Getting Started

Real Estate vs. Stocks: Part 2 – Average Returns for Average Investors

by Brandon · 7 comments

(This article is part two in a two-part series on stocks versus real estate)

Last time, I discussed the idea of the “hero stock” and why the idea of “just picking that one special stock” is absurd and dangerous to your money.

In an answer to this gamble, many financial advisers recommend a diversified (spread out) portfolio, using mutual funds to spread out risk over dozens or hundreds of large companies. This definitely spreads out the risk of losing all one’s money on a company that goes out of business.  The stock market on average over the past 40 years has provided an average return of around 10% per year. Stock salesmen love to point to this number and tell you that this return is better than anything you could get in real estate. Just give them all your money, plus their commissions, and they will provide for your future.

The problem is – with stocks and mutual funds, you are giving up the most important part of your ability to make money – your brain. You are completely dependent upon forces out of your control to make money. Yes, the stock market has traditionally provided a generally stable return, but this return is miniscule to what you could earn in real estate.  Are mutual funds better than nothing? Yes!  Anything is better than burying your money in the ground (or a checking account). An average return of 10% is better than losing money to inflation. However, average returns are for average investors.

By reading articles like this one – it is clear you are not a typical “bury in the ground” or average investor. You want more.  Real estate investing will give you more. Why? One word: leverage. Leverage is the ability to use borrowed money make you money. When you buy a stock, $20,000 lets you buy $20,000 worth of stock. With real estate, however, $20,000 will let you purchase $100,000 or more worth of property (or $500,000 if it is your personal home).

Lets look at an example.

You have $20,000 this year to invest. You want to decide between buying diversified stocks or real estate. Let’s look at both:

  1. $20,000 invested for 10 years and receiving an annual interest rate of 10% could be worth $54,140.86 – a gain of about $34,000. Not to bad. This equates to an average annual gain of almost 17%.
  2. You purchase a newer three-bedroom, two bathroom home in a family neighborhood for $100,000.  You put a down payment of $20,000 (the sellers pay closing costs). Total mortgage payment (on the resulting $80,000 at a 5% bank loan) is $430 per month. The home rents for $1200 per month.  After paying taxes, insurance, a maintenance guy to fix stuff when it breaks, and a other incidentals, you cashflow about $450 per month or $5400 per year. Putting this money back into the loan (not that you would have to, but to compare apples to apples from the stock scenario above), after ten years you will owe nothing on the loan.  Zip. Zero. Additionally, property in the US has appreciated at an average of 3% per year. So, you now own a property that is worth $135,000. Even taking out your initial investment and the cost it would take to sell, you have over $100,000 in equity, equating to a 50% return on investment – three times higher than that of the mutual funds. This 100,000 can now be used to invest in something bigger, better, and with more value.

At the risk of sounding too biased, there are drawbacks to real estate investing.  For one, the money is not liquid. This means that if you suddenly wanted to pull out all your money, it would take time.  Stocks are much easier to get in and out with.  Additionally, stocks do not require any extra leg work. You don’t need to drive by the stock, get phone calls from the stock, or evict a stock.  However, personally I could not invest in something that I couldn’t materially participate in. Perhaps its a lack of trust in others, but I want to have complete control over the destiny of my money. When I make or lose money, I want to make it or lose it by something I did or didn’t do.

This scenario is not a once in a lifetime deal or even a great deal. It is a very conservative look at investing. I believe in maximizing return by purchasing properties well below their value, adding tens of thousands of dollars in equity before even closing on the deal. In the house scenario above, I would have paid $60,000 for it instead, adding hundreds to monthly cashflow and tens of thousands in immediate equity. That is true real estate hacking.

P.S. looking for hard money loans in California? Be sure to check out my friends over at northcoastfinancialinc.com. They have very competitive rates, can fund within a week and specialize in fix and flip loans and other hard money loans.

The Nine Niches of Real Estate Investments

by Brandon · 2 comments

I do not like nuts. Pecans, almonds, peanuts, walnuts, cashews, and all other nuts make me cringe. So when I open up a gift box of assorted chocolates, I tend to panic a bit, desperately desiring the milk chocolate goodness with the soft caramel inside but fearing the dreaded trojan horse filled with nuts and evil. When I choose wrong, I spend the next hour spitting tiny shards of nuts out of my teeth and vowing never to eat another chocolate from the mystery box again. For those who know me, though, that is a short-lived promise.

Real Estate Investments are like a box of chocolates. No, not in the Forest-Gump-Never-Know-Whatcha-Gonna-Get kind of way. Rather, there are many different types of investments all within the same “investment box”. Some might appeal to one type of person, some might appeal to another type of person. However, each investment uses most of the same basic principles and fundamentals.

Just as I tend to focus in on the caramel-filled chocolates in the box, I also have focused in on my niche in the field of real estate investments – small multifamily properties. However, you might be different. Your background, relationship to risk, family life, and your location may all affect which area of real estate you will begin investing in. The following is a brief summary of the nine major types of real estate investments.

