Once you’ve maxed out your 401K, and invested the extra funds into a regular taxable investment account, at some point you’ll have enough to purchase a single-family home investment property, which is our next recommended investment.
This means you’d be able to cash out your investments, pay any capital gains taxes, and use them to buy a property. First, you need to decide if owning an investment property is for you. The advantage is that the returns, especially when taxes are considered, are better than stocks. The downside is that you actually have to get involved with tenants, repairs, etc. You will also need to decide whether you are comfortable with using leverage (a fancy word for a mortgage) on your real estate, as debt will increase your return, but add an element of risk.
Stocks are a truly passive investment. You buy an index fund, sit on it, and let it grow. You don’t need to research stocks, and please don’t watch investment shows on MSNBC. Buy and hold, that’s it.
That’s a good thing, because most people who get too involved with stocks buy at the wrong time (when prices are high) and sell at the wrong time (when prices are low) based on “research” that usually is written to sell fear or greed. We’ve taken the path of continuing to buy the same stocks over and over, and it’s worked really well for us, and we’ve gotten great returns. Most people who over analyze stock purchase and performance do worse in the long run.
Investing in Real Estate
Real Estate, on the other hand, is an active investment. There’s no way around it. You’ve got to actively take a part in researching neighborhoods to make sure you’re purchasing the right area. You’ve got to actively take part in managing tenants. You’re going to have periods of time when your houses are empty because tenants leave. It’s not buy-and-hold.
As we’re writing this, we’re in the middle of the COVID-19 panic of 2020. I had tenants who could not pay their rent early on. I was also prohibited from evicting them for several months. I was still in the position of being required to pay my mortgage. This is a major issue, and I never considered the possibility that I might be forced to pay carrying costs, without the ability to evict non-paying tenants. Luckily, I was able to work out favorable arrangements with my tenants, and they are repaying a missed month or two over the course of their tenancy.
So why the heck do I invest in real estate? Isn’t it too much of a headache? Well, I feel that the extra return, especially the income yield, is so much better with real estate that it’s worth the hassle. Because I have cash reserves, I’m able to weather temporary storms that may come up, including COVID-19.
In addition, the tax benefits from depreciation are so great that they help my wife and I shelter all our real estate related income, similar to a 401K. In addition, new laws related to accelerated depreciation help us reduce our tax burden from other income. It’s an overall great deal. So where do you start?
Why Single-Family Homes are the Place to Start Real Estate Investing
My suggestion is that you start with single family homes. Sure, there’s a ton of other real estate investments out there, but the problem with them is that there’s too much room for error, and too much knowledge that must be obtained in order to invest wisely. In addition, single family homes are much less expensive, the ones we purchase are in the low $200K range, and allow you to diversify your real estate holdings much faster. At the beginning of your journey as a real estate investor, it’s best to keep it simple.
You should look for quality homes that won’t need a ton of maintenance. One of the most frustrating things that can happen to a real estate investor is getting calls from a tenant needing to fix leaky toilets, sinks, etc. Make sure you have a quality inspection of a prospective home, and get any issues fixed prior to renting. Buying newer homes, or even brand-new homes (where allowed by the builder) is another great idea. The extra you pay up front will be paid back ten-fold by the lower maintenance expenses and avoidance of headaches.
Make sure you’re purchasing properties in good neighborhoods with good schools. Those types of properties will always have a line of tenants with kids willing to rent, and who will want to stay awhile. Providing good homes to good people is a great honor.
Speaking of tenants, it’s a good idea to make sure you investigate your tenants thoroughly to make sure they’ll pay the rent and not trash the property. Credit checks, references from prior landlords, and checking to make sure they actually have the job they claim to have are all important factors to ensure you have a successful property. Post COVID, it’s a good idea to get a sense of their payment history during the pandemic. Not so much whether they paid, but the circumstances. Did they still have a job and stiff their landlord? Well, that’s going to be a bad tenant for you. It’s equally valuable to have a tenant like mine, who lost their job and worked out a deal with me to pay their rent on the backside. That doesn’t show up on a credit report, but says a lot about my tenant’s honor and integrity.
