Real Estate Investing: How it Works and How to Get Started

In the midst of all the “get rich quick” schemes, there is an income-generating method that has stood the test of time: real estate investing.

While the real estate market can go up and down, and investing is not without its risks, real estate investing is still one of the most secure types of investments. The key to making a profitable investment is doing your research and finding the ideal investment property.

How do you make sure you’re making a good investment? In this guide, we answer all of your burning questions so that you can get started with real estate investing the right way.

How Does Real Estate Investing Work?

Real estate investing works to earn investors money through rent income and value appreciation when they purchase a rental or commercial property. Investors earn a rental income from tenants living on the property, or paying to rent the property for their business.

Rather than purchase a property to resell, investors can purchase a property and generate a recurring income by renting the property to tenants or businesses. As their income grows, investors can invest in additional properties, growing their real estate investment portfolio. 

Benefits of Real Estate Investing

The benefits of investing in real estate expand far beyond simply earning a side income. Many people choose to invest in real estate for the tax benefits, the flexibility owning multiple properties provides, and more.

Turnkey Rental Properties: Are They the Right Investment?

The benefits of investing in real estate include:

• Passive Income. The asset does the work so you don’t have too.  This is especially true when you hire a property management company to collect the rents and pay the bills for you. 
• Building Equity. When the property value goes up as you pay off your mortgage, you build equity, or wealth, which you can then leverage to acquire additional rental properties.
• Building Cash Flow for Retirement. Real estate investing can help you generate stable cash flow over time, which you can then use to fund your retirement.
• Diversifying Your Investment Portfolio. Remember, stock value can go to zero, but real estate will not.  Plus it provides income.   If you are already investing through other methods, adding an investment property is a great way to diversify your portfolio.
• Tax Benefits. Real estate investing can provide you with tax benefits, such as through depreciation, helping you retain more cash.
• Mitigating Risk. Markets cycle and companies come and go, but people always need a place to live.

3 Ways to Earn Money from Real Estate Investing

There are three primary ways to earn money from your real estate investments. These include:

1. Experiencing an increase in your property’s value
2. Collecting rental income by leasing out your property to tenants
3. Generating profit from a business that depends on your real estate property

For the purposes of this article, we will be focusing on the last two methods: rental properties and commercial real estate. We’ll discuss how to make money from each of these types of investments.

Wondering what type of real estate investment has the highest return on investment (ROI)? That all depends on you finding an affordable property that presents high income-earning potential.

Rentals as a Real Estate Investment

One of the most popular ways to make money from real estate investing is through rentals. You buy a house or apartment building, rent out the units, and earn money through rent payments from your tenants.

However simple this sounds, it’s not always easy. First, you typically need to clean up or even renovate the place to make it appealing to renters. Then, you have to advertise your property to find tenants. Finally, you need to settle on a lease agreement, manage your property, and collect payment from tenants. 

Due to all of these responsibilities, many real estate investors decide to hire a property manager. The property manager does all of the above so staying on top of your property is relatively hands-off for you. This is the best way to earn a truly passive income from your investment.

Making Money with Commercial Real Estate

Another way to make money with real estate is by leasing your building or units out to a business. Businesses typically pay more than residential tenants because they need office space to conduct business. You still collect “rent”, but you have the benefit of earning more from businesses or corporations.  In addition, businesses typically only report issues during normal working hours, and are generally far less emotional about their tenancy.  This means the commercial investing typically has fewer headaches for the investor.

Not every building will be attractive to businesses. If you go the commercial real estate route, you will want to find something that has what businesses are looking for (like a lot of traffic, connectivity to major commerce areas, large office space). You’ll likely want to hire a leasing agent to find high-paying businesses that would be interested in renting your space.

How to Invest in Real Estate – 8 Steps

Once you decide what type of real estate investment you want to make – residential or commercial – it’s time to find the perfect property. However, just because a property looks nice and is in a popular area doesn’t mean it will be a smart (or profitable) investment.

To avoid losing money – and gain money instead – it’s important that you do your research. Below, we have broken down how to invest in real estate in 8 simple steps to help you find the right property.

Step 1: Get Educated

You can find tons of free resources online to educate you on the best real estate investment opportunities, how to calculate return on investment (ROI), how to evaluate a neighborhood, where the path of building progress is, and what expected lease rates are.  An experienced Commercial realtor will be able to help you sort through the options, and you’ll want to weigh a variety of factors before you make your decision.

Here are a few things to consider:

• What is your primary goal.  I.E. Passive income, long term equity, retirement income, or a tax shelter
• Have you considered the total cash outlay required to achieve your goal?
• Have you considered the type of financing you will use and have you spoken with a lender to make sure you can qualify?
• Have you identified the type of property that you are interested in?  Single family, multi-family, retail, office?
• How much time can you allocate to the management of the investment?
• Will you need a property manager?
• Are the properties you are looking at in good neighborhoods that have a lot to offer potential tenants?  If not are they in the path of progress?
• Will the income generated provide cash flow, cover the mortgage and expenses, and give you the return you are looking for.  Do you anticipate a high rate of return for a modest initial investment?
• What is your budget? How much money would you be willing to borrow?
• How much time are you allowing yourself to find the perfect property?
• How is your local real estate market? Is now a good time to buy?
• Who are the professionals that can help you?

These are just a few of the many factors you might consider when finding an investment property. 

Don’t feel like you have to rush your decision to “get in before everyone else!”. You want to make money, so it’s crucial that you make an informed decision.  At the same time, great deals are attractive to lots of investors.  Make sure you are prepared to strike while the iron is hot!

