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Real Estate Investment The Complete Guide
1. BASICS OF REAL ESTATE INVESTMENT- A COMPLETE GUIDE
When you invest in real estate, your goal is to put money to work today and make it grow so you have
more money in the future. You have to make enough profit, or "return", to cover the risk you take,
taxes you pay, and the costs of owning the real estate investment such as utilities and insurance.
In other words, once you understand the basics of the game Real Estate Investment really can be as
conceptually simple as playing monopoly. Your goal is to buy properties, avoid bankruptcy, and
generate rent so that you can buy even more properties. But "simple" doesn't mean "easy". If you
make a mistake, you could find yourself broke or worse.
The 4 Ways Real Estate Investors Make Money
When you invest in real estate, there are several ways you can make money:
Real Estate Appreciation: This is when the property becomes more valuable due to a change in
the real estate market, the land around your property becoming scarcer or busier such as a major
shopping center going in next door, or upgrades you put into your real estate investment to make it
more attractive to potential buyers or renters. Real estate appreciation is a tricky game and is
riskier than investing for cash flow income.
Cash Flow Income: This type of real estate investment focuses on buying a real estate property,
such as an apartment building, and operating it so you collect a stream of cash from rent, which is
the money a tenant pays you to use your property for a specific amount of time. Cash flow income
can be generated from well-run storage units, car washes, apartment buildings, office buildings,
rental houses, and more.
Real Estate Related Income: This is income generated by "specialists" in the real estate industry
such as real estate brokers, who make money through commissions from buying and selling
2. property, or real estate management companies who get to keep a percentage of rents in exchange
for running the day-to-day operations of a property. For example, a hotel management company
gets to keep 5% of a hotel's sales for taking care of the day-to-day operations such as hiring maids,
running the front desk, mowing the lawn, and washing the towels.
Ancillary Real Estate Investment Income: For some real estate investments, this can be a
huge source of profit. Ancillary real estate investment income includes things like vending machines
in office buildings or laundry facilities in low-rent apartments. In effect, they serve as mini-
businesses within a bigger real estate investment, letting you make money from a semi-captive
collection of customers.
If you’re looking into real estate investments, you likely want to earn
wealth on real estate based on risk you are taking, while minimizing the
amount of time you need to spend attending to the property. In order to
accomplish this, you need to make some smart choices upfront when
buying investment property. Your goal should be to strive to get as close
as possible on as many of these optimal scenarios as possible:
Pays a Fair Cash-on-Cash Return
When you buy property you are taking money out of your liquid financial assets
– stocks, bonds, CDs – and investing it into a very illiquid asset – real estate.
You were earning a rate of return on your financial assets, such as 4 percent or
6 percent, and you should strive to earn a fair cash-on-cash rate of return on
your real estate. To do this, you need to pro forma your deals and buy cash
flow-positive properties that earn you decent returns – not those prize
properties that are negative, negative, negative.
Isn’t Too Risky an Investment
All real estate is extremely high risk. Development of real estate, land, Tenant-
In-Common (TIC) investments, private real estate funds, fixer uppers, etc., all
have much higher risk profiles than just simply buying a nice established cash
flow investment property. In many of those investments, you will never see a
dime of your money again because there are just so many things that can go
wrong! So if you want to own real estate, consider simply taking fee simple title
in your own name – or an entity you wholly own – to the properties you
purchase. In addition, you must do the proper due diligence, analyze, test,
review reports, etc., to make a lower risk real estate decision.
3. Doesn’t Require a Lot of Time or Managing
Some properties just require way too much time and management to make
them smart investments. Examples include vacation rentals, low quality
properties in bad areas, college rentals, etc. Nice boring properties rented for as
long as possible to decent credit profile tenants seem to take the least time to
manage. In addition, treating your tenants fairly and with respect goes a long
way towards keeping good relations with them; and reducing your hassles when
there is an issue you need to address. And believe me — there will be issues!
It’s the nice, boring, wholly owned, in good shape, cash flow-positive properties
that are the best investments. They are out there for your picking, but it’s not
as simple as finding a property on the MLS and buying it.
You need to do some hard work, research, read up, and make smart, educated
decisions to acquire the best real estate investments!
Cashflow + Equity + Leverage
So where do the profits come from? One of the things I love about investing in properties are the
many factors, when carefully managed, that work in my favor.
