So you’re thinking about getting started in real estate investing, but you’re not sure where to begin. Maybe you’ve seen an ad on Facebook or Instagram, or perhaps a ‘guru’ is selling a $1,000 course promising a ‘secret’ to get rich with passive income through real estate.
The truth is, real estate investing can be a great way for working professionals to build wealth outside of the stock and bond markets. However, it is certainly not a passive opportunity nor a get-rich-quick option.
In this article, we’ll cover:
- Why Real Estate Investing Can Be a Higher Yield Investment Than Stocks or Bonds
- Strategies for Investing in Real Estate
- Financing Options for Real Estate Investments
- How to Get Started
1. Why Real Estate Investing Can Be a Higher Yield Investment Than Stocks or Bonds
The CFA Institute explains that the return (IR) expected from an investment is broken down as follows:
Here’s what each component means:
- Risk-Free Rate: The minimum return expected from the lowest-risk short-term investment available, such as the US 90-Day Treasury.
- Inflation Premium: The expected annualized inflation during the investment holding period.
- Liquidity Premium: The extra return required for holding an illiquid investment. For example, selling a home is less liquid than selling a US government bond.
- Size Premium: A higher return expectation for smaller opportunities that institutional investors cannot pursue, such as a $100,000 house flip.
- Equity Risk Premium: Varies by asset class. In stocks, it depends on confidence in a company’s management. In real estate, it may depend on a house flipper’s renovation success or a landlord’s ability to secure high-quality tenants.
Fundamentally, if you compare an equity investment in a public company with a private real estate investment of the same risk level, you should expect a higher return from the real estate investment due to its illiquidity and smaller opportunity size. This creates opportunities for retail real estate investors.
2. Strategies for Investing in Real Estate
Value Add and Sell
Also known as house flipping, this involves purchasing a distressed property, renovating it, and selling it for a profit. Key costs to consider include financing, attorney/title fees, and real estate fees. Use this Fix and Flip Calculator to evaluate potential opportunities.
Buy and Hold
Buying rentals is another effective strategy for retail investors. However, finding profitable rental properties has become more competitive. Costs to consider include:
- Loan Payments (Principal & Interest)
- Insurance
- Property Taxes
- HOA Fees (if applicable)
- Property Management and Maintenance Fees
The monthly rent minus these costs is called Net Operating Income (NOI). Aim for properties with an NOI/Purchase Price ratio of 6%-10%.
Buy, Value Add, and Hold
Also known as the BRRRR strategy (Buy, Rehab, Rent, Refinance, Repeat), this involves flipping a property and then renting it out instead of selling. Once the property is improved, you can obtain a cash-out refinance loan based on its new value, potentially recovering your initial equity. Use this BRRRR Calculator to evaluate opportunities.
3. Financing Options for Real Estate Investments
Fix and Flip Loans
Fix and Flip Loans are short-term, interest-only loans. They often cover a percentage of the purchase price and 100% of the renovation costs. For instance, a lender might finance 80% of the purchase price and 100% of the rehab budget. These loans typically have a term of 6-12 months and are repaid upon selling or refinancing the property.
DSCR Loans
Debt Service Coverage Ratio (DSCR) loans are long-term, fully amortizing loans for rental properties. The rent collected must exceed the costs to own and operate the property.
DSCR = Rent / (Principal & Interest Payment + Taxes + Insurance + HOA Dues)
Typically, DSCR loans have a maximum LTV ratio of 80% of the property’s value.
4. How to Get Started
Start by evaluating opportunities on sites like Zillow or Realtor.com. Use the investment analysis calculators provided in this article for fix-and-flip and BRRRR strategies. Once you identify a property supported by sound investment analysis, begin reaching out to an investment property lending firm to find the best fit for your needs.
Bio: “Zach Cohen is the CEO of Ridge Street Capital and has originated over $25M of U.S. Real Estate Debt on single family, multi-family, and commercial investment properties. Zach loves working with local real estate investors with ambitious goals of building big investment portfolios. He is hyper-focused on serving the niche of regionally focused real estate investors and dedicates his time to building out Ridge Street’s capital stack and constantly improving the company’s processes to make getting loans efficient. He is a former Aerospace Engineer and active entrepreneur with core values of integrity and determination.”
Headshot: attached