Real Estate Investing For Dummies E-Book

Eric Tyson

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Sprache: Englisch

Seitenzahl: 861

Veröffentlichungsjahr: 2024

Beschreibung

Make smart decisions in any real estate market

Real estate is always on the radar of investors looking for growth opportunities. Real Estate Investing For Dummies is your no-nonsense guide to adding real estate to your own portfolio. Considered one of the most desirable investment types, real estate is a great way to build wealth—if you know how to navigate the challenges. This book teaches you how to enhance your income by buying investment properties. It includes help with building a plan for raising capital, finding properties with promise, and becoming a successful property manager. With tips on increasing property value and creating a real estate portfolio that matches your goals, this guide is a must for any would-be real-estate investor.

• Understand the different types of real estate investment and build a team that will help you succeed
• Finance your investments and locate properties that generate income
• Learn how to research real estate investment opportunities and sell at the right time
• Increase the value of your assets and become a property manager

This book is designed for real estate investing beginners who are eager to purchase property for the purpose of building wealth. Experienced investors will also love the portfolio-enhancing advice inside.

Leseprobe

Real Estate Investing For Dummies®

To view this book's Cheat Sheet, simply go to www.dummies.com and search for “Real Estate Investing For Dummies Cheat Sheet” in the Search box.

Table of Contents

Cover

Title Page

Copyright

Introduction

About This Book

Foolish Assumptions

Icons Used in This Book

Beyond This Book

Where to Go from Here

Part 1: Getting Started with Real Estate Investing

Chapter 1: Evaluating Real Estate as an Investment

Understanding Real Estate’s Income- and Wealth-Producing Potential

Recognizing the Caveats of Real Estate Investing

Comparing Real Estate to Other Investments

Determining Whether You Should Invest in Real Estate

Fitting Real Estate into Your Plans

Chapter 2: Covering Common Real Estate Investments

Seeing the Various Ways to Invest in Residential Income Property

Surveying the Types of Residential Properties You Can Buy

Considering Commercial Real Estate

Buying Undeveloped or Raw Land

Chapter 3: Considering Foreclosures, REOs, Probate Sales, and More

Finding Foreclosures and REOs

Getting a Jump on Foreclosure and REO Competition with Short Sales

Contemplating Lease Options

Probing Probate Sales and Auctions

Chapter 4: Taking the Passive Approach

Using Real Estate Investment Trusts

Understanding Tenants in Common

Comprehending Triple Net Properties

Eyeing Notes and Trust Deeds

Looking at Tax Lien Certificate Sales

Considering Limited Partnerships

Chapter 5: Fast Money: Small Down Payments and Property Flips

Purchasing with No Money Down

Buying, Fixing, and Flipping or Refinancing

Chapter 6: Building Your Team

Knowing When to Establish Your Team

Adding a Tax Advisor

Finding a Financial Advisor

Lining Up a Lender or Mortgage Broker

Working with Real Estate Brokers and Agents

Considering an Appraiser

Finding an Attorney

Part 2: How to Get the Money: Raising Capital and Financing

Chapter 7: Identifying Sources of Capital

Calculating the Costs of Admission

Rounding Up the Required Cash by Saving

Overcoming Down Payment Limitations

Chapter 8: Financing Your Property Purchases

Taking a Look at Mortgage Options

Reviewing Other Common Fees

Making Some Mortgage Decisions

Borrowing Against Home Equity

Getting a Seller-Financed Loan

Mortgages That Should Make You Think Twice

Chapter 9: Securing the Best Mortgage Terms

Shopping for Mortgages

Solving Potential Loan Predicaments

Part 3: Finding and Evaluating Properties

Chapter 10: Location, Location, Value

Deciding Where to Invest

Finding Properties to Add Value

Evaluating a Region: The Big Picture

Investigating Your Local Market

Evaluating Neighborhoods

