When it comes to real estate investing, many people make it much harder than it really needs to be. The guru’s want you to think it’s hard, so you’ll pay them 10’s of thousands of dollars to teach you the “insider secrets”.
Truth is, there are a few key things to know to be on the path to success and freedom (both financial and time) in no time!
The Newbie’s Guide to Real Estate Investing
1. You’re Not Buying A House To Live In Personally
This is probably the biggest thing I deal with when it comes to new investors. They want to tour every single property like it will be one they will live in soon.
When it comes to investing in real estate, you need speed.There is nothing fast about going to look at a house. Nothing.
Scheduling tours, coordinating access with existing tenants, “thinking about it”, “sleeping on it”, whatever else needs to happen before you actually sit down, run the numbers and determine if it makes sense.
When buying an investment, the numbers have to work first.
If you can’t buy it at the right price for the numbers and returns (return on your money) to work, then don’t waste your time going to look at it. You can write up 10-15 offers on properties in the time it takes to go look at one.
Once you have one under contract at a price that works financially, you can then vet the property to make sure it structurally and aesthetically works with your numbers.
This is a bit backward from a traditional home purchase, but makes sense now, right?
If some work needs to be done, you renegotiate that with the seller and either reduce the price, they make the repairs, or you walk away from the deal. At no time were you at risk of losing any money.
You’re in an inspection contingency phase, so you’re protected.
2. Run The Numbers
This is the first step when determining whether an investment is worth a second look. Run some quick numbers to see if it makes any financial sense before you even waste time with offers. But how do you do this?
- Start with the rent. You can take the current rent (if it’s already a rental) or use sites like Zillow or Rentometer to get an idea of current rents in the area. Then assume that 50% of the monthly rents are going to expenses. This is a quick rule of thumb. This isn’t set in stone and isn’t rocket science. Every market will be different by a few percent. Here in my markets, we see closer to 45% in expenses, but 50% works well and is conservative. This number (income minus expenses) is called Net Operating Income (NOI).
- Once you take the rent minus expenses (or just multiply rent by 50%) you can then multiply it by 12 – because there are 12 months in a year. This will give you the annual income of the property after you’ve paid expenses.
- If you take the annual income and then divide it by the purchase price, you will get the rate of return, or ROI (return on investment), of the deal. This assumes there is no loan or mortgage and is the simplest calculation. This is also the closest comparison to the stock market in a true purchase and return number. If you’re above 8%, you’re beating the historical average of the stock market, and in my opinion, have a decent investment (at first glance).
- You need to weigh factors like crime, schools, etc when determining what level of return you should expect on an investment. Just like in the stock market, the more risk, the more reward. You wouldn’t expect to have a very high-risk stock and get a very low-interest rate. Same thing works in real estate.
- Once you determine if the numbers work, you can make an offer and get it accepted by the seller. Once this happens, you’re now ready to actually go check the place out. This can be done by yourself, a third-party inspection company, or a combination of the two. Once you’ve checked the place out, any major repair items that need to be addressed before a tenant can move in need to be accounted for in your calculations. Just add them to the bottom number with the purchase price when calculating return on investment (ROI). This most likely will throw the numbers off and you’ll need to reduce the original purchase price to accommodate the needed repairs.
3. Choose A Property Manager
Assuming you’re under contract and negotiated the repairs or a reduced price to get the numbers to work, you’re now moving forward with the deal. Congrats!
The most important step in the success of your investment will be your property manager, and that includes you. Many people choose to manage their own properties in the beginning.
For someone that thinks they want to do this, I recommend you giving it a shot. Eventually, you end up with a tenant situation that makes you realize there are professionals doing this for a reason.
I highly recommend professional property management.
A key factor is the number of units the management company is handling on a monthly basis. You would be surprised how many a guy with a pickup truck and some tools can handle.
What we have found over the years is that 250 units seem to be the magic number. Managing more than this consistently requires a solid team, systems, processes and procedures that will help everyone be successful.
Look at the fees! The monthly fee that you will pay your rent for the property to be managed will range from market to market, but the standard across the industry tends to be 10%.
This means if you have $1000 in rent, $100 will be paid to the PM each month to manage the unit for you. This is a small price to pay for the time freedom you get from dealing with the unit.
Additionally, this is a small price compared to what some other fees can be.
- Lease up fee. This can range from anywhere between 1/2 to 1 month’s rent as a commission paid to the PM. Make sure you know what this fee is because you will pay it each time a new tenant is placed.
- Eviction fee. Eviction is a scary thought, but it’s not that bad and not that big of a deal. Eviction fees can be scary though, as these can range dramatically from PM to PM. Make sure you ask!
- Other Misc fees. Good PM’s are going to charge you the two main fees listed, and their monthly fee. On top of this, many PM’s will try and charge fees for other things like inspections, tune-ups, etc. Make sure you ask what other fees are involved.
4. Close The Deal, Place Tenants
Once you’ve selected a PM, you’ll want to get signed up with them and let them know that you are planning on using them for the property. This way they can be prepared and ready to run when you close on the deal and become the owner.
In the case where the property is vacant, you will need a tenant to start making money. Screening and placing tenants aren’t as hard as people think. We recommend the following things:
- Income Verification – Nothing is worse than being in over your head with your finances. Verifying 2-3x the monthly rent in income is key here to make sure that when things get tough for the tenant they have enough money to pay their bills, and most importantly, you!
- Criminal Background Check – What you can and can’t check for and use against a tenant for placement purposes varies by state, so make sure you rely on your PM here to guide you on legal landlording. Where allowed, make sure you run a background check so you know who you are dealing with.
- Credit Check – This one may or may not matter as much to you when it comes to scoring. In a lot of cases, tenants aren’t going to have great scores and this is the reason they are renting. In other cases, they don’t want to be tied down to a purchase and their credit will be squeaky clean. The key here isn’t the score, it’s the outstanding debt. While checking the income was important, so is knowing what hidden bills the tenant has to pay. If the tenant makes $10,000 per month but has a $6000 per month judgment with the court, they really aren’t making $10,000. Make sense? You need to run this so you know the entire picture.
- Eviction Check – As a landlord, this one is huge. Just like you hear where after the first divorce, second and third marriages have an even smaller percentage chance of working out? Same thing in evictions. People are scared of them. Tenants are scared of them until they go through them. Then they aren’t anymore. There are tenants out there that have been through the process enough to know how to fight it, how to beat it, and in some states, this can mean them living in your property rent-free for a very long time. Making sure your tenant has a clean eviction history shows that they have paid their rent and honored their contracts in the past.
5. Get Help
All of this can seem overwhelming and daunting, especially if you’re not investing locally. Many investors live in very expensive markets which make it very cost prohibitive to buy locally.
They then consider investing remotely, or “Out-of-state”. This can provide its own challenges, as now on top of everything else you just had to do, you need someone locally you can trust to help you be successful.
For example, The Marie Paul Company in Cleveland, Ohio helps investors by sourcing rental properties, has great contacts and connections with local property managers, contractors, insurance carriers, lenders, title and closing companies, attorneys, and real estate professionals. They are able to bridge the gap for remote investors.