When it comes to building wealth, real estate is the best investment around. Billionaire Andrew Carnegie famously said that 90% of millionaires got rich in real estate, and it’s still true. The question is, how do you get your foot in the door? It used to be that getting into real estate meant buying a home and living in it while you paid it off. While that’s a reliable way to build wealth, it can take a decade or two. In this era of the retired 40-year-old, people want a shorter investment timeline than “your entire adult life,” and as the industry’s grown, various entrepreneurs have pioneered some near-bulletproof real estate investment strategies. Let’s take a look at some of the most effective, and figure out which is the best option for you. House flipping is everywhere; there are nearly a dozen different flipping-related reality TV series on air right now.
Fixing and Flipping
It’s popular for a very good reason: it’s lucrative. While the average profit on a house flip is at an eight year low, according to Attom Data Solutions, it still comes out to $62,700 per transaction. Flip half a dozen houses a year, and you’re going to be making a very good living.
Of course, the hard part is turning a profit on all your flips. Part of the reason why house flipping is so alluring is that it’s a risky, go-it-alone proposition; you’re buying a home, fixing it up, and then trying to sell it for more than you paid. If you can’t manage that, you may end up losing money or, even worse, find yourself stuck with a house you never wanted to own long-term. It’s a gamble.
But if you follow a few simple principles, you’ll seriously raise your odds of success.
Buy your flip as Low as Possible
This one’s a no-brainer, but it deserves special emphasis. It’s going to be tough to turn a profit on your house flip if you overpay on the front end. And the less you pay for the home, the more breathing room you’ll have if your renovation goes over budget (and it will often go over budget, especially when you’re getting started), or if the market flattens before you put your property back on the market. Negotiate down as far as possible, and then try to go a little bit lower.
One important note: before you hit the negotiating table, make sure your credit and cash reserves are in order. Aim for a FICO score of at least 700, and a 20% down payment, though even then financing can be tricky. Remember how we said house flipping was ubiquitous now? If you find a fixer-upper with great value, odds are that you’ll have a lot of competition for it.
Identify Homes with Value
One of the hardest parts of being a house flipper is looking through a property’s present condition, and seeing its potential. Target homes with good access to things like quality schools, public transit, shopping and nightlife, and major roads and highways. After all, these are the kind of amenities your future buyer will be looking for.
A good general rule is to look for the lowest-valued home in a high-quality neighborhood. Even if the home is smaller than its neighbors, people will often buy a modest home just to get into a coveted neighborhood.
Get an Accurate Estimate to ensure profitable flipping
Once you’ve settled on a home to fix and flip, put together a precise estimate of how much it’ll cost to get the home into sellable condition. Stick to the kind of renovations that are sure to increase a home’s value, like a repaved driveway, updated bathrooms, or a fresh coat of paint.
Every dollar you spend on renovations is taken out of your future profits, so make sure you’re targeting homes that only need light work, such as aesthetic updates. Homes with serious structural issues, like a cracked foundation, a leaky roof, or a termite infestation, aren’t good bets for a profitable flip.
Do the Work
You’ll need to find reliable, honest contractors to do the work well, on time, and under budget. This is going to be one of your most important relationships as a house flipper, so make sure you do your due diligence. Your contractor should be familiar with the local permitting and zoning regulations, too; it doesn’t matter how good the work is if it doesn’t pass inspection.
This isn’t a “hands off” phase of the house flip, where you can check in once a week while the contractor does all the renovations. You’ll want to touch base daily to make sure the work is being done right, and that the budget is being respected.
Market and Sell
When your home is ready to hit the market, you’ll want to get the word out. If you’re in a hot neighborhood, you may have a buyer lined up before renovations are even complete; everyone else should consider partnering with an experienced local agent. A great agent can get your home on the MLS, help attract potential buyers, arrange open houses and showings, and help negotiate the best possible sale price.
Once you’ve made it through closing, paid all your contractors, taken care of your short-term capital gains taxes (which could be up to 35% if you sell within a year), and calculated your profit, it’s time to do it all over again. Flipping houses is, above all, a hustle.
Investing in Rentals
Rental property has one huge advantage over other forms of real estate investment: passive income. When you own rentals, you have rent checks coming in each and every month; even Apple stock doesn’t pay dividends that often.