Mastering Seller’s and Buyer’s Markets

Chapter 11: Understanding Leases and Property Valuation

The Need to Evaluate a Lease

Reviewing a Lease: What to Look For

Evaluating Real Estate’s Profit-Making Potential

Reviewing the Sources of Property-Valuing Information

Establishing Value Benchmarks

Chapter 12: Valuing Property through Number Crunching

Understanding the Importance of Return on Investment

Figuring Net Operating Income

Calculating Cash Flow

Surveying Lease Options

Grasping the Three Basic Approaches to Value

Reconciling the Three Results to Arrive at a Single Value

Putting It All Together: Deciding How Much to Pay

Chapter 13: Preparing and Making an Offer

Negotiating 101

Preparing to Make Your Offer: Understanding Contract Basics

Addressing Key Provisions in the Purchase Agreement

Presenting the Purchase Agreement

Chapter 14: Due Diligence, Property Inspections, and Closing

Opening Escrow

Conducting Formal Due Diligence

Negotiating Credits in Escrow

Determining How to Hold Title

Closing the Transaction

Part 4: Operating the Property

Chapter 15: Landlording 101

Hiring Management Help: Yes or No?

Finding and Hiring Pros

Testing for Environmental Issues

Deciding on Rental Policies

Working with Existing Tenants upon Property Acquisition

Finding Stable, Trustworthy Tenants

Renovating and Upgrading to Add Value

Chapter 16: Protecting Your Investment

Developing a Risk Management Plan

Getting the Insurance You Need

Chapter 17: Recordkeeping and Accounting

Organizing Your Records

Knowing What to Account For

Doing Your Accounting Manually

Using Software

Chapter 18: Looking at Tax Considerations and Exit Strategies

Understanding the Tax Angles

Considering Exit Strategies

Taking in a Final Note on Taxes and Your Profits

Part 5: The Part of Tens

Chapter 19: Ten (Plus One) Ways to Increase a Property’s Value

Raise Rents

Reduce Turnover

Consider Lease Options

Develop a Market Niche

Maintain and Renovate

Cut Back Operating Expenses

Scrutinize Property Tax Assessments

Refinance and Build Equity More Quickly

Take Advantage of Tax Benefits

Be Prepared to Move On

Improve Management

Chapter 20: Ten Steps to Real Estate Investing Success

Build Up Savings and Clean Up Credit

Buy Property in the Path of Progress

Buy the Right Property at the Best Price Possible

Renovate Property the Right Way

Keep Abreast of Market Rents

Recover Renovation Dollars through Refinancing

Reposition Property with Better Tenants

Become or Hire a Superior Property Manager

Refinance or Sell and Defer Again

Consolidate Holdings into Larger Properties

Index

About the Authors

Advertisement Page

Connect with Dummies

End User License Agreement

List of Tables

Chapter 1

TABLE 1-1 How a Rental Property’s Income and Wealth Build Over Time

Chapter 4

TABLE 4-1 The Best REIT Funds

Chapter 12

TABLE 12-1 Sample Investment Commercial Property Cash Flow

TABLE 12-2 Market Data Summary

TABLE 12-3 Adjusting Sales Price to Determine Value

Chapter 14

TABLE 14-1 Typical Allocation of Expenses

TABLE 14-2 Usual Accounting on Closing Statement

Chapter 18

TABLE 18-1 Calculating After-Tax Cash Flow

TABLE 18-2 Calculating Total Gain or Loss on Sale

TABLE 18-3 Adjusted Basis Calculation

TABLE 18-4 Capital Gain from Appreciation

TABLE 18-5 Total Tax Liability Calculation

TABLE 18-6 Substituted Basis Calculation in an Exchange

List of Illustrations

Chapter 4

FIGURE 4-1: Property types invested in by REITs.

Chapter 10

FIGURE 10-1: Property knowledge sheet.

Chapter 14

FIGURE 14-1: Sample interior unit inspection checklist Robert uses for large mu...

FIGURE 14-2: Sample interior unit inspection checklist (page 2 of 2).

Guide

Cover

Table of Contents

Title Page

Copyright

Begin Reading

Index

About the Authors

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ERIC AND ROBERT’S PRINCIPLES FOR SUCCESS

by Eric Tyson and Robert S. Griswold

Real estate is a proven wealth-building vehicle.

Investing in rental properties can generate current income and significant tax benefits as well as build equity from appreciation over the years and decades.

