How to Begin Investing in Real Estate
An unusually long and harsh winter is delaying the start of the spring housing market, but for the investment-minded, continued low interest rates and high demand for rentals appear to outline an opportunity.
Institutional investors and their buckets of cash have dominated many markets for the past several years, according to real estate data cruncher CoreLogic. But at the end of 2014, cash sales declined to a national average of 36.1 percent, down from 38.8 percent in November 2013. CoreLogic also reported that the foreclosure inventory declined 34 percent at the end of 2014. That means individual investors are starting to have a shot at lower-priced properties ripe for fixing up and renting, real estate professionals say.
If you are thinking of tiptoeing into real estate as an investment, you have two basic approaches, says Leonard Baron, a lecturer at San Diego State University and author of several self-published guides to investing in real estate.
Buying shares in a real estate investment trust. You can invest in a REIT, but doing so involves buying shares of a portfolio of properties. “It’s really more like buying a stock or buying into a fund,” Baron says. “It’s a completely different animal from owning real estate directly.”
Direct ownership. This is anything but a passive investment, Baron says. “People think it’s easy money, that there’s not a lot of work, that tenants will pay on time and that pipes never leak,” he says.
Some individuals enter the market by buying a small apartment building, he explains. You should research diligently to find a good deal on a building that produces positive cash flow and has no hidden defects that will require expensive repairs. Don’t take investment guidance from a real estate agent, Baron warns. To them, everything is a good investment, because they only win a commission when you buy.
Don’t assume your personal experience as a homeowner translates to managing rentals, just on a bigger scale, he adds. From complying with fair housing rental regulations to insurance, to making sure the property complies with building codes and common-sense safety guidelines, property management dominates your wallet and your time. “It’s a very complicated asset. But because it’s a physical asset, people think it isn’t complicated,” Baron says. “People way underestimate the number of issues that come up.”
One way to test your tolerance for being a landlord is to buy a duplex or a small apartment building, with the aim of living in one unit and renting the others.
A nascent rebound seems to be buoyed by millennials who are edging into the market as owner-occupants. Thin on cash, 20-somethings are finding they can gain a toehold into homeownership by buying a small, multiunit property, such as a duplex or three-apartment building. Their plan is to live in one unit and rent out the others, says John Mosey, president and CEO of Northstar MLS, a Saint Paul, Minnesota-based data service for real estate brokers.
Although this arrangement can stretch down payment dollars, it also demands a Himalayan learning curve: first-time homeownership simultaneous with first-time landlord.
The most important consideration for potential first-time landlords is to not assume today’s rising rental rates will lift future cash flow, Mosey says. Today’s tight rental market will be eased as projects under construction enter the market. That means rents will level off, so it’s best to work cash flow and return numbers using conservative projections, Mosey says.
Key cash-flow factors include not only predictable costs, such as property taxes, but also variables that can affect the appeal of the units to potential renters. For example, Mosey says, you may think including heat and water in the monthly rent will attract renters. But the actual cost of heat and water is quite different for a single occupant compared with a unit shared by three roommates. The more water and heat they use, the less money you keep.