Investing in real estate is an excellent financial decision. However, the broad category of real estate investing includes various revenue streams, more popularly known as strategies. These many options can be confusing for a novice investor. You may think of wealth accumulation through real estate investing as scaling a mountain.
You are a daring mountain climber, of course. The mountain's summit resembles your financial and personal objectives. Along the road, there are many checkpoints or sub-goals. Plans for how to first ascend the figurative mountain are called strategies. They are the most direct and secure ways to lead you to the peak. And strategies are akin to the climbing equipment that enables you to ascend certain routes.
Many real estate investors become mired in strategies without understanding why they are employing those strategies in the first place. Gaining proficiency in methods without a strategy will only improve your ability to hike straight off the proverbial financial cliffs.
Therefore, it is advised that you define your basic real estate investing objectives, such as achieving financial independence or acquiring a specific number of free and clear rental properties. Decide on one or two preferred tactics, then stick with them. All of the strategies you learn will then be considerably more effective.
For easier understanding, three distinct strategies are mentioned and explained below:
These are possibly the safest strategies to begin investing in real estate. And in some circumstances, with a little labor, you can start even with a little money.
1. Live in the property and then rent it out
As the title suggests, this technique simply entails residing in a home that will thereafter be rented out. Thus, the property must serve both as your current residence and a potential future investment. This approach can be used several times to create a small portfolio.
2. Live in and then sell the property
The Live-In Flip involves buying a house, moving in, making improvements, and then waiting two years or longer to resale it for a profit. If you adhere to IRS regulations, you won't owe any taxes on profits up to $250,000 for single filers and $500,000 for married couples filing jointly.
3. House Hacking
Living in a house that generates revenue, such as a duplex, triplex, fourplex, or a property with additional space that can be rented out, like a basement, guest room, or spare bedrooms, is known as house hacking. You can cut your overall housing expenditures by renting out a portion of your home.
The fact that you may learn about the rental market while residing in your rental makes house hacking an excellent method. And after you've lived there for a while, you can leave and turn the house into a long-term rental.
4. The “buy, remodel, rent, refinance, repeat” strategy
When carefully carried out, this method is a great way to begin your investment career with a rental portfolio without running out of money. In essence, in your search for houses that need work you can purchase for less than their market value.
When purchasing a property, you utilize short-term financing or cash, and once it has been repaired, you refinance it with a long-term loan. If done correctly, you can withdraw most or all of your initial capital for the following deal.
It functions best when you use it early to start developing your portfolio. It makes sense to eventually switch to lesser leverage and lower risk strategies rather than continuously leveraging as much as possible.
Related Read: The Ultimate Guide to Financing a Rental Property
Instead of being a real estate owner, debt techniques put you in a lucrative and frequently passive lender's position.
1. “Hard” money lending techniques
Hard money lending is known as offering short-term financing to investors in real estate who purchase rental properties or fix-and-flip properties.
The loans typically have higher interest rates, upfront charges, and lower loan-to-value ratios. The tactic carries significant dangers in addition to the potential for great profit.
Make sure you're protected if you must return the properties after a foreclosure. You should thoroughly educate yourself before engaging in hard money lending.
2. Investing in discounted notes
Creating or acquiring notes, or real estate debt, at a discounted price from the note's full value is known as discounted note investing. This margin of safety allows you to lower your risk while generating significant rewards.
One method of discounted note investing entails purchasing overdue notes from banks or other owner-finance sellers. People often default while trying to pay off the payday loan. Although this is a profitable technique, the Dodd-Frank Act and other federal and state laws have made it considerably more challenging for small investors to maneuver.
With a few exceptions, small lenders and investors need to follow the same stringent regulations as major lenders. Before using this tactic, it is very important to seek legal counsel.
Long-Term Wealth Building Strategies
Turning a tiny nest egg into a sizable sum of wealth is the main goal of wealth-building tactics. The best method for achieving this goal has long been real estate investing.
1. Buy and hold rentals (Long Term)
This plan involves buying properties with the purpose of retaining them for a very long time. Rental income, a tax shelter from depreciation charges, loan amortization, and price growth are all advantages of this patient and are very effective techniques.
2. Buy and hold rentals (Short Term)
This strategy entails purchasing and holding rental properties for up to five years. By remodeling, increasing the rent, lowering expenses, or any combination above, this tactic is frequently used to force property appreciation, also known as adding value.
For turn-around operations involving multiple apartment buildings, the short-term buy-and-hold strategy excels. It also works effectively for renting out properties in expensive areas that don't have strong cash flows.
3. The trade-up strategy
For investors with an entrepreneurial spirit and the ability to manage many moving components, the Rental Trade-Up Plan is ideal. With the use of a tactic known as a 1031 tax-free exchange, shifting from smaller to larger properties can help you swiftly increase your real estate wealth and income. The Trade-Up Plan functions essentially as follows:
You accumulate the funds necessary for a down payment, closing costs, and cash reserves before purchasing a basic rental home, such as a duplex, at a little discount. After that, rent out the property, increase your equity, and save money for a while—say, two years.
Once you have some equity, you will sell the home and use a 1031 tax-free exchange to buy a larger home at a slightly lower price. Repeat until you achieve your financial objectives, then keep growing.
This strategy succeeds because it combines three effective investment strategies:
1. Bargain acquisitions - Purchasing reliable rental properties at a little lower price.
2. Debt leverage - Possessing a larger property for only 20 to 25 percent of the original cost.
3. Tax-free exchange - Gain equity from a sale, pay no taxes, and then purchase a different property.
Any real estate strategy must be detailed, which calls for local expertise. Additionally, the specific application is determined by your particular situation. You should look for local, skilled individuals to assist you in putting these concepts into practice.
Related Reading: How Much Does Landlord Insurance Cost?
4. Rental debt snowball strategy
The Rental Debt Snowball Plan is one of the best strategies for steadily increasing wealth, lowering risk, and finally producing a steady source of rental income.
It basically entails collecting all the income from your present rentals and other sources, then concentrating that income on paying off one mortgage loan at a time. The brilliance of this approach is in how quickly debt repayments begin to snowball or accelerate over time.
5. The all-cash rental strategy
Because the All-Cash Rental Plan uses the rental income to snowball growth, it is comparable to the Rental Debt Snowball Plan. But you can merely save cash and buy a rental real estate with no debt instead of using mortgages. A high-priced market would make it difficult to get started with an all-cash investment, but it's still a wise choice in many cases.
These paths you might take with real estate help you climb the financial mountain. Each has benefits and drawbacks of its own. Remember that the majority of investors combine various techniques periodically.
As an illustration, you might start with house hacking and go on to long-term buy & hold rentals. Don't be concerned if you attempt one tactic and find it doesn't work for you. Buying and selling real estate is indeed an entrepreneurial endeavor.
Before you locate your sweet spot, you may need to experiment and attempt things that don't work. To keep on putting in the effort is the key factor here.
About The Author: Lyle Solomon has extensive legal experience, in-depth knowledge, and experience in consumer finance and writing. He has been a member of the California State Bar since 2003. He graduated from the University of the Pacific’s McGeorge School of Law in Sacramento, California, in 1998 and currently works for the Oak View Law Group in California as a Principal Attorney.