Although many people can succeed investing in real estate, rental property investing isn’t for everyone.

Consider your investment preferences and personal temperament before buying property. Do you have the time to devote to real estate investing? Are you comfortable troubleshooting problems or hiring a property manager?

Make sure you’re financially fit before investing in rental properties. Pay particular attention to your monthly budget and make sure that you have adequate insurance coverage. Most successful real estate investors build their real estate investment portfolio through saving money and then gradually buying properties over the years.

Don’t underestimate the importance of establishing good credit. The best returns on real estate rely upon the use of credit to obtain the leverage of using OPM (other people’s money).

Your first (and often one of the best) real estate investment is buying a home to live in.

Real estate is the only investment that we know of that you can live in or rent to produce income. You can also derive large tax-free profits when you sell your principal residence at a higher price than you paid for it.

Focus on residential properties in the beginning.

Residential property is an attractive investment and is easier to understand, purchase, and manage than most other types of property. If you’re a homeowner, you already have experience locating, purchasing, and maintaining residential property.

Among residential property options, our top recommendations are small apartment buildings and single-family homes.

Attached housing makes more sense for investors who don’t want to deal with building maintenance and security issues. Attached-housing prices tend to perform best in developed urban environments.

Have your real estate team in place before you begin your serious property searching.

Line up a real estate agent, loan officer, tax advisor, lawyer, and so on early because the real estate investor with the best resources can identify the properties to ignore and those worthy of careful consideration. Move quickly — the speed at which you can close a transaction is an advantage in any type of market.

Look for properties in the path of progress.

Areas where new development or redevelopment is heading are where you want to be. The best real estate investment properties are ones that are well located and physically sound but cosmetically challenged and poorly managed.

You don’t get rich trying to find no-money-down real estate investment deals.

Don’t believe informercial hucksters. Don’t expect to buy top-notch rental properties that way.

Making at least a 20 to 25 percent down payment provides access to the best financing terms.

You can make smaller down payments — even as low as 10 percent or less — but you often pay a much higher interest rate, loan fees, and private mortgage insurance. Leverage, or the use of the lenders’ money to cover the majority of your acquisition costs, can boost your rates of return. But too much leverage can be dangerous if the rental market turns and your debt expenses are high.

As the size and complexity of the deal increases, financing options become less attractive.

The financing options for larger apartment buildings (five or more units), commercial, retail, industrial, and raw land generally require more money down and/or higher interest rates and loan fees. But more advanced real estate investors can enjoy higher overall returns plus the benefits of easier management and stability from long-term tenants.

For low entry costs, consider real estate investment trusts (REITs) and lease options.

You can buy these exchange–traded securities (which can also be bought through REIT-focused mutual funds) for a thousand dollars or less. With lease options, you begin by renting a property you may be interested in purchasing later, and a portion of your monthly rent goes toward the future purchase. If you can find a seller willing to provide financing, you can keep your down payment to a minimum.

We prefer the adage of “Location, location, value.

” It clearly emphasizes location but also the importance of finding good value for your investment dollar. Owning real estate in up-and-coming areas with new development or renovated properties enhances finding and keeping good tenants and leads to greater returns. Properties in great locations with extensive deferred maintenance, especially aesthetic issues that can be inexpensively addressed, are another great opportunity.

Make real estate investments close by.

Buy property within two hours away by your favorite mode of transportation. Venture farther only when you really know another real estate market and regularly find yourself there for other reasons or you’ve found an excellent property manager.

Any decision about where to invest starts with an evaluation of the overall region’s economic trends.

If the area isn’t economically sound, then the likelihood for successful real estate investments is diminished.

You’re purchasing a future income stream or cash flow when you buy an investment property.

What you pay for a property and the cash flow it generates makes a significant difference in the success of your investment. The key is identifying which properties sellers have underpriced.

Don’t rely on the seller’s numbers when evaluating a property’s potential.

Speak directly with the seller to determine the history of the property and their motivation for selling. But don’t rely on historic operating results offered by the seller or broker. Develop your own numbers through evaluating the property with a team of qualified professionals who are specialists in the physical and fiscal management of real estate.

