Is it a good time to buy real estate?
Hmmm, that’s a complicated question, and there is no correct answer for everyone. Some people try to time the market, which can result in overanalyzing, or what people call “analysis paralysis.” Other people jump right in with two feet without carefully analyzing their purchase. There is a happy medium and some key metrics one should consider before investing in real estate to build your wealth and get on the road to financial freedom.
That said, NOW is the right time to educate yourself about investing in real estate so you will be confident and have your finances in order when the time is right. Real estate investing can be daunting to a beginner, but when done the right way, it is one of the best ways to build wealth. Keep reading to find out more about this proven wealth-building mechanism.
My name is Gretchen, and my husband and I have nine doors. We aren’t big-time investors, and we bought our first property when we were in our 50s. In the six years since we bought our first property, we have more than doubled our net worth and increased our income with solid, reliable investments. Last month we purchased what will become our dream retirement home as part of our real estate investment strategy.
Neither of us has a background in real estate or finance; we don’t make huge salaries, I am a graphic designer, and he is a marketing guy.
Our biggest regret is that we didn’t invest sooner.
Why should I invest in real estate?
Set Goals
You must determine your goals and how much time you want to spend working on your real estate portfolio. We wanted some income that would be primarily passive, properties we could manage part-time by ourselves until we retire, and an opportunity to diversify from the stock market into something safe and predictable.
- Do you want a few properties to diversify your income and net worth, or do you want to be a multi-family mogul?
- Do you want to be hands-on and renovate the properties yourself?
- Do you want to buy turnkey properties that are rent ready?
- Do you want to retire at 35?
- Most importantly, how much time and risk are you willing to take to achieve your objectives?
Risk vs Reward
Of course, the more risk, the greater the reward, but there is also a more significant opportunity for a downside. Real estate isn’t a get-rich-quick scheme, so you should be prepared to hold on to your investments for several years in case the market drops. If you purchase the right property with adequate cash flow and screen your tenants carefully, you will have long-term success because you can weather a downturn.
Friends and relatives warned us it was risky when we purchased our first rental property. Every single one of them owned stocks and mutual funds. My husband and I also own stocks and mutual funds as well, but aren’t they risky too? The average person has no idea if those companies will be the next Enron or if the CEO is doing shady deals. It is easy to drive by our rental properties and we control who rents them. Since the beginning of 2022, our 401(K)s have dropped about 20%. However, during this same timeframe, we increased our monthly income by an additional $975 because we were able to raise rents on some of our units. Through real-estate we are able to be financially free.
Friends and relatives also warned us we’d get calls in the middle of the night to fix toilets. Well, it has been 6 years with as many as ten doors, and it hasn’t happened yet. Yes, we get occasional texts about maintenance issues, but we call the plumber or repairman. Again, we intentionally improved and maintained our properties, cutting down on surprises.
When is a good time to invest in rental properties
Although we looked at a minimum of fifteen properties, two stand out in my mind. The first was a solid, brick four-plex in a rough neighborhood that barely cash flowed and an off-market two-unit property that consisted of a small house and smaller cottage that needed what we thought was a ton of costly electrical and cosmetic work.
Within ten years, the neighborhood where the fourplex was located became one of the hottest spots in town and would have appreciated over five times the purchase price. We could have rented that mid-century gem to hipsters for a small fortune or made it into condos and sold them one by one. Sigh…
The off-market house and cottage wouldn’t have been as costly to renovate as we thought. We hadn’t educated ourselves on renovation costs and would have rented for double what we estimated because we didn’t understand the rental market. It would have been an excellent investment. That said, we didn’t have a crystal ball and learned a lot looking at and analyzing those and other deals.
What I learned doing my research.
For about five years, I listened to hundreds of podcasts, read many books, and talked to many investors. I learned that real estate is such an excellent investment because if you purchase it correctly, it provides more ways to increase your personal wealth than just receiving rent from your tenants. If you invest some of your money in a stock or mutual fund, the money will likely grow over time. Of course, as we all know, it is subject to market dips and increases, and you have no idea how the companies we own stock in are being managed.
With real estate, as long as the rent covers the mortgage, maintenance, and repairs, plus some for reserves, the fluctuating value of the actual property really doesn’t matter too much in the short term. Investing in real estate isn’t a get-rich-quick scheme, although people have become very wealthy quickly under certain market conditions.
Investing in real estate has Five Powerful Wealth Building Mechanism
There are five main features of real estate investing which maximize returns. Other investments might give you one or two of these features. Still, real estate offers cash flow, the opportunity to leverage a 20% investment to control 100% of the property (mortgage payoff), tax benefits (depreciation), and an increase in the value of the asset (appreciation).
1. Cash Flow
Cash flow is the rent received from your tenant minus payments on debt service (mortgage), taxes, property insurance, and other expenses like upkeep, garbage, utilities, and property management (if you don’t manage your own properties).
Because you can increase rents over time, your cash flow is likely to rise. According to the Consumer Price index from the US Bureau of Statistics, historically, rents have risen an average of about 3.75% yearly between 1980 and 2022. If you have a fixed-rate mortgage, your principal and interest payments will remain the same, so your overall cash flow should increase. That said, don’t assume you won’t need reserves if something breaks down or your tenant stops paying.