Finding the Perfect Rental Property
Selecting rental properties is much like picking out a house to flip. You’ll want to look for desirable neighborhoods with low crime, access to transportation, and plentiful amenities.
Additionally, you’ll want to look at the vacancy rate and the average rents. If the area has a high vacancy rate, you’ll have to lower your rent to attract tenants, which will affect your bottom line. And if the average rent won’t cover your expenses, the whole arrangement is flawed.
There are two traditional rules for evaluating rental properties. One is the “12 times Rule.” It states that for a rental property you should pay no more than 12 times the annual rent you expect to collect. So if you expect to charge $2,000 a month for a prospective rental, that comes to an annual rent of $24,000; 12 times $24,000 comes to $288,000. Any higher than that, and you’re courting insolvency.
The other general rule is the “1% Rule.” This rule states that your projected rent from a property should be about 1% of the purchase price. So if a property is priced at $300,000, it would have to fetch a monthly rent of $3,000 to make financial sense.
Money In, Money Out
So what are your expenses? Including the obvious expense of the mortgage payment, you’ll have various other financial responsibilities, and they can add up; typically, your expenses come to 35 80% of your gross income.
Property taxes are going to be one of the largest single expenses for any rental. You can easily research your property’s assessed value, and what the property tax rate in your area is; come up with an annual figure, divide it by 12, and add it to the monthly budget.
Next, you’ll need insurance. Landlords don’t need full homeowner’s insurance, but you will want hazard insurance, which will cover the physical property against damage. You might also want to look into liability insurance, which will cover you in the event that someone is injured on your property. You can even purchase loss of rents coverage, which will compensate you if you lose rental income to natural disaster or something similar.
A property manager isn’t a strict requirement, but they can be well worth the money they charge, which is usually 6-8% of rents collected. If you opt to be a full-service landlord yourself, you’ll have to deal with 4AM phone calls, clogged toilets, and noise complaints yourself.
And finally, you’ll want to put aside 5-10% of your monthly rent income for repairs and maintenance. Add all these expenses up, and you’ll have a very good idea of how much rent you need coming in to break a profit. If you’re in the red, you need to reduce your expenses. If you’re in the black - carry on.
Beyond Flipping & Investing: Wholesaling Properties
You know those “We Buy Houses for Cash” signs you see on telephone poles and medians? Do you ever wonder who puts those up, and answers the phone if you call the number on the sign? Well, it could be you, if you decide to go into property wholesaling.
Think of wholesaling as flipping houses, but without the renovation. Wholesalers find distressed or undervalued properties, negotiate the lowest sale possible, get them under contract, and then sell that contract to a third party. Wholesalers are middlemen, and since they only make a small profit on each transaction, their money is made on volume.
Reaching the Sellers
If you’re a lone wolf huster-type, being a wholesaler could be right up your alley. Unlike the previous strategies, it takes very little capital upfront, and you won’t have to deal with any tenants or contractors. You will, however, have to find motivated sellers, and convince them to sell at a low price. Traditionally, these buyers are found through marketing campaigns. Social media and direct mail are popular and effective, and many wholesalers use, yes, those bandit signs on telephone poles. (They may be eyesores, but they work.)
Building Your List
But before you put any properties under contract, you’ll need to cultivate a list of buyers. Remember, you’re not actually buying any properties; you’re only acting as a conduit to the investors. That means you’ll have to build up a network of investors and real estate professionals who have the interest and financial means to buy off-market distressed properties. This is done mostly by old-fashioned networking, at auctions, conventions, and real estate events.
Making the Offer
Once you have a property in mind, and a list of potential buyers, it’s time to make an offer. Make sure you’ve done your research on the property. Find out what the owner still owes on the property; very often, they’ll sell for that figure just to get out from under the mortgage. Remember to make your initial offer low, so you can bargain up; experts suggest starting as low as 40% of the eventual ideal price. Owners of distressed properties are often very eager to sell.
Make sure you’ve determined if there are unpaid taxes or HOA fees associated with the property; those will likely have to be settled by the buyer, so take that into account when you make your offer.
Writing the Contract for the flip
Once you’ve settled on a price, make sure the contract has an assignment clause that allows you to quickly sell the contract to a third party. If your buyer falls through, and you can’t find a replacement investor in a certain amount of time, the contract will expire. If your investor buys the contract, you can expect your payment in 30-60 days.