analytics. We also provide a Real Estate Heatmap that analyzes real estate markets and neighborhoods to help you find the best locations. And if you’re looking for off-market properties like foreclosures and short sales, you can find them in the Property Marketplace.
To learn more about our tools and how we’ll help you make faster and smarter real estate investment decisions, click here.
FAQ: When Should I Start Investing in Real Estate?
Once you’ve learned how to invest in real estate, if you believe it’s the right investment choice for you, you might be wondering when exactly should you start investing. The short answer is: The right time is when you’re financially ready and can afford this commitment. However, always remember that the real estate market goes through cycles and keeps changing. This is why we keep saying you should do your research. Find out if market trends and predictions are in your favor as a real estate investor. Study the niche you’re interested in and learn what exactly it requires from you to get started. Once you’re confident you’ve got what it takes and that the time is right, take the plunge and start your free trial with Mashvisor to find your first investment property!