The buy-and-flip real estate investment strategy can work, but it also has a downside.

Buying and flipping can be a way to make quick money in real estate if you time your investments correctly in a rapidly rising real estate market. However, flipping can cause your profits to be taxed as ordinary income, and you could lose during a market downturn.

Bottom line:

Real estate professionals, and you, should value a property based on the projected net operating income (NOI).

Project the NOI preferably for the next few years. Projecting the NOI is time consuming and requires a lot of experience, especially if you plan property changes to increase income and/or reduce expenses.

Real Estate Investing For Dummies®, 5th Edition

Published by: John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030-5774, www.wiley.com

Copyright © 2025 by Eric Tyson and Robert S. Griswold

Media and software compilation copyright © 2025 by John Wiley & Sons, Inc. All rights reserved, including rights for text and data mining and training of artificial technologies or similar technologies.

Published simultaneously in Canada

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Introduction

Welcome to Real Estate Investing For Dummies, 5th Edition! We’re delighted to be your tour guides. Throughout this book, we emphasize three fundamental cornerstones that we believe to be true:

Real estate is one of the three time-tested ways for people of varied economic means to build wealth (the others are stocks and small business). Over the long term (decades), you should be able to make an average annualized return of 8 to 9 percent per year investing in real estate.

Investing in real estate isn’t rocket science but does require doing your homework. If you’re sloppy doing your legwork, you’re more likely to end up with inferior properties or to overpay. Our book clearly explains how to buy the best properties at a fair (or even below market value!) price. (Although we cover all types of properties, this book concentrates more on residential investment opportunities, which are more accessible and appropriate for nonexperts.)

Although you should make money over the long term investing in good real estate properties, you

can

lose money, especially in the short term. Don’t unrealistically expect real estate values to increase every year. Downturns in the local real estate prices may create temporary buying opportunities, but we aren’t real estate day traders. When you invest in real estate for the long term, which is what we advocate and practice, the occasional price declines should be merely bumps on an otherwise fruitful journey.

About This Book

Real Estate Investing For Dummies, 5th Edition, covers tried and proven real estate investing strategies that real people, just like you, use to build wealth. Specifically, this book explains how to invest in single-family homes; detached and attached condominiums; small apartments including duplexes, triplexes, fourplexes, and multiple-family residential properties up to 20 to 30 units; commercial properties, including office, industrial, and retail; and raw (undeveloped) land. We also cover indirect real estate investments such as real estate investment trusts (REITs) that you can purchase through the major stock exchanges or a real estate mutual fund. We also broach the advantages and disadvantages to timeshares and other fractionized residential real estate ownership.

We’ve always relied on tried-and-true methods of real estate investing, and our core advice is as true today as it was before the real estate downturn in the severe recession of the late 2000s and the surge in prices for many types of real estate in the early 2020s.

If you expect us (in infomercial-like fashion) to tell you how to become an overnight multimillionaire, this is definitely not the book for you. And please allow us to save you money, disappointment, and heartache by telling you that such hucksters are only enriching themselves through their grossly overpriced podcasts and seminars.

Unlike so many real estate book authors, we don’t have an alternative agenda in writing this book. Many real estate investing books are nothing more than infomercials for high-priced learning tools and products or seminars the author, or some group, is selling. The objective of our book is to give you the best crash course in the fundamentals of real estate investing so that if you choose to make investments in income-producing properties, you may do so wisely and confidently.

Here are some good reasons why we — Eric Tyson and Robert Griswold — are a dynamic duo on your side:

Robert Griswold has extensive hands-on experience as a real estate investor who has worked with properties of all types and sizes. He is also the author of Property Management Kit For Dummies (Wiley) and was the author of two popular nationally syndicated real estate newspaper columns for more than 20 years. He appeared for more than 15 years as the NBC-TV on-air real estate expert for Southern California. And for nearly 15 years, he was the host of the most popular and longest running real estate radio show in the country — Real Estate Today! with Robert Griswold on Clear Channel Communications.