Should you borrow money to buy real estate? I do, and I think it’s generally a good idea to do so. However, you can easily get yourself in trouble here. A mortgage on a piece of investment property allows you to buy that property sooner. Since your tenant is paying you rent, in effect they’re paying your mortgage for you. While you do have to pay interest to the bank, your investment property should be appreciating in the long term, and all that appreciation comes to you in the form of equity. Your debt principal stays fixed.
That’s an important consideration, because it’s why so many people make a ton of money in real estate, over time. If I pay $50,000 down on a $200,000 property, and it appreciates 5%, it’s now worth $210,000. But my earnings are not 5%, because I only invested $50,000. My earnings are 20% ($10,000 appreciation divided by $50,000 cash investment.
So, it’s absolutely true that debt will allow you to earn a higher return. But debt also adds risk, and can cost you your investment property if you’re unable to pay the mortgage. As we’re learning in the COVID-19 pandemic, you may not always be able to evict non-paying tenants. You’d better have cash to cover this. When you buy a new property, make sure you have 3 months of mortgage payments and expenses (faucets and toilets break) for each house you own. Now, realistically, after 3-4 houses, you can ratchet down this savings account. Why? Because the law of averages dictates you likely won’t have issues at all your properties, and eventually that cash can be reinvested for a better return. Still, it makes sense to have plenty of cash on hand of problems that inevitably arise.
You can’t get around risk in any investment, and I’ve outlined several risks inherent in real estate investing through single family homes. There are four ways to reduce that risk, as much as is possible:
- Keep extra cash;
- Put down a good down payment;
- Only use fixed-rate 30-year mortgages; and
- Never refinance your investment properties.
Let’s unpack each of these concepts a little further.
First, always have extra cash available. Three months reserves plus some set aside for expenses for each property, like I mentioned above, which can be ratcheted down slowly as you acquire more properties. That’s worth restating. You will have tenants leave, you will have repairs, you will have issues. Too many real estate investors don’t have the cash ready to back themselves up when it comes to their properties. The result is poor tenant retention, unrepaired issues, and a property that won’t sell for top dollar once you want to sell it.
Next, you need to put down a good down payment, at least 25% of your purchase price. Putting down less than that will leave you with razor thin margins, and not much cash flow. True, the less you put down and the more you finance the higher your yield on your invested cash will be. However, you’ll be adding an element of risk that is really not worth it. In addition, as of this writing, most banks will give a discounted interest rate if you have 25% down. They want to see that you have skin in the game, and won’t walk away from the investment if it declines in value, as happened so often during the Great Recession from 2007-2009. Back then, plenty of “real estate investors” bought over-valued properties with no cash down and interest only mortgages. When interest rates rose, their rents no longer covered the mortgage, and they defaulted. Soon thereafter, the economy turned south, and they could no longer even sell their houses to get out of the deal. Many walked away, leaving the bank holding the bag. Banks are now setting terms to make this much less likely to happen in the future.
Third, always used 30-year fixed rate mortgages on your properties. As I mentioned above, back in the Great Recession, a lot of “investors” were caught skinny dipping when the tide came out. There were a couple of reasons for this related to mortgages. First, they bought adjustable rate mortgages that ballooned into a higher interest rate at the end of the initial term, which was often 2-5 years. Once that interest rate increased, their rents no longer covered their mortgage, and they were left with no option other than foreclosure. Second, the Great Recession was a liquidity crisis, meaning that banks were not as willing to lend as they had been before. Prior to the recession, an investor was able to get a loan with less than 20% downs and with very loose credit underwriting standards. A common phrase back then was NINJA loans, meaning No Income No Job. That ended, and a lot of investors couldn’t get a replacement loan. Again, their only option was foreclosure. The solution is to set your loan up front for the long term. If your loan is set to pay off over 30 years, and your property cash flows with a few hundred dollars per month above your mortgage, it’s very unlikely that rents will drop in the future to the point you can’t cover your mortgage. This is especially true if you’ve put down a solid 25% down payment. Make sure you set your loan terms up front, with a 30-year fixed mortgage, so that you don’t get left hanging (and leave others holding the bag) when times get tough.