PROFITS COME FROM POSITIVE CASH FLOWS.
Basically, I collect rents from some carefully chosen tenants. Then I pay expenses including PITI
(principle and interest on my mortgage, property taxes, insurance) and a whole pile of other variable
expenses such as maintenance, turnover, marketing and in some cases utilities and management.
What is left in my pocket are cash flows. While the largest profits in real estate aren’t typically derived
from cash flows, this is a key part of the trifecta. A healthy positive profit in coin buffers you from the
tantrums of a market and a larger economy. That and some cash in your pocket is a nice way to
supplement, and some day pay for, a pleasing lifestyle.
4. PROFITS COME FROM EQUITY.
Most people get this. It is like a stock. The value of your property increases. So what drives an
increase? Over the long term, inflation will create a steady pressure upon most, if not all, properties.
While there are exceptions, over a long enough time horizon, you can pretty much count on it. Most
properties though gain or loose true equity by local market forces driven by consumer demand. In
short, good incomes, availability of lending and more people wanting houses than the availability of
supply drives up prices. Think supply and demand. When I look at where to invest, Julie & I spend a
lot of time looking at market research to identify locations which have opportunity for growth and
stability for longevity. Every time I’m looking at a new neighborhood, I look for the key financial
indicators (core industries, growth of rental base, unique features). In addition to buying in the right
place, you can also force equity (see deal types) by doing remodels or repurposing a property.
PROFITS (CAN) COME FROM LEVERAGE.
You can buy properties all cash. In fact, nearly 40% of property in the United States are owned free
and clear with no debt. Used correctly, debt is your friend. This is called leverage. If you can acquire
and control a cash-flow positive property, for the minimum of capitol possible, you gain in three ways.
First of all, it leaves more money in your pocket to go acquire other assets. The more you can
effectively apply your capital, in a strategically diversified situation, the better a return you will see.
Second, as long as the property is legitimately cash positive and you didn’t do some absurd interest-
only or highly variable loan, each and every month a small part of your mortgage payment goes
towards your principal. Basically, my tenants are buying me a house, one month at a time.
5. Lastly, and perhaps most importantly, increases in equity get magnified. Lets say that your property
goes up 10% in value this year. Its a good year and I think a lot of markets will see this kind go
growth in 2013. If you own a 100k property out right, you get a 10% or 10k increase on your money.
Not bad at all. On the other hand, you leverage the property using a loan and put have 20k equity
(20% down). A 10% increase on the property is still 10k, but a 10k return on a 20k investment is a
50% return. That is a 5x magnification due to leverage. While this can work to your benefit, it can also
work against you as many people have found out over the last 5 years, so leverage carefully.
Deal Types
There are so many possible deal types in real estate investing. For the purpose of addressing 1st time
investors, there are a few very well paved paths.
BUY & HOLD
The classic. The strategy with buy and hold is fairly simple. Find a solid property that you feel
confident will rent well over the long haul and cashflow with the right loan. Rent it and collect a small
check. Take good care of it, pick great tenants and let them pay down your principal while rents
increase over time with demand. Watch your checks get bigger over time. The day your loan is paid
off, your monthly check increases and provides a nice piece of your retirement. This is my plan. Julie
and I have slowly and carefully acquired homes. We started by buying one for ourselves, building a
new downpayment and then turning it into a rental. Eventually we got tired of moving, and switched
to carefully choosing awesome rentals. My math says somewhere between 10-12 paid off three
bedroom units in the santa cruz area is enough to offer our financial freedom.
6. FORCING EQUITY
There are number of creative ways to increase the value of a property.
Many great investors have found an underperforming property and based upon experience and some
effort, increase the cash flow. That could come from better marketing, property management and
more. After all, if you increase the monthly net operating income, you increase the value of the
property to other investors.
In other cases the property is repositioned, such as changing an apartment building into a homeless
shelter. Many times a dud in one situation, could be a major winner for another niche.
The most common, and the only place I have personal experience so far, is in the remodel. Julie and I
have picked up a few houses with great bones, and some seriously worn down cosmetics. 30-40k
later, they shine, and the property value has increased by quite a bit more.
FLIP
Buy a junker, fix it up nice, sell it to someone who appreciates your hard work. Pocket the money and
do it again.