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Real estate investing 101 isn’t a course taught in any business school, but understanding how to make money in this sector of the economy is important for anyone who owns a home or is interested in investing in income property. While this market can be complicated, there are some basic rules that anyone who wants to make a profit should follow. Consider these the four basic principals of real estate investing 101.
1) Always Invest for Cash Flow; Not Appreciation
This is one of the most common mistakes that new real estate investors make. They purchase a piece of property, then rent it out at a loss for years under the mistaken belief that when it comes time to sell the property they will make enough profit to make up for the years that they lost money. In truth, this is one of the riskiest ways to invest, because it assumes that the value of the property will always appreciate. This is not always the case. In fact, during the 2008 real estate crash home values went down 30%. Rents during that period only decreased by 3%. This means that anyone who sold property during the housing bust most likely lost the money they originally invested. If they had also been taking a monthly loss, that means the entire venture lost money.
Instead, think about how your property can make you money every month. Keep your monthly costs (mortgage, maintenance, taxes, etc.) below what you charge in rent. If you’re considering purchasing a property and can’t make your monthly number come out in your favor, walk away. Your goal should be to generate steady income from your investments, and use any potential windfall from selling the property as a way to buy more properties.
2) See Each of Your Investments
Spend time really looking at each property you are considering purchasing, even if you won’t be the sole owner. When you’re looking at a potential rental you want to really take the time to learn about the maintenance of the property. Look for signs of water and structural damage during your walk-throughs or on the time-stamped photos that are sent to you. Also ask about the age of major appliances and systems such as the air conditioner and water heater. Maintenance costs can be hard to predict, but there are ways to minimize them if you know the issues with a property before you buy.
3) Get Your Assumptions In Writing
This is true when buying, renting, and selling. Real estate transactions come with a lot of legal protections and scrutiny, so it makes sense to take the time and money to make sure everything is done right. In particular, pay attention to the issues surrounding homeowner’s associations. Understand your duties as the property owner, and make sure that you include clauses in each of your rental contracts that ensure your tenants understand and comply with the rules. Also pay attention to the local rules regarding evictions and damages.
When buying property, have all of the information given to you about the maintenance and upkeep of the property included in the contract. This is crucial for getting the property insured, and later you’ll need this information if anything goes wrong. In rental contracts, make sure that the maintenance obligations of the tenant are spelled out. If they are responsible for all repairs below $50, make sure the contract says so.
4) Never Own Investment Real Estate In Your Own Name
Take the time to create an LLC, and use it to manage all of your rental properties. Using LLCs for investing in real estate might cost you a couple of hundred dollars in the short-term, but in the event of a disaster you will want to have the legal protection that comes with conducting business in an individual entity. Without it, a bank or other creditor can come after your other income and personal assets in the event that you are no longer able to make payments on one of your properties or if a tenant sues you for negligence. With an LLC you’ll be legally protected from losing anything that is not included as part of the corporation.
While you’re at the lawyer’s office, take the time to learn local landlord and tenant law. There is always something you can learn about the real estate business.
These four basic rules of real estate investing 101 are meant to be general guidelines. There will always be a property that defies these guidelines, but they are a good place for a novice real estate investor to start.