Finally, never refinance your properties to pull cash out of them, either to spend or invest in other properties. You want your equity in properties to increase in value over time relative to your debt load. Your rents will increase as well, and this will continually create a larger margin of safety in your portfolio, because even as one tenant leaves, and you temporarily lose rental income, you’ll be able to cover that mortgage with other properties. If you constantly refinance as soon as you have some equity, even to buy other properties, you’ll always be in a position where you NEED that property rented full time to cover your mortgage. Let your properties debt-to-equity ratio (what you owe divided by what the property is worth), decrease over time. It’ll make your world a lot less stressful.
WHAT ABOUT OTHER TYPES OF REAL ESTATE?
How long should you stick with single family homes? At some point shouldn’t you look at commercial properties? What about Multi-Family, meaning apartments? Well, I think you should stick with single family homes for a while, for several reasons.
First of all, other property types require a lot more active management on the part of an investor. With single family homes, you can hire a manager to handle tenants, minor repairs, etc. With other types of real estate, it’s true you can hire managers, but there’s always going to be lots of decisions that need to be made from an investor perspective, such as when major improvements need to be made, tax considerations, and financing decisions. That’s definitely not insurmountable, but single-family homes are very simple, and there’s something to be said for that.
Competition from larger investors is also fierce in the commercial and multifamily world. While it’s not impossible to find good commercial deals, it’s much more difficult, and takes a very savvy investor. Most deals under $1 million listed on loopnet.com or other commercial real estate sites have a lot of issues that require hands on “value-adding”. That’s difficult to do unless you have a lot of experience. Again, I’m not saying that’s impossible, but you don’t run into that as much in the single-family market. There’s a lot of great properties in great shape for much lower dollar amounts than in the commercial world. That takes a lot of risk off the table. Once you have a robust single-family portfolio, if you’d like to jump into commercial, then by all means do so. But learn real estate investing through single-family homes to avoid making major mistakes.
I also like single family because of how easy the lending process is compared to commercial loans. Single-family homes give you a great runway because you can use low interest conventional loans to invest in up to 10 houses (20 for married couples) before you even have to think about non-conventional loans or commercial loans. A conventional loan is offered through a normal bank, but is guaranteed by one of two government sponsored entities, Fannie Mae and Freddie Mac. These loans are “packaged” by the bank along with other similar loans and sold on the secondary market as bonds.
From your perspective as the borrower, conventional loans are very easy to obtain. Banks have a systematic process for reviewing and approving these loans. You’ll provide information like tax returns and W-2’s, and the bank will approve you (assuming you’ve got good credit and otherwise qualify) and quickly fund your loan, because they know they can sell qualifying loans on the secondary market for a quick profit.
As I mentioned before, I really like the idea of 30-year fixed rate loans, because it takes a lot of uncertainty out of your real estate investing. You’ll be able to know what your mortgage payment will be each month, and it won’t go up should interest rates change in the future. As time goes on, and you’re able to raise rents, your margin between the rent payment and your mortgage payment will grow. Contrast that to lending that’s fixed only for a 5-year period, which is common to the commercial real estate world. Your interest rate could be much higher at the end of your term, leading to a higher payment. That’s a risk and a complication you don’t want to mess with until you’ve got a lot of capital and experience!
My recommendation is that you stick with a single-family until you’ve used up your allotment of conventional loans. By that time, if you’ve followed my approach, you’ll have a lot of experience, cash flow, and equity to weather any storms you face while learning to invest in other (potentially) more lucrative real estate types.
SHOULD YOU MANAGE YOUR OWN PROPERTIES?
The question of whether or not you should manage your own properties gets asked a lot. I think it’s possible to manage your own properties, for a while. I also think it’s a good idea to get some experience managing tenants if for no other reason than to understand how the processes of qualifying tenants, negotiating rents, dealing with repairs, etc..
However, at some point, especially if you’ve got a day job, you’re going to need to hire a property manager to take care of your properties. You need to be an investor, and put your capital to work. You want to focus on your career, so you can earn more money and buy more real estate. Don’t make the mistake of letting property management become a second job.
In looking for a property manager, you should ask for recommendations from other real estate investors who have had a good experience. There are all kinds of property managers out there,. It helps to understand how they’ve interacted with other investors so you understand how they work, and the good and bad.