Types of Real Estate Investments:

  • Raw Land –This is as “raw” as it gets (see what I just did there!). Purchasing land usually does not produce cashflow, but can be improved to add value. Land can also be subdivided and sold as well for profit.
  • Water/Mineral/Oil/Gas Rights – The cousin of investing in raw land, this is the process of buying and selling a person’s (or company’s) right to use the minerals (or water, oil, gas, etc) on a property.
  • Single-Family Homes – This is the most common investment for most first time investors. Single-family homes are easy to rent, easy to sell, and easy to finance. Single-family homes may be more difficult to cashflow, and can take a significant amount of time and effort to purchase just one unit.
  • Duplex/Triplex/Quads– Small multifamily properties (2-4 units) such as these are one of my favorite investment routes. These property types combine the financing and easy purchasing benefits of a single-family home with the cashflow benefits and less competition found in larger investments. Best of all, these properties can serve as both a solid investment as well as a personal residence for the smart investor. See “Getting Started Investing in Real Estate – Part 3: Creating Criteria” for more information.
  • Small Apartments – Another favorite of mine, small apartment buildings are made up of between 5-50 units. These properties can be more difficult to finance, as they rely on commercial lending standards instead of residential lending standards. However, these properties are excellent in terms of cashflow. They are too small for large, professional REIT’s to invest in (see below) but too large for most novice real estate investors. Additionally, the value of these properties are based on the income they bring in. This creates a huge opportunity for adding value by increasing rent, decreasing expenses, and managing effectively. These properties are a great place to utilize on-sight managers who manage and perform maintenance in exchange for free or decreased rent. At this level, real estate can truly become 90% passive.
  • Large Apartments – These buildings are the larger, nicer complexes you see all around the country, often times in upper-middle class neighborhoods in the suburbs. They often include pools, work-out rooms, full time staff, and high advertising budgets. These properties cost tens of millions of dollars to buy but can produce solid returns with minimal hassle.
  • REITs– REIT stand for a Real Estate Investment Trust. At the risk of oversimplifying, a REIT is to a real estate property as a mutual fund is to a stock. Many investors pool their funds together, forming a REIT, and allow the REIT to purchase large investments such as shopping malls, large apartment complexes, and skyscrapers. The REIT then distributes profits to investors. This is one of the most hands-off approach to investing in Real Estate, but do not expect the returns found in hands-on investing.
  • Commercial– Commercial investments can vary significantly in both size and style, but ultimately involve leasing property to businesses. Many commercial investors lease buildings to small local businesses, while others rent large spaces to supermarkets or big box superstores. While commercial properties often provide good cashflow and consistent payments, they also have much longer holding periods during times of vacancies. While most residential properties can be rented within weeks, commercial property can sit empty for months or even years. New investors should avoid these types of investments until they have significant cash reserves to weather the vacancy storms.
  • Notes – Investing in “notes” involves the buying and selling of paper mortgages. Often times an owner of a property may choose to offer financing and “carry the mortgage”. In this case, a “note” would be created which spells out the terms of the contract. For example, an apartment owner decides to sell his property for one million dollars. He offers to carry the full note and the new buyer will make payments of 8% per year for thirty years, until the full one-million dollars is paid off. If that owner suddenly needed to get the full balance of the loan, he might choose to sell that mortgage to a “note buyer” for a discount. That note buyer will then begin collecting the monthly payments and decide if they will keep the note or try to sell it for profit.

As you can see, there are a lot of different types of investments and within each type there are sub-types as well and different roles within those sub-types. This may seem daunting, but the wide variety of different types of investments is actually a great thing, as there is a type of real estate that appeals to almost everyone.  For me, I love finding under-developed small multifamily properties and adding value to increase cashflow and equity. That is my chocolate with caramel.  What is yours?

P.S. looking for hard money loans in California? Be sure to check out my friends over at northcoastfinancialinc.com. They have very competitive rates, can fund within a week and specialize in fix and flip loans and other hard money loans.

Getting Started Investing in Real Estate – Part 3: Creating Criteria

by Brandon · 4 comments

This article is part three in a four part series on Getting Started Investing In Real Estate (to read part one, click here or to read part two click here) I first explored the importance of gaining an educational foundation before anything else in real estate. Next, I explained the necessity of creating a plan so you are not wandering like the Old Testament Hebrews in the desert. Today, it’s time to formulate the criteria for the house you will be searching for.

What Your First Investment Should Look Like

Your first purchase should be your own home. However, in the words of Robert Kiyosaki and his Rich Dad Poor Dad book, “Your home is not an asset. It is a liability”.  In other words, a typical home – while it may increase in value over time – is not an investment.  It will usually end up taking money out of your pocket, not putting money into it.  That’s not to say it isn’t important, but how can you combine the need for shelter with an investment that makes sense?