Robert also holds the Counselor of Real Estate (CRE®), Certified Property Manager (CPM®), Certified Commercial Investment Member (CCIM®), Accredited Commercial Manager (ACoM®), Real Property Adminstrator (RPA®), Professional Community Association Manager (PCAM), Certified Communty Association Manager (CCAM®, Graduate Realtor Institute(GRI®), and Accredited Residential Manager (ARM®) designations. He earned a bachelor’s degree and two master’s degrees in real estate and related fields from the University of Southern California’s Marshall School of Business, where he learned from renowned professers such as Arthur B. Laffer, best known for the Laffer curve.

Eric Tyson is a former financial counselor, lecturer, and coauthor of the national bestseller Home Buying For Dummies (Wiley), as well as the author or coauthor of numerous other bestselling books in the For Dummies series, such as Personal Finance, Investing, Mutual Funds, and Small Business.

Eric has counseled thousands of clients on a variety of personal finance, investment, and real estate quandaries and questions. A former management consultant to Fortune 500 financial service firms, Eric is dedicated to teaching people to better manage their personal finances. For more than 30 years, he has successfully invested in real estate and securities and started and managed several businesses. He earned an MBA at the Stanford Graduate School of Business and a bachelor’s degree in economics at Yale.

Foolish Assumptions

Whenever authors sit down to write a book, they have a particular audience in mind. Because of this, they must make some assumptions about who their reader is and what that reader is looking for. Here are a few assumptions we’ve made about you:

You’re looking for a way to invest in real estate but don’t know what types of properties and strategies are best.

You’re considering buying an investment property, be it a single-family home, a small apartment complex, or an office building, but your real estate experience is largely limited to renting an apartment or owning your own home.

You may have a small amount of money already invested in real estate, but you’re ready to go after bigger, better properties.

You’re looking for a way to diversify your investment portfolio.

If any of these descriptions hit home for you, you’ve come to the right place.

Icons Used in This Book

Throughout this book, you can find friendly and useful icons to enhance your reading pleasure and to note specific types of information. Here’s what each icon means:

We use this icon to highlight when you should look into something on your own or with the assistance of a local professional.

This icon flags concepts and facts we want to ensure that you remember as you make your real estate investments.

Here we point out potentially interesting but nonessential (skippable) stuff.

This icon points out something that can save you time, headaches, money, or all of the above!

Look for this icon to find real-life examples of real estate situations to help exemplify a point.

Here we’re trying to direct you away from blunders and boo-boos that others have made when investing in real estate.

Beyond This Book

In addition to the content of this book, you can access some related material online. Head to www.dummies.com and type “Real Estate Investing For Dummies Cheat Sheet” in the search box to find additional tips for investing.

Where to Go from Here

If you have the time and desire, we encourage you to read this book in its entirety. It provides you with a detailed picture of how to maximize your returns while minimizing your risks in the real estate market. But you may also choose to read selected portions. That’s one of the great things (among many) about For Dummies books. You can readily pick and choose the information you read based on your individual needs. Just scan the table of contents or index for the topics that interest you the most.

Part 1

Getting Started with Real Estate Investing

IN THIS PART …

Understand that real estate is just one of many available investment options for you and grasp why you may want to consider it in your investment portfolio.

Identify the pros and cons of managing rental properties and how you can fit different types of real estate into your overall personal financial plans.

Examine the gamut of real estate options, such as foreclosures and lease options, so that you know which ones may be better choices for you, depending on your circumstances.

Separate fact from fiction when it comes to passive real estate investments (for example, real estate investment trusts) if actively managing a property isn’t for you.

Take a look at riskier approaches like no money down and property flipping.

Begin to assemble a team of competent professionals who can assist you with investing in real estate.

Chapter 1

Evaluating Real Estate as an Investment

IN THIS CHAPTER

Focusing on the potential of real estate investing

Contrasting real estate with other investing options

Deciding whether real estate is really for you

Arranging your investment and financial plans to include real estate

When coauthor Robert first entered the real estate field while attending college decades ago, his father, a retired real estate attorney, advised that he use his employment income primarily to pay day-to-day living expenses and allocate money each month into long-term financial investments like real estate. This solid advice has served Robert well over the years.

It’s never too early or too late to formulate your own plan for a comprehensive wealth-building strategy. For many, such a strategy can help with the goals of funding future education for children and ensuring a comfortable retirement.