I think a good property manager can be an asset, but you’ve got to train them on how to handle matters in the manner you want, and give them authority to handle issues up to a certain dollar amount. What you don’t want is your property manager calling you every week with problems, because you might as well insert yourself into dealing directly with the tenant. Ask for references of prospective property managers, and be ready to move quickly if they are not meeting your expectations.
In terms of cost, you can expect to pay 8% to 10% of the gross rental income to your property manager. While this cost is high, a good property manager can make sure you’re not really doing anything on existing properties other than collecting rent and making major repair decisions. Generally, day to day decisions can be made by your property manager, and they (instead of you) will field phone calls from tenants.
A good property manager should do more than just manage the property. They should provide you advice on what the likely rent will be for rentals you’re considering buying. They should deal with a lot of properties in your surrounding area, and will be able to tell you (within $25-$50) what your rent will be if you buy a new property. That’s a pretty good resource when you’re looking at a possible new purchase.
WHAT SHOULD YOU LOOK FOR WHEN INVESTING IN A SINGLE-FAMILY HOME?
Now that you’ve decided to invest in single family homes, the question is what should you buy? How can you make sure you’re actually making a good investment? How can you set yourself up for success as a real estate investor?
The answer is that you need to buy good quality houses, in good neighborhoods, at good prices. You need to buy a property that’s likely to attract good tenants, who will pay stable rents. You want those tenants to love the property so they make the decision to stay there for an extended period of time, so you don’t have to continually relet the property.
The first step in thinking about real estate Is understanding how to calculate the returns from your investment. Once you understand that, you can start looking for good quality properties to add to your portfolio. I’m going to first teach you how to first (a) run the numbers in a real estate deal so you can determine what deals would be appropriate, and then (b) how to look at properties to determine whether they might make a good investment. That might seem a little backwards, but I truly feel that looking at properties is useless until you understand whether the property is mathematically a good investment.
RUNNING THE MATH
The first thing you need to understand is how to estimate the return a property will bring, and then back into a value for the property that will give you the return you’re seeking. In my mind, the absolute minimum you should take for a real estate investment is a 6% cash-on-cash return, although I’m certainly looking for better than that. Personally, if property is under 10%, it’s got to be a really good property in an area that I think will appreciate significantly over time, in order to give me a significant “growth” return above the cash-on-cash “income” return. Remember that there’s two components to a return, (1) growth and (2) income. With real estate, the growth comes from appreciation and the income is the net of the rent above your mortgage and other expenses.
Cash on cash return is the cash income earned on a property relative to the cash invested in a property. Again, I’m considering the net rental income (after all mortgages and expenses) only, and not any growth in the value of the house over time. While growth is obviously great, and the equity you build in a house increases your net worth, in real estate deals you need to make sure the cash return is adequate, because that’s what’s going to pay your mortgage and eventually provide the income you need to meet your living expenses. You need a minimum standard for cash on cash return in order to make sure you’ll be able to easily cover your mortgage and other expenses related to the property. If your cash-on-cash return is under 6%, it means the property you’ll introduce an element of risk of not generating enough cash to cover your expenses.
However, note that your cash on cash return can be too high, IF you’re using too much leverage on a property. You can raise your cash on cash return by borrowing more on a house. That’s because it reduces the amount of cash you’ve got invested in the property. However, borrowing too much creates less of a margin by increasing your mortgage, and that’s not advisable. So, any cash-on-cash return can only be considered legitimate if you’ve got a minimum of 25% down on the property. Otherwise, it’s not safe.
Let’s use an example to illustrate how cash-on-cash return works. Let’s pretend you’ve looked at a property that is listed at $195,000 that would cost $200,000 after ALL closing expenses. You need to factor in those expenses as they are really a cost of purchasing the property. Generally, closing costs are going to be in the neighborhood of 2-3% of the cost of the house. So, when something is listed for $195,000, you need to tack on an additional $5,000 or so in costs, which brings your cash invested cost of acquiring the home up to $200,000.
The market rental comparisons suggest that the rental property would bring in $1600 per month, or $19,200 per year. You’re paying cash so there’s no mortgage. Taxes are 2% (or $4,000) per year, and you estimate that it will cost around 5% of the rent, or $960 per year, for insurance and repairs. You’ll also pay an 8% management fee, which will equal $1,536 each year.