Step 2: Understand the Benefits (and Risks)

Above we covered some of the benefits of real estate investing, but you should also be aware of the risks. As with any investment, there is always the possibility of not making as much money as you anticipated, breaking even, or even losing money (by having to resell the property for less than what you bought it for). Fortunately, with sound real estate investing, these are not the norm.

Do your research so you can come up with a reasonable estimate on how much of a return you will generate from your investment. Then, educate yourself on the market to assess any possible risks. This is the point at which it may be smart to talk to a real estate investment professional who is well-versed in evaluating the risks of real estate investing. For example, liquidity risk, market risk, and interest rate risk are a few of the factors that can influence financial gain or loss.

Step 3: Set Your Goals

What are your goals when it comes to real estate investing?

If you reviewed the Benefits section above, you know that real estate investing can bring more than just a side income. In fact, investors purchase real estate for different reasons, and it doesn’t always have to do with generating passive income.

Knowing your goals will help you choose the right property for you.

For example, if you know that you want to eventually move into your investment property, then you’ll obviously want to choose something that appeals to your needs. If, however, your goal is to make money with commercial real estate, then you may want to purchase a property that will be in long term demand. Are lots of new companies moving to town?  Consider large office space.  Is there a major housing project going up nearby?  Perhaps a retail center will be needed.  Are you near a university?  Storage and housing are always in demand.  Try to think long term, not just in terms of what will generate the fastest return or is the cheapest option.

Step 4: Get Financing

Most investors understand the concept of a down payment on a loan.  For most investment loans this will equal a minimum of 20% of the purchase price.  However, you will also need money for any improvements, plus an operating fund to cover expenses during the lease up.  If you already have money for a downpayment, then you are ahead of the curve. 

Lenders prefer to lend to business owners rather than just investors.  As a result they offer more aggressive terms to businesses who qualify.  In this case, you’ll have to provide tax returns, profit and loss statements showing you are a solid business with a good track record.  If you can prove this, you may qualify for a small business loan that only requires a 10% down payment when your business activities will cause you to occupy at least 51% of the building you are purchasing.  This can be great for owners, as they can lease out the other space and use the income to offset their expenses.

For non-owner occupied property, which are straight investment deals,  There are fewer options, and it requires a higher down payment.  Typically 20% down and a 25 year amortization period.  The banks may also only give you a five year note with a balloon payment.  

Your real estate agent will typically have some great lending pro’s that can assist you and help you make the best choice.  The earlier you start this process the better the chances of getting a great property, so don’t put this off.   

Step 5: Cash for a Down payment

Once you know your budget, you can determine the amount of cash you’ll need for a downpayment.  Lenders will want to see an excess cash balance to be sure you are a strong borrower.  The money can come from index funds, mutual funds, savings etc, but the bank will want to make sure it is liquid at the time of purchase.

If you are working with a real estate agent, be honest about what you can afford. They will also inform you on whether the amount you have set aside is realistic for the properties you want. It may be that you have big dreams but need to save up for a bit longer in order to acquire the perfect property.

Step 6: Explore Your Real Estate Options

With your goals in mind and budget set, you can begin exploring real estate investing opportunities.

An agent can do research on your behalf, schedule tours, and negotiate with property owners. Working with an agent is the ideal option, as it is less time-consuming and ensures that you are able to compare a wide range of options.  A good agent will be able to perform side by side financial comparisons so you can see exactly how two separate investments will perform financially.  This will ensure you are able to make the best choice.

Step 7: Be Aware of Tax Implications

If you are selling an investment property and purchasing a new one, this is critical.  Any profits you make are taxable as capital gains.  However, the government encourages investors to reinvest in real estate.  As such they created what’s called a 1031 Exchange.  This allows investors to sell a property and invest in a new property of similar or higher value and defer all taxes.  Understanding this concept before you buy investment property will really help you prepare for an eventual exit strategy from the investment.  During your ownership the government allows you to write off a percentage of the investment each year from your taxes.  This helps the cash flow during ownership, but all of that tax has to be reclaimed at the sale, unless you utilize a 1031 Exchange.  Speaking to a tax advisor prior to investing in real estate is a really important part of the process and can save you thousands of dollars.

Step 8: Hire a Property Management Company

Once you find an investment property, navigate the buying process, and officially get the property in your name, it’s time to start generating an income! However, be aware that finding people to fill your units can be easier said than done, and handling their calls and repair request, can quickly become overwhelming.

That’s why hiring a property management company really is your best option. Not only will they market your listings to prospective tenants, but they will also check their credit history, and manage any vendors and repairs that may come up.  Property managers pay your bills out of the rent collected, and make sure you are ready for tax season when it comes.  They send the lease to the new tenant, collect monthly payments, manage your accounts receivable, compile your balance sheet, produce a cash flow statement, advise you on cash vs accrual accounting,  handle maintenance, pay sales tax, disburse your net income, and more – everything you would have to do on your own if you took the self-management route.

It may cut into your positive cash flows initially to hire a property manager, but they will help you make the greatest return by keeping your units filled and ensuring that your tenants pay rent on time. Also, they often get special deals with contractors, so you’ll save money on maintenance and repairs as well.

Why hire a property manager vs take the self-management approach? Check out this page to learn more.

Should You Invest in Real Estate?

If you want to make an investment that will generate money for years to come, then real estate investing may be right for you. However, as with any type of investing, your success depends on being informed and understanding the market.

Our guide has grazed the surface in terms of what you need to know when it comes to real estate investing. Every individual situation is unique, so you need to speak to a professional who will take a tailored approach. They will help you find the best investment opportunity for you.

Want to find the perfect investment property or looking for property management services? Contact us to speak to a trusted real estate investment professional.

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