Odds are you weren’t born rich. I wasn’t. Odds are you don’t have an invention to change the world. I don’t. You have probably figured out that you will not become truly financially independent (i.e. not getting up for work every day unless you want to) by working for someone else. But that’s perfectly okay! There is still a path to financial freedom. We’ve all seen the HGTV, A&E, and DIY shows about real estate on TV (“Flip This House,” “Million Dollar Listing,” etc.). Everyone seems so rich! Well, it is TV, but I can tell you that many of these people are indeed very wealthy. Andrew Carnegie once said, “Ninety percent of all millionaires become so through owning real estate.” That’s a pretty staggering statistic. I bet the true percentage is a bit lower, but it probably isn’t that far off. You may be asking yourself, “How do I invest in real estate?” There are many variations, but we will cover the five most popular. The choice is yours.
- Buy a house, and be a landlord – When I tell people that I am a landlord, I get mixed reactions. Three out of four people look at me like they feel sorry for me. These folks inevitably follow up with comments like, “I couldn’t do it. Getting up in the middle of the night to unclog a toilet… I just couldn’t do it.” Another common response is, “I don’t want to spend my time chasing my rent money.” I get it. People don’t want to be bothered. Maybe I’ve been lucky, but the financial benefits absolutely pay for the work I do as a landlord. The golden rule for this real estate investment strategy is simple. Make sure the property “cash flows.” So long as you are putting more cash in your pocket than comes out every month (i.e. gross rents collected minus all bills and debt service should equal a positive number), the equity you are building in the property is your reward (AKA profit). To learn how to be a landlord, I suggest reading Rich Dad’s Advisors: The ABC’s of Property Management: What You Need to Know to Maximize Your Money Now.
- Buy a house, and hire a property manager – So you don’t want to be a plumber at 4:00 AM or chase your rent money. Okay. Hire a property manager? A decent property manager will charge 10 percent of gross rents collected as his fee (note: I said gross rents, not profit). The same, “Make sure the property cash flows,” rule applies here, but now you have taken 10 percent off the TOP! Does your property still cash flow? Maybe, but the numbers are going to be much tighter. You need to do the math. In future posts, we will explore cash flow in detail and will see how property management can kill your return in certain cases. When you have more units than you can personally manage (>15 or so), you really do need a property manager. When you have a lot of units, the numbers start to look better, and you can afford property managers. If you want to hire one, this article has some good tips.
- “Flip” a house – This is by far the riskiest way to invest in real estate, especially if you haven’t inspected the property before the purchase. You cannot get a conventional or FHA mortgage on a house that you intend to flip because it will not pass the bank’s inspection. If it passed the inspection, then you probably aren’t going to make any money because the house isn’t in bad enough shape for you to add substantial value. Therefore, you need cash (from your savings or a private investor) to buy these homes in “disrepair”, which means a whole lot of your money is at risk or you are under a tremendous time crunch to get out from under the private money loan. You also are buying the house “as-is,” which means you had better be extremely handy or have a rabbit’s foot in your back pocket. There will be surprises, and you have to foot the bill for these expenses with, you guessed it, CASH! If you intend to make a profit by flipping, you really need to be prepared to put in long, physically demanding hours and be good at managing your blood pressure (maybe you are a Zen Master – I’m not). Think you can just hire people to fix it for you? That’s fine if you do not mind making $10,000 for six months of supervising. If you are feeling brave, The Book on Flipping Houses: How to Buy, Rehab, and Resell Residential Properties (BiggerPockets Presents…) is a good place to start.
- REITs – Real Estate Investment Trusts are companies (technically a corporation, trust, or association) that are strictly regulated by the Internal Revenue Service (IRS), and if publicly-traded, the Securities and Exchange Commission (SEC). According to the SEC, “A real estate investment trust (“REIT”), generally, is a company that owns – and typically operates – income-producing real estate or real estate-related assets. REITs provide a way for individual investors to earn a share of the income produced through commercial real estate ownership – without actually having to go out and buy commercial real estate.” Publicly-traded REITs are similar to common stock that you are familiar with. However, the managers of the trust must follow VERY specific profit distribution rules in exchange for preferential tax treatment. REITs must pay out at least 90 percent of their taxable income to the shareholders. IRS code allows REIT shareholders to avoid double taxation that typical C-corporation shareholders encounter by exempting the distributed dividends from the REITs taxable income. REITs are a solid choice for investors who do not have the time to or want to deal with #1 – #3. However, as a REIT shareholder, you have as much control over the investment decisions of the company as you would if you bought 10,000 share of Bank of America (BAC) stock (VERY LITTLE!). Lots of information is packed into Cash Is King: Investing in REIT Preferreds to Generate Long-term Income.
- Be the Bank! – So you don’t want to be a landlord. You don’t want to worry about property managers killing your returns. The sound of flipping a house gives you the chills. You want to have real control of your money. You want insurance (AKA collateral) on your investment. When you put your money into your local bank, the bank uses the money to make loans (many of them mortgages). The spread between what they charge borrowers and what they pay you is their profit. Centuries ago, bankers realized that making a loan on a piece of tangible real estate is much safer than almost any other type of investing. If the borrower doesn’t pay, the lender can recoup their money by foreclosing on the property. Why not bypass the middleman (the bank), and earn 100 percent of the interest that is ultimately earned using your money? Bypassing the bank and lending directly to those who get their hands dirty is called private money lending or hard money lending. Returns range from six to 10 percent. Try getting that out of a Certificate of Deposit or your savings account!
My question to you – “Of the five options presented above, which one makes the most sense for you?” To learn how to earn high, secured returns by financing real estate transactions, see my webpage (full disclosure – I am the President of South Buffalo Reatly Company).