So, your cash from the property, each year, will be $12,704, which is that $19,200 amount less all the costs I’ve listed. Your cash invested in the property is $200,000. When you divide $12,704 by $200,000 you arrive at a 6.35% annual cash on cash return. For me, that’s good enough, but not great. In order to get a 10% return, I’d need to pay less for that house. Specifically, I’d need to pay $127,040 for that deal to work. Now, in all likelihood, a house listed for $195,000 isn’t going to drop to $127,040.
Let’s think this through. First, you could be looking in an area of town where the rentals don’t justify the costs of the house. That’s a bad market for real estate investors. You need to start by identifying areas that have good cash flow relative to property values.
Another solution could be to use leverage. In our example above, imagine that instead of paying $200,000 in cash, you pay $50,000, and finance the rest. Let’s assume your mortgage will be for $150,000 at a 4% rate of interest. This would mean a monthly payment of $716 per month, or $8,592 per year. This increases your total annual expense to $15,088. Now your net income on the rental, which was $12,704 above, is reduced further to $4,112 per year. However, your cash in the deal is only $50,000, and not $200,000. Dividing $4,112 by $50,000 gives you a cash on cash return of 8.2%, which is almost 30% higher than the 6.35% cash on cash return listed above, which is much better.
Now imagine if we found a property similar to the one above, but it was in need of significant repairs. Maybe the roof needed to be replaced, the fence line was rotted, there was shag carpet, popcorn ceiling, and avocado green counters that came from the mid-70’s. That’s the kind of property you want to be looking for…if you have some extra cash to rehab the place. That’s because you’ll often be able to buy it at a significantly reduced price, which will increase your cash-on-cash return.
Let’s say that properties in the area that were in good shape, and up to date, would fetch the $200,000 listed above. What’s this property worth? Probably a lot less. Let’s say you could get this property for $170,000, and get it up to the same condition as nice properties in the neighborhood for $20,000. That’s not a stretch by any means.
Now you’ve got a property that you’ve paid $190,000 for total, that generates the same $1,600 per month, or $19,200 per year. However, your mortgage is now less, only $692 per month (or $8,304 per year) because you’ve paid only $190,000 for the property. Your taxes are less, only $3,800 per year. That makes your total expenses $14,600 per year. Note that the total amount you would have put down on the property, 25%, is only $45,000, rather than the $50,000 listed above.
Now we divide your annual net profit from your rehabbed property, which is $4,600, by the $45,000 of cash you’ve got invested in the property, and you’ll come up with a 10.2% return, which is superb.
So, the point of these examples is that you’re often not going to get a great return in real estate by just buying any old property for cash. You’re going to need to use the tools of reasonable leverage and discounted real estate in order to generate great cash-on-cash returns. I would suggest focusing first on getting great deals on properties, so that you need to use as little leverage as possible in order to generate the return you’re seeking. Under no circumstance should you put down less than 25% on a rental property, because (a) your mortgage costs will go up and (b) your risk will go up significantly if rents go down, because you may not be able to cover the mortgage and generate positive cash flow. Don’t be tempted to juice your cash-on-cash returns by taking unnecessary risks.
A quick note about financing rehabs. Generally, you’ll need to do a little more work in obtaining financing for a rehabbed property. The best-case scenario would be that you have the cash to rehab the property first, and then can refinance the property once it’s finished. If you need to get a loan for the deal, you may run into a bit of a challenge getting a loan to cover both the property and repairs. Another alternative is to use a line of credit, but that will only work if you’ve got sufficient equity in your house (or other assets like a stock portfolio) to secure a line of credit of that size. Banks are no longer willing to offer lines of credit on an unsecured basis for most customers, although you will see this happen in some private banks for wealthy customers.
Another common option to the lending problem above is to take out a short term “hard-money” loan from an investor. These loans are at very high interest rates, and are designed to be a short term “bridge-loan” until you complete the project and take on permanent financing. Personally, I think these loans are too risky, and I’d suggest just waiting until you have the financial means to get a normal loan on a property, as described above.
It’s important to do the math on a potential deal to make sure it makes sense to you, and gives you at least a 6% cash-on-cash return, and hopefully one that’s higher than that. This should form your bottom line offer for the property. Note that you may get into a deal, and find out that there’s more repairs, or it’s more expensive than you thought, so the return is only 5%. Not the end of the world, but make sure you have some margin there. If you made an offer that was only going to net you a 5% return, and those same problems arose, you might be stuck with a negative cash flow property, which is no good.