The challenge involved with real estate is that it takes some real planning to get started. Contacting an investment company and purchasing some shares of your favorite mutual fund or stock is a lot easier than acquiring your first rental income property. Buying property need not be too difficult, though. With a financial and real estate investment plan, a lot of patience, and the willingness to do some hard work, you can be on your way to building your own real estate empire!

In this chapter, we give you information that can help you decide whether you have what it takes to make money and be comfortable with investing in real estate. We compare real estate investments to other investments. We provide some questions you should ask yourself before making any decisions. And finally, we offer guidance on how real estate investments can fit into your overall personal financial plans. Along the way, we share our experience, insights, and thoughts on a long-term strategy for building wealth through real estate that virtually everyone can understand and actually achieve.

The vast majority of people who don’t make money in real estate make easily avoidable mistakes, which we help you avoid.

Understanding Real Estate’s Income- and Wealth-Producing Potential

Compared with most other investments, good real estate can excel at producing periodic or monthly cash flow for property owners. So in addition to the longer-term appreciation potential, you can also earn investment income year in and year out. Real estate is a true growth and income investment.

The following list highlights the major benefits of investing in real estate:

Tax-deferred compounding of value:

In real estate investing, the appreciation of your properties compounds

tax-deferred

during your years of ownership. You don’t pay tax on this appreciation/profit until you sell your property — and even then, with some careful planning, you may be able to roll over your gain into another investment property and avoid paying taxes. (See the “

Being aware of the tax advantages

” section later in this chapter.)

Regular cash flow: If you have property that you rent out, you have money coming in every month in the form of rents. Some properties, particularly larger multi-unit complexes, may have some additional sources, such as from parking, storage, or laundry equipment.

When you own investment real estate, you should also expect to incur expenses that include your mortgage payment, property taxes, insurance, and maintenance. The interaction of the revenues coming in and the expenses going out is what tells you whether you realize a positive operating cash flow each month.

Reduced income tax bills:

For income tax purposes, you also get to claim an expense that isn’t really an out-of-pocket cost — depreciation. Depreciation enables you to reduce your current income tax bill and hence increase your cash flow from a property. (We explain this tax advantage and others later in the “

Being aware of the tax advantages

” section.)

Rate of increase of rental income versus overall expenses:

While not always true in recent years, often over time, your operating cash flow and even your net profit, which is subject to ordinary income tax, should rise as you increase your rental prices faster than the rate of increase for your property’s overall expenses. What follows is a simple example to show why even modest rental increases are magnified into larger operating profits and healthy returns on investment over time.

Suppose that you’re in the market to purchase a single-family home that you want to rent out and that such properties are selling for about $300,000 in the area you’ve deemed to be a good investment. (Note: Housing prices vary widely across different areas, but the following example should give you a relative sense of how a rental property’s expenses and revenue change over time.) You expect to make a 20 percent down payment and take out a 30-year fixed rate mortgage at 6 percent for the remainder of the purchase price — $240,000. Here are the details:

Monthly mortgage payment

$1,440

Monthly property tax

$300

Other monthly expenses (maintenance, insurance)

$300

Monthly rent

$2,100

In Table 1-1, we show you what happens with your investment over time. We assume that your rent and expenses (except for your mortgage payment, which is fixed) increase 3 percent annually and that your property appreciates a conservative 4 percent per year. (For simplification purposes, we ignore depreciation in this example. If we had included the benefit of depreciation, it would further enhance the calculated investment returns.)

Now, notice what happens over time. When you first buy the property, the monthly rent and the monthly expenses are about equal. By year five, the monthly income exceeds the expenses by about $300 per month. Consider why this happens — your largest monthly expense, the mortgage payment, doesn’t increase. So, even though we assume that the rent increases just 3 percent per year, which is the same rate of increase assumed for your nonmortgage expenses, the compounding of rental inflation begins to produce larger and larger cash flows to you, the property owner. Cash flow of $300 per month may not sound like much, but consider that this $3,600 annual income is from an original $60,000 investment. Thus, by year five, your rental property is producing a 6 percent return on your down payment investment. (And remember, if you factor in the tax deduction for depreciation, your cash flow and return are even higher.)

