Real Estate Can Be for Everyone: Real Estate Basics
Adapted From It All Adds Up: Designing Your Game Plan for Financial Success by Devon Kennard
Does my journey spark an interest in your own real estate investing path? If so, here are some tips to help you get started:
1. Choose and evaluate the market you are interested in: You want to look for areas that are growing or that have the potential to grow. And you want to know what the median income is in the area. What rent would you like to charge in that area? Can the residents afford that? What is the appreciation rate in that area?
2. Find the right vendors: such as property managers, contractors, and real estate brokers. Again this is all about making connections.
3. Evaluating/underwriting: You will need to learn what a good deal is and what is not. What can you afford and what do you have to say no to? It’s important to learn how to underwrite your deals. A few metrics I like to consider when underwriting a deal are the 1 percent rule, cap rate, cash-on-cash return, and appreciation potential. Once I have those four metrics, I can usually make a decision pretty quickly about whether I want to move forward with an offer or pass on that investment.
UNDERWRITING STEPS:
1 percent rule: When initially looking at potential investment properties, using the 1 percent rule is a quick way to see if a deal is worth considering. All you have to do is take the price of the property and multiply it by 1 percent. That gives you the amount of rent you should ideally be shooting for in order to make a profit.
Cap rate: This is a great way to evaluate how much income the property actually generates. This calculation is net operating income/purchase price of the property.
Cash-on-cash return: This is my favorite metric because this has a direct impact on my mailbox money. The formula is this: net income after financing (NIAF)/capital invested. NIAF means you take the NOI and subtract the mortgage payments. What is left is the net income after financing. You take that number and divide it by how much money you originally invested in the deal. For me, any deal that I can get an 8 percent COC return or higher on is one I will definitely buy!
Appreciation potential: This is the one evaluation I consider that is actually based on speculation. When I am evaluating a potential area in which to invest, I like to look at the appreciation rate over the last five years in that area and get a sense of how much and how fast properties in the area are appreciating. I typically like to find areas where properties are appreciating at 3 percent or higher annually. What’s important here is passive appreciation, meaning you buy the property and do nothing to it, but it increases in value every year by 3 percent or greater. You can also get appreciation for a property by getting a deal on a property that is below market value. The last way to get appreciation is by forcing it. This is called forced appreciation because you are doing something to the property to increase its value.
4. Consider buying turnkey properties: These take little to no repair work once you buy them. If you are just starting out, know little about real estate, or you’re too busy to put a lot of time into it, a property that’s ready to go is easier than a fixer-upper. The downside is your return might not be as high, at least initially, but depending on your goals and lifestyle, that is okay—at least it is for me.
5. Consider flipping homes: If you’re someone who has a little more risk tolerance and is willing to put in manual labor, flipping a home is a great way to generate a good return in a short amount of time.
6. Consider investing out of state: Many people are afraid to invest where they don’t live, but it’s a great way to get into the game.
7. Consider buying multifamily properties: Consider this: you purchase a multifamily home with four units and rent each out for $1,000 a month. Let’s say that one month, someone defaults on their payment, but you still have $3,000 coming in from the other tenants. Now, if you buy a single home and rent it out for $2,000 a month and that renter defaults, you’re out the entire amount. There are some perks to multifamily. In addition, multifamily investments allow you to scale faster.
8. Consider owning triple net lease commercial buildings: Triple net (or NNN) means that the tenant is covering all the property expenses: usually property taxes, insurance, and maintenance. As the owner, you do not have to worry about any of the expenses involving the property. If you purchase an NNN lease property, all you need to deduct from your income is the loan payment. NNN lease investments are truly passive and justify why I will eventually invest in this kind of commercial property as well. The key with NNN lease properties is finding tenants with very strong finances. If you can manage to buy a building with a tenant that is a national brand like McDonald’s, Starbucks, Amazon, or Panera, then you are in great shape. One thing to note is the more established the tenant, typically the lower the return you can expect, which is why some people buy NNN leases with tenants that are not as established as major national companies because although it’s riskier their return is higher.
Buying real estate will help you flip the bag! There are so many ways to invest in real estate, so find which strategy matches your risk tolerance and personality and go for it!