Real estate investing has become popular as people began to focus on increasing multiple sources of income.
Done right, you can make a significant return on your money, but as with any other type of investment, “never invest in something you don’t understand (or can’t explain to a fifth grader… “)
Even Mark Twain knew that real estate investing was valuable, as he said: “Buy land. They don’t do it anymore… “
One of the main reasons most people refuse to invest in real estate is lack of knowledge… There is a misconception that it takes a lot of time and money, but you will be surprised by the many different ways to get started in real estate.
If you’re unsure of where to start figuring out how to start investing in real estate, let’s start by looking at the different types of real estate investing.
Types of real estate investment
Wikipedia defines real estate investment as buying, owning, managing, renting and / or selling real estate for a profit.
The four main categories of real estate are usually divided as follows:
1) Residential real estate
Most are familiar with residential real estate, which includes:
- private houses
- condominiums
- townhouses
- duplexes / triplexes / quads
2) Commercial property
Commercial real estate is real estate that is used to conduct business for a profit.
Examples include:
- office buildings
- retail trade (strip centers)
- storage units
- apartment building (five or more apartments)
3) Industrial property
These properties serve the purposes of the industrial business.
Examples include:
- shipping warehouses
- power plants
- factories
4) Earth
Land is a property on which there are no buildings.
Owners can earn on the land by:
4 ways to make money on real estate
# 1 Cash flow
Cash flow is what remains after the monthly payment of all real estate and mortgage expenses.
One of the first places where I learned about cash flow was from the book Rich dad, poor dad…
Cash flow is what attracts most real estate investors as it helps eliminate fear relive your money in retirement.
Most of us will learn that we have to work over 40 years and do our best to build as large a nest egg as possible, in the hope that it will not deplete when sinking occurs, plus taxes.
But if you invest in assets with a continuous cash flow, you can rest easier knowing that your expenses are being paid.
# 2 Appreciation
If you’ve ever bought and sold a home for a profit, you’ve felt grateful.
Recognition occurs when the value of a property increases (rises in price) over time. Like the stock market, the housing market has its ups and downs (2008 crash). But historically, property values in the United States have tended to rise.
There are two main types of appreciation:
Passive
Passive evaluation occurs as result of time… Usually, the total value of houses increases with the inflation rate (about 3-4%).
Compelled
Forced recognition is the concept of increasing the value of a property when it is physically renewed / improved. You will see this kind of appreciation in added value deals.
Some ways to achieve this are to update your countertops, appliances, and lighting. Thus, you can increase the rent, thereby increasing the total Net operating income…
This, in turn, increases the value of the building.
# 3 Loan repayment
Depreciation is the process of paying off a debt (in this case a mortgage) over time through regular payments.
A portion of each payment is for interest payments, and the remainder is applied to the principal.
The repayment schedule is determined by the ratio of interest to principal in each payment.
Initially, the majority of each payment goes to interest payments. As the loan is repaid, large portions are used to pay off the principal.
What’s good about it is that tenants pay the mortgage every month. This means that you do not need to take out a huge loan to cover the property.
Here’s an example:
Let’s say you purchased a $ 500,000 apartment complex with a $ 400,000 mortgage. During the time that you held it in your hands, it paid off (had zero cash flow) and was never evaluated – which is very unlikely… Stay here with me while I try to prove my point.
So guess what after paying off your 30 year mortgage? You now have a $ 500,000 free apartment complex that you never had to save for. Why? Your tenants bought it for you to repay the loan. A good thing!
# 4 Tax Benefits
One of the most overlooked benefits of real estate wealth creation is the associated tax breaks.
The IRS loves it when people buy property and for this reason offers many great tax incentives.
Here are some common deductible expenses:
- repair
- property management costs
- insurance premiums
- property tax
Over time, wear and tear lowers the value of the rental property and its contents. This process, known as depreciation, is tax-free.
The deduction can be made for the expected life of the property, but it needs to be spread over several years.
You can get help with a cost sharing study that identifies and reclassifies personal property assets into reduce amortization time for tax purposes, which reduces current tax liabilities.
You can also use 1031 exchanges, which may allow you to defer taxes on any sale indefinitely.
Active or Passive Investor?
One of the most important decisions you will have to make is which route you want to take: Active and passive real estate investing
As for me, I thought I wanted to be an active investor as that was the only thing I knew about when I started my self-education process.
I have a few friends who are good at running local affairs in my city. I thought about the pros and cons of a homeowner for several months and even went with them to look at several single-family homes.
But then I realized, going through the process, that I didn’t want a second job… My goal was to create other sources of income so that I could start taking off work and spend more time with my children (while they are still under our roof).
Again, what’s best for me may not be right for you. My advice is to think long and hard to guide you on the right path.
Active investor (DIY)
The most active investors (landlords) I know who also have “day jobs” have tended to be in real estate in some form or fashion in the past. Unlike them, I had no real estate other than the house in which I grew up.
If you want to continue your active career in real estate, you need to have two things at your disposal:
Here are some questions to be answered:
- Full-time jobs and family responsibilities leave you enough free time to be an active investor?
- Have you been involved with real estate investing? If not, how do you plan education myself?
- Have you had a mentor to show you what it takes to be successful in this business?
If you answered “No” to these questions, then perhaps you will be better passive investment…
Passive investor (Hands off)
Here’s the good news. There are several different ways to passively invest in real estate, especially for busy professionals.
Again, this is the path I took as I wanted to benefit from additional stream of income and more free time minus the headaches associated with managing the property yourself.
It was a win-win situation for me.
Putting it all together
Research shows that over 90% of US millionaires have real estate in their portfolio. They know real estate investing has a proven track record and offers the potential to generate significant returns and diversify portfolios.
Once you’ve decided whether you want to become an active or passive investor, make sure you understand and weigh the risks and potential rewards before you start.
Take the time to educate yourself to make the right decisions that you will need later.
This article originally appeared on The Money Mix and has been republished with permission.