TABLE 1-1 How a Rental Property’s Income and Wealth Build Over Time

Year

Monthly Rent

Monthly Expenses

Property Value

Mortgage Balance

0

$2,100

$2,040

$300,000

$240,000

5

$2,434

$2,136

$364,995

$223,440

10

$2,821

$2,247

$444,075

$200,880

20

$3,793

$2,523

$657,337

$129,600

30

$5,097

$2,896

$973,020

$0

31

$5,250

$1,500

$1,011,937

$0

In addition to the monthly cash flow from the amount that the rent exceeds the property’s expenses, also look at the last two columns in Table 1-1 to see what has happened by year five to your equity (the difference between market value and mortgage balance owed) in the property. With just a 4 percent annual increase in market value, your $60,000 in equity (the down payment) has more than doubled to $141,555 ($364,995 – 223,440).

By years 10 and 20, you can see the further increases in your monthly cash flow and significant expansion in your property’s equity. By year 30, the property is producing more than $2,200 per month cash flow and you’re now the proud owner of a mortgage-free property worth more than triple what you paid for it!

After you get the mortgage paid off in year 30, take a look at what happens in year 31 and beyond to your monthly expenses (big drop as your monthly mortgage payment disappears!) and therefore your cash flow (big increase).

Recognizing the Caveats of Real Estate Investing

Despite all its potential, real estate investing isn’t lucrative at all times and for all people — here’s a quick outline of the biggest caveats that accompany investing in real estate:

Few home runs:

Your likely returns from real estate won’t approach the biggest home runs that the most accomplished entrepreneurs achieve in the business world. That said, by doing your homework, improving properties, and practicing good management (and sometimes enjoying a bit of luck), you can do extremely well!

Upfront operating profit challenges: Unless you make a large down payment, your monthly operating profit may be small, nonexistent, or negative in the early years of rental property ownership. During soft periods in the local economy, rents may rise more slowly than your expenses or they may even fall. That’s why you must ensure that you can weather financially tough times. In the worst cases, we’ve seen rental property owners lose both their investment property and their homes. See the section “Fitting Real Estate into Your Plans” later in this chapter.

Ups and downs:

You’re not going to earn an 8 to 9 percent return every year. Although you have the potential for significant profits, owning real estate isn’t like owning a printing press at the U.S. Treasury. Like stocks and other types of ownership investments, real estate goes through down periods as well as up periods. Most people who make money investing in real estate do so because they invest and hold property over many years.

Relatively high transaction costs:

If you buy a property and then want out a year or two later, you may find that even though the property has appreciated in value, much (if not all) of your profit has been wiped away by the high transaction costs. Typically, the costs of buying and selling — which include real estate agent commissions, loan fees, title insurance, and other closing costs — amount to about 8 to 12 percent of the purchase price of a property. So, although you may be elated if your property appreciates 10 percent in value in short order, you may not be so thrilled to realize that if you sell the property, you may not have any greater return than if you had stashed your money in a lowly, risk-free, FDIC-insured bank account.

Tax implications:

Last, but not least, when you make a positive net return or profit on your real estate investment, the federal and state governments are waiting with open hands for their share. Throughout this book, we highlight ways to improve your after-tax returns. As we stress more than once, the profit you have left after government entities take their bites (not your pretax income) is what really matters.

These drawbacks shouldn’t keep you from exploring real estate investing as an option; rather, they simply reinforce the need to really know what you’re getting into with this type of investing and whether it’s a good match for you. The rest of this chapter takes you deeper into an assessment of real estate as an investment as well as introspection about your goals, interests, and abilities.

Comparing Real Estate to Other Investments

Surely, you’ve considered or heard about many different investments over the years. To help you grasp and understand the unique characteristics of real estate, we compare and contrast real estate’s attributes with those of other wealth-building investments like stocks and small business.

Returns

Clearly, a major reason that many people invest in real estate is for the healthy total returns (which include ongoing cash flow and the appreciation of the property). Real estate often generates robust long-term returns because, like stocks and small business, it’s an ownership investment. By that, we mean that real estate is an asset that has the ability to produce periodic income and gains or profits upon refinancing or sale.