LOCATION, LOCATION, LOCATION
You’ve heard the phase “location, location, location”, right? Well, that saying is definitely true when selecting a property. One of the big mistakes you can make in single-family homes is buying in a neighborhood where the math works, but the location is awful. There are plenty of neighborhoods like this, and you need to stay away.
The problem with bad neighborhoods is that they are not attractive to the good quality tenants you’re looking to get. You’ll run a greater risk of not getting paid, or your property being damaged. In addition, your property won’t appreciate over time. It’s tempting to jump on one of those $50,000 properties you see when searching the internet, because they seem cheap, and the rents advertised in the area seem like they’ll provide you with a great deal of cash flow for that price. Stay away, you won’t make that much because you’ll have a ton of vacancies overtime, because any tenant worth their salt is going to want to live in a better neighborhood.
But you don’t want to invest in too nice of a neighborhood either. What? That’s crazy, you say! I thought you would want to buy in the best neighborhood possible. The reality is that in really good neighborhoods, the yields are lower. You have less demand for rentals, because so many people are buying their houses. You’ll find that there’s a limit to the rent you can charge, because there’s a limited number of people who will be willing to pay to live in that neighborhood. You’d probably be better off buying four $200,000 houses in a good rental neighborhood than one $800,000 house in a top-notch wealthy neighborhood. It’s important to remember when thinking “location, location, location”, you’re looking for a neighborhood that is the best for investors, not necessarily the best place in town to live.
So how do you know what’s an in-between neighborhood, where you’ll make a healthy profit? You need to do some research to find your targets. Obviously, you have to consider your price point. How much of a down payment do you even have available? That’s going to limit your search to neighborhoods that fall within that framework. Here’s some tips for looking at neighborhoods for investments.
The first thing to look at is schools. Families make great tenants, because they tend to stay longer, have more stability, and pay rent on time. You can look at the greatschools.com rating for a property on realtor.com, to get a sense of how the schools are. Generally, the elementary school ratings are going to be higher than the high schools. I look for elementary schools that are above a 7, and high schools that are above a 5.
In school districts where everything is a 9 or 10, you’ll probably find that home prices are really high. This will probably be more than you want to spend on a down payment, and also the rents won’t justify the extra cost when you calculate yield. However, there are often older subdivisions in these school districts where you can find cheaper homes that make sense. In our neighborhood, where the average home price is around $600,000, there’s a couple of neighborhoods, with older homes, that are in the low $300k range. These make great investments, because there’s a ton of parents looking to rent these to get their kids into the school district.
In addition to schools, you want to understand whether a neighborhood is growing or shrinking. A great indicator is to look at the types of shopping available in a neighborhood. Are there brand-new large retailers, like Target, Walmart, etc.? Does the mall attract great quality stores that bring in a lot of shoppers? Are there brand-new restaurants being built, with national chains going in? Those companies spend a TON of money on neighborhood research. They want to be in growing communities that will have MORE potential shoppers over time.
Contrast that with a community with a lot of run-down commercial properties, with a lot of vacancies, and struggling businesses renting space. That’s probably a good sign that financially successful businesses don’t want to be in that area, because they don’t see growth potential.
Be careful of going into an area with too many luxury brands, as that may (but not always) indicate that the local houses are too expensive and won’t generate great returns. But as a rule of thumb, the better the shopping potential is judged by large retailers and restaurants, the better the neighborhood will be for you as an investor, assuming you can find a good deal.
WHERE DO YOU FIND DEALS?
Once you’ve learned how to calculate the cash on cash returns of a property, and you’ve narrowed down your search to some good neighborhoods, how do you actually go about finding deals? You obviously know the general prices of properties in the neighborhood, presumably from realtor.com or trulia.com, or some similar site.
The next step is to actually look at potential properties and make offers. When you’re beginning, this means you need to find a quality realtor. Realtors are beneficial in a number of respects, first, they have access to the Multiple Listing Service (or “MLS”) in the area. This shows not only what current properties are available, but gives market comparisons, or “Comps”, which will tell you what similar properties have sold for, in order to give you an idea of what potential properties are worth. I find the MLS is more accurate than the websites mentioned above, and will put Comps in a much better format, so you can truly get a good idea of what a property is worth.