Simply, don’t follow the blind masses and go search for that perfect home with the white picket fence that pushes the bounds of what you can afford.  You will have plenty of life ahead of you for that home and much more if you desire.  However, if you want to build a solid foundation for using real estate to fund your life adventures, you need to buy the correct house that is an asset to you and fits with your investment plan.

What should I buy?

I recommend that you look into a small multifamily building such as a duplex, triplex, or 4-plex.

Why?

A small multifamily property has several distinct reasons for making it the ideal first purchase.

  1. Easy To Finance: Multifamily properties with 2-4 units are as easy to finance as single-family homes. You can get into a home for around 3.5% down payment and ask the bank to pay the closing costs. If the property is already filled with tenants, you will also receive the security deposits from the existing tenants when you take over.
  2. Easy to Gain Experience: Multifamily properties will get your feet wet in the landlord business. I’m not saying you need to be the one fixing toilets at 3 a.m. (see my 5 Tips for Hassle-Free Tenant Management). However, the experience you gain from these small units will translate into a lifetime of headache saving skills.
  3. Easy to Cashflow: When starting out in Real Estate, your goal should be to get your cashflow as high as possible. This means the money that goes out in bills must be much less than the money coming in. As landlord – you get to keep the difference. This is cashflow.  Multifamily homes are generally much easier to get good positive cashflow on, thus they are the perfect tool to get you out of your day job and on with your life.
  4. Less Competition:  Small multifamily houses are outside the radar to most home buyers, so the law of supply and demand is on your side in getting a killer deal. Less competition = a better deal for you.

Are you going to fail miserably if you go out and buy a typical single family home as your first purchase? No. However, the financial benefits of a multifamily home will put you far ahead in your investing career and set you up for a higher likelihood of success. Tomorrow’s post will be the last in this series and will focus on the actual steps to purchase your first home.

Leave a comment below and then click here to go to part four in this series “Getting Started Investing in Real Estate”

P.S. looking for hard money loans in California? Be sure to check out my friends over at northcoastfinancialinc.com. They have very competitive rates, can fund within a week and specialize in fix and flip loans and other hard money loans.

Getting Started Investing In Real Estate – Part 1: Gaining Free Education

by Brandon · 10 comments

Investing in Real Estate at a young age requires a different approach, style, and skillset than investing at an older age. However, the principles behind sound investing do not change whether you are twenty or eighty.  This article is part one of a four part series on how to begin investing in real estate at a young age. If you only read one article – let it be this one.

My brother recently received his tax rebate check of over $1000 and asked me, “I want to invest this money – how should I start?”.

He expected me to tell him the secret to buying a house with a minimal down payment or a hot new tip on investing in gold (which I am adamantly opposed to, but that is topic for another post). Instead, I told him to use that $1000 to gain education.  No, I don’t mean college or a cheesy seminar with a so-called “guru”.  In fact, I suggested he use his money to take a week off work and spend a week at the beach reading books.

Education is the first step to any investment dream and congratulations, by reading this blog you have already taken that first step.

There are numerous ways to learn how to invest, most which are free.  The technique you use to learn greatly depends on your learning style.  The following is a list of just a few. I encourage you to check out as many as you can to determine your favorite way to learn.

  • Books – This learning method goes without saying, but I would like to emphasize the power of public libraries in gaining free education.  This technique resonates most with my personal learning style. During the first year after I decided to get into real estate investing at twenty-one years old, I checked out every book in my library’s regional collection dealing with real estate investing – well over a hundred – and read each one cover to cover.
  • Blogs – These are an amazing source of information, written by people living in the trenches of real estate. Websites such as http://www.BiggerPockets.com offer hundreds and hundreds of articles, forums, and blog posts teaching every conceivable aspect of real estate investing.
  • Mentors – If I were to go back and start over, I would have started earlier with this technique. People love to share what they know, and seasoned real estate investors are no difference.  Get to know who the major players in your town (ask any real estate agent or join your local real estate investment club) and offer to take them to coffee. It is amazing the number of pitfalls and regrets you will avoid by simply learning from those who have been there. In addition – these contacts you make will help you in more ways than one in developing you into a world class investor.
  • Podcasts – A recent innovation in the real estate investor world, there have been a number of great Podcasts that have emerged in the last few years. My current favorite is the Real Estate Guys Radio show. If you have an iPod or Iphone, you can listen to over a HUNDRED hour long shows covering a wide variety of real estate topics whenever you want – for free.

What are your favorite inexpensive or free ways to learn?

Leave me a comment below and then click here to read part two of “Getting Started Investing In Real Estate.”

P.S. looking for hard money loans in California? Be sure to check out my friends over at northcoastfinancialinc.com. They have very competitive rates, can fund within a week and specialize in fix and flip loans and other hard money loans.

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