2. Leverage
Leverage on real estate is just a term for buying properties with borrowed money. Using leverage allows you to control and own the property without immediately paying the property’s total purchase price. Instead of paying $200,000 cash out-of-pocket for a property, you only need to pay a percentage (usually 20% on non-owner occupied property with 1-4 units). You will get a mortgage for the remaining amount of the purchase price.
Suppose you purchase our hypothetical property at $200,000 as a non-owner occupied (rental) property. In that case, you may only pay 20% down, or $40,000. and you will get a mortgage for $160,000, but you will reap the rewards of the property’s appreciation on the entire $200,000 and collect 100% of the rents from the property.
Leverage can also be a hedge against inflation. If you choose a fixed-rate mortgage on $160,000, that amount won’t increase with inflation. You will still owe the same monthly payment and get to pay it with an inflated dollar. As shown in the example bar graph, rents will have risen, but your principal and interest payment will remain the same.
3. Mortgage Payoff
On a mortgage with a standard 30-year term, all you need to do is keep the rental property occupied with good tenants and well maintained, and you will own your property free and clear in thirty years. Your tenants will actually pay the property off for you.
If you have converted a portion of your primary residence into a rental unit, you will have tenants paying off all or a portion of your mortgage, and you will have lowered or no living expenses.
4. Depreciation
The federal government allows real estate investors to depreciate their property over time. This means you are allowed to write off a portion of the cost of the property as well as improvements made to the property on your taxes.
Three important facts about depreciation for residential properties in real estate:
- Land does not depreciate.
- The building does depreciate, for residential properties the depreciation time is 27.5 years. Over 27.5 years, the IRS lets you depreciate the building to zero.
- Interior improvements like appliances and flooring also depreciate, but on different schedules defined by the IRS.
Other tax benefits for investing in real estate will be covered in future blog posts. Consult your tax professional for details about claiming depreciation on rental properties.
5. Appreciation
When a property increases in value over time, it is called appreciation. Residential real estate appreciation can vary significantly from market to market, year to year. According to the National Association of Realtors, historically, residential real estate increases by 5.7% per year.
In the short term, residential property prices may fluctuate, so you shouldn’t expect to “flip” a property in this current market.
Investors can force appreciation by renovating properties to repair structural defects, update mechanical systems, make them more functional, update the cosmetic attractiveness, add a garage, an additional unit, bedroom, or bathroom to an existing property. This will result in higher rental income or cash flow and make the property worth more to purchasers if you decide to sell.
Even if you don’t do significant upgrades but keep your property functional, structurally sound, and rent-ready, your property will appreciate over time. And because of your tenants, the mortgage will be paid off.
How Do I know if it is a Good Deal?
My husband and I are very risk-averse and suffered from extreme analysis paralysis. After years of research, reading tens of real estate books, listening to podcasts, and reading blogs, we devised a strategy that fit our risk tolerance and financial goals.
Educate yourself
The first book I read that made me look at investing, money and working differently was the classic Rich Dad Poor Dad by Robert Kiyosaki; that book is a game changer. It is an easy read and helped me gain a new mindset . I changed how I looked at money and financial independence. Everyone should read it. I was so inspired by what Mr. Kiyosaki had to say that the next book I read was Rich Dad’s CASHFLOW Quadrant: Rich Dad’s Guide to Financial Freedom. This book helped me implement the thinking in Rich Dad Poor Dad. I wish I had read it thirty years earlier. After reading these books, I read and listened to podcasts more in line with real estate investing. If I was in the car or working out, I was learning from a podcast. I will discuss some of those resources in another blog.
After educating ourselves, we decided to invest in small multi-family properties. We looked for properties that needed some work or that had some hidden feature that made the property desirable, like an area that could become an extra bedroom or even an additional unit. We converted a three-car garage into a two-bedroom cottage at one property and converted a 2 story Victorian into two units at another property. By doing this, we increased our cash flow by several thousand dollars a month and forced appreciation.
Our Philosophy
Our philosophy is that unless you can afford to speculate by purchasing for appreciation, investing for cash flow and long-term holding is always better. We also like multi-family properties, duplexes (two units) or triplexes (three units) because it is unlikely all the units will be empty at one time. We feel that our cash flow is more secure in these properties.
Upon purchasing the properties, we typically update them so they are a little nicer than the properties they are competing with, and so that we have less unexpected maintence.
Having newly renovated properties also keeps our maintenance costs low, and it has reduced the number of calls we get from tenants.
If the market flattened or dropped off like it is now, we were unlikely to have a terrible loss because the tenants would continue to pay the mortgage and generate cash flow. Because the properties we purchased had more than one unit, there are multiple sources of revenue. All the rent wasn’t coming from a single unit.
As a result, we have always been able to reap the benefits and wealth diversity real estate investing allows. Buying for cash flow and forcing appreciation limited our risk. Because the housing market is dropping now, the next year or so may be a buying opportunity of a lifetime, but when you buy smart, it is possible to make a great deal in any market.
It’s Never Too Late to Invest in Real Estate
Unfortunately, we were in our fifties before we purchased rental real estate. I do regret we hadn’t started earlier. We weren’t aware of some of the strategies that are being used every day by real estate investors.
Now is the perfect time while the market settles down to get your finances in order and educate yourself about options in real estate investing.