A realtor will also benefit you by being able to write the contract on your property. I’m a lawyer myself, and have reviewed and written thousands of contracts, but even I use the advice of a realtor in new locations, because every state and even every city has different local practices and nuances that you’ll only know if you’ve done a ton of real estate deals in that area, like a local realtor.
You’ll also benefit from having a realtor (and more specifically the realtor’s team) handle your transaction. There are appraisals, inspections, repair requests, etc., that need to be done over the course of a transaction. Trying to do this yourself can not only be frustrating, but counterproductive, as you can easily make a mistake, or miss something that will cost you more in the long run.
It’s true that using a realtor will cost you money, even as a buyer. Don’t let anyone tell you different. The fact that the seller, and not you, are paying the realtor is irrelevant. If you were to go without a realtor, you could request a 2.5% or 3% reduction in the fee, as the seller would keep more of the proceeds. Despite this, it’s still a good idea to use a good realtor, as you’ll end up saving money and time, as well as finding good deals. Don’t try to go it alone, especially early in your career as an investor.
So how do you find a good realtor? I’ll first say there’s a ton of bad ones out there. It seems like there’s a million realtors in every city, looking to cash in on acting as an intermediary in real estate deals. A lot of them don’t know anything about finding deals, running numbers to see if properties are a good investment, and don’t care if you get screwed as an investor!
Moreover, a lot of real estate agents focus on helping buyers find homes as personal residences, or helping sellers sell their home. This is residential real estate, rather than investment real estate. While these agents may understand how to price and sell homes, it’s totally different than helping an investor find good deals. Generally, the best agents in the residential market are going to work with the highest priced homes (so they get paid more), and those are generally not the homes you want to invest in anyway.
You need to find an agent who is focused on finding investment deals for investors. The first step is to ask other real estate investors you know for recommendations. Great real estate investors usually know great real estate agents. Most investors will be happy to refer out their agent, because they know that they can’t close on every deal a good agent can find, and want to make sure their agent is taken care of.
Good investment real estate agents will be out scouring for deals. They’ll look on the MLS daily for potential deals, and work with other agents to understand how the property would work as an investment. They’ll understand rental comps, and be able to determine what a property would likely bring in terms of monthly rental income. They can figure out how much repairs are likely to cost, in order to arrive at the true cash on cash yield a property will bring.
Good investment real estate agents will also own investment real estate of their own. If they truly believe that real estate is a good investment, they’ll be putting their own money into deals. In fact, you want to be with the type of agent who is only giving their investment clients deals when they themselves can’t close, due to lack of funds. Good real estate agents can also give you referrals for lenders, property managers, handymen, etc.
They’ll also try to go directly to potential sellers, cutting out other agents because they know they can save their investors’ money that way. Smart agents will take 2% or 3% commissions, knowing that their investors will close on any property they find quickly if it’s a good deal. This will bring higher yields to their investors.
Many of these agents who go directly to sellers for their clients are referred to as “wholesalers”. That just means that they are looking to connect buyers and sellers in “off-market” transactions, cutting out a listing agent. Generally, this works better for the buyer than the seller, because the price will be reduced due to lack of competitive bidding from multiple potential buyers.
Often a wholesaler will actually put the property under contract with the seller themselves, and then “flip” the contract to an investor for a higher price, the difference being their profit. For instance, the wholesaler might lock in a contract price at $150,000, and then sell that contract to an investor for $5,000, making the investor have $155,000 in the deal. That would still work out for the investor if the yield makes sense, and smart investors would gladly pay for such a deal.
You might be wondering why the seller would accept such a deal? Why would they ever sell off-market to someone, when it’s pretty clear they could get a higher price through hiring a listing agent? The reasons are many, and probably there’s many more than I’m going to list. Maybe they don’t know what their home is worth. Maybe they don’t have the money to put in the repairs that are necessary to get top dollar. Maybe the price offered is the price they had in mind for their house. Maybe they don’t want to go through showings and the hassle of listing their house on the open market. Whatever the reason, these deals are plentiful, and will net you the highest returns.