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Launch Your Real Estate Investment Journey in 7 Smart Steps
Ready to dive into real estate investing? Your first move should be to arm yourself with solid information. Get to know your various investment possibilities and clearly define your financial aspirations. Keep in mind that all investments carry a degree of risk, and in the real estate world, some ventures are certainly riskier than others.
1. Master the Real Estate Fundamentals
Anyone thinking about real estate investing needs to understand its core mechanics. It’s really helpful to grasp how market conditions influence which investment types might be your best bet right now. The current market also affects how (and if) you can secure financing for an investment and how quickly you can expect to see a return.
Familiarize yourself with essential real estate concepts like profitability, cash flow, and various funding methods. Learning the vocabulary and key ideas now will set you up to tackle bigger topics down the road, such as how to make money in real estate and how to build a robust real estate portfolio.
One excellent way to kickstart your learning is to take a course from a respected real estate trade group, like the Institute of Real Estate Management or the National Apartment Association. Both offer valuable webinars, comprehensive courses, and professional certifications.
2. Pinpoint Your Personal Risk Threshold
Real estate investing is inherently risky. The amount of risk you take on will vary significantly based on the type of investment you choose. As an investor, you’ll need to define your risk tolerance, which the U.S. Securities and Exchange Commission describes as “an investor’s ability and willingness to lose some or all of an investment in exchange for potential returns.” Simply put, it’s not just how much you might be willing to lose, but also how much you can truly afford to lose.
Your risk tolerance will be shaped by your personal and financial circumstances. For example, if you’re supporting a family, carrying a mortgage, and facing substantial monthly expenses, you’ll likely lean towards safer investments. On the flip side, if you don’t have dependents, carry minimal debt, and enjoy a healthy amount of disposable income, you might be in a better position to handle a riskier play.
Diversifying your portfolio is one of the smartest ways to avoid taking on too much risk. When you hold multiple assets with varying risk levels, your overall portfolio stands a better chance of weathering market shifts or if one asset underperforms.
3. Select Your Investment Type
Real estate investing offers a spectrum from completely hands-on involvement to entirely passive participation. First-time investors might feel more comfortable with a lot of third-party support and guidance, while more seasoned investors often prefer greater autonomy.
Here are some popular real estate investment avenues to consider:
- Real Estate Investment Trusts (REITs): A REIT is a company that generates profit through real estate, often by owning income-producing properties or office buildings. As an investor, you can buy shares in the company, similar to buying a mutual fund, to add real estate exposure to your portfolio. REITs usually have low upfront costs but are subject to market volatility.
- Rental Properties: A rental property is a house or apartment you buy with the specific intention of leasing it to tenants. As your tenants pay rent, you create a steady income stream and build equity in the property. Keep in mind that rental properties come with high initial costs and can demand significant effort for upkeep and management.
- Commercial Real Estate: This category refers to properties leased to businesses, including hotels, retail stores, and offices. Typically, these investments offer longer lease terms, leading to more consistent cash flow. However, commercial real estate can also be quite sensitive to economic shifts.
- Crowdfunded Real Estate Investment Platforms: These platforms allow individual investors to contribute capital to a real estate project of their choice. It’s important to note that, in many cases, these funds can be illiquid for an extended period.
- Mortgage-Backed Securities (MBS): An MBS is essentially a collection of multiple mortgages that loan originators bundle together and sell to bond market traders. It’s a very indirect way to invest in the mortgage sector.
- Tax Lien Investing: This involves purchasing tax lien certificates at auction, which are issued when a property owner fails to pay their property taxes. Ultimately, you could gain ownership of the home if it’s foreclosed on, but the original owner also has the option to settle their tax bill and keep the property.
4. Choose Your Real Estate Market Wisely
The specific market where you decide to buy will heavily influence what constitutes a sound real estate investment.
Begin by figuring out how much you can comfortably invest and then search for properties that fit that budget. Analyze the area’s economy and job market to determine if it’s growing. It’s also crucial to consider population growth and the general profile of the renter demographic.
Certain areas are in high demand, making them competitive but potentially very promising for investment. These are typically rapidly expanding locations rich in opportunities and entertainment. So, you’ll need to research what the best places to invest look like for you. Don’t forget your personal preferences either. Some investors prefer to manage their own properties, which is easier if you live nearby, but investing in markets outside your local radius is absolutely possible.
5. Begin Your Property Search
Once you identify something you might want to buy, thoroughly research the investment property itself and its surrounding neighborhood. A property in poor condition or an undesirable location will inherently hold less value.
You can assess the potential profitability and inherent volatility of a specific property using analytical software and reporting services. A great starting point would be to consult our guide to the most promising places to invest in real estate in the U.S., which was compiled based on key metrics like population, median home sales price, gross rental yield, vacancy rate, and housing price growth index.
6. Nail Down Your Financing
After finding the perfect investment property, the next critical step is to secure its financing.
You’ll discover that obtaining financing for an investment property can be more challenging than getting a mortgage for your primary residence. Lenders typically have stricter mortgage criteria for investment properties because borrowers are often more inclined to prioritize payments on their primary home, which increases the lender’s risk.
While it’s still possible to buy an investment property with a traditional mortgage, you’ll likely face a higher interest rate. Other financing options include:
- Freddie Mac’s Investment Property Program: This program is designed to help borrowers secure the necessary financing for investment properties with one to four units.
- Real Estate Crowdfunding: This approach involves inviting the public to help fund your venture. You’ll ask other investors to contribute to financing your real estate investment, thereby sharing the risk with them.
- Holding Multiple Mortgages: You might be able to take out more than one mortgage to help finance your real estate investments. However, this strategy can be risky, and some banks might be hesitant to let you hold multiple mortgages simultaneously.
- Loans for Flipping Houses: You might be able to get a loan specifically for house flipping from a private lender. A hard money loan, a home equity loan, or a cash-out refinance can often be better ways to fund house flipping ventures than a traditional mortgage.
- Opportunity Zones: These zones encourage investment in economically disadvantaged communities by offering tax incentives under the Tax Cuts and Jobs Act of 2017. This is a great option if you’re looking to help revive an economically underprivileged area.
7. Consistently Monitor Your Performance
While every investor will have unique goals, they all share the common objective of building an income stream and making money. It’s crucial to assess your progress towards these goals by diligently tracking your gains and losses.
For example, if you’ve invested in a REIT, you’ll want to compare your dividend payments to your upfront costs to determine your breakeven point and when you start turning a profit. If you’ve purchased a rental property, you’ll need to know how many months of rental income it will take to offset your initial expenses.
Using profit and loss statements will clearly show whether your investment is moving towards profitability or losing money.
There are several different ratios and calculations you can use to understand your progress. Some work better for specific property types, like residential versus commercial, so it’s important to do your homework before applying any particular metric. Examples of key metrics you might need include net operating income (NOI), internal rate of return (IRR), and operating expense ratio.