Our research and experience suggest that total real estate investment returns are comparable to those from stocks — about 8 to 9 percent on average, annually. Over recent decades, the average annual return on real estate investment trusts (REITs), publicly traded companies that invest in income-producing real estate such as apartment buildings, office complexes, and shopping centers, has appreciated at about this pace as well. See our discussion of REITs in Chapter 4.

And you can earn long-term returns that average 10+ percent per year if you select excellent properties in the best areas, hold them for several years, and manage them well.

HOW LEVERAGE AFFECTS YOUR REAL ESTATE RETURNS

Real estate is different from most other investments in that you can typically borrow (finance) up to 70 to 80 percent or more of the value of the property. Thus, you can use your small down payment of 20 to 30 percent of the purchase price to buy, own, and control a much larger investment. (During market downturns, lenders tighten requirements and may require larger down payments than they do during good times.) So when your real estate increases in value (which is what you hope for and expect), you make money on your investment as well as on the money that you borrowed. That’s what we mean when we say that the investment returns from real estate are enhanced due to leverage.

Take a look at this simple example. Suppose you purchase a property for $300,000 and make a $60,000 down payment. Over the next three years, imagine that the property appreciates 10 percent to $330,000. Thus, you have a profit (on paper) of $30,000 ($330,000 – $300,000) on an investment of just $60,000. In other words, you’ve made a 50 percent return on your investment. (Note: We ignore cash flow — whether your rental income that you collect from the property exceeds the expenses that you pay or vice versa, and the tax benefits associated with rental real estate.)

Remember, leverage magnifies all your returns, and those returns aren’t always positive! If your $300,000 property decreases in value to $270,000, even though it has only dropped 10 percent in value, you actually lose (on paper) 50 percent of your original $60,000 investment. (In case you care, and it’s okay if you don’t, some wonks apply the terms positive leverage and negative leverage.) Please see the “Understanding Real Estate’s Income- and Wealth-Producing Potential” section earlier in this chapter for a more detailed example of investment property profit and return.

Risk

Real estate doesn’t always rise in value — witness the decline in most parts of the United States during the great real estate recession of 2008-2012. That said, while interest rate sensitive, real estate market values generally don’t suffer from as much volatility as stock prices do. To illustrate, take the excitement surrounding the rapid, sustained increase of technology and internet stock prices in the late 1990s that turned into the dismay and agony of those same sectors’ stock prices crashing in the early 2000s. Many stocks in this industry, including those of leaders in their niches, saw their stock prices plummet by 80 percent, 90 percent, or more. Generally, you don’t see those kinds of dramatic roller-coaster shifts in values over the short run with the residential income property real estate market.

However, keep in mind (especially if you tend to be concerned about shorter-term risks) that real estate can suffer from declines of 10 percent, 20 percent, or more. If you make a down payment of, say, 20 percent and want to sell your property after a 10 to 15 percent price decline, you may find that all (as in 100 percent) of your invested dollars (down payment) are wiped out after you factor in transaction costs. So you can lose everything.

You can greatly reduce and minimize your risk investing in real estate through buying and holding property for many years (seven to ten or more). Remember that many of these fantastic success stories about amazing profits on “flipping” single-family homes and small rental properties are just like gamblers who only tell you about their biggest winnings or forget to tell you that they turned around and lost much of what they won. Although there is a lot of hype on television, streaming content, and the internet about “flipping properties” for crazy short-term profits, think of real estate as a long-term investment.

Liquidity

Liquidity — the ease and cost with which you can sell and get your money out of an investment — is one of real estate’s shortcomings. Real estate is relatively illiquid: You can’t sell a piece of property with the same speed with which you can whip out your ATM card and withdraw money from your bank account or sell a stock or an exchange-traded fund with a click of your computer’s mouse or by tapping on your smart phone.

We actually view real estate’s relative illiquidity as a strength, certainly compared with stocks that people often trade in and out of because doing so is so easy and seemingly cheap. As a result, some stock market investors tend to lose sight of the long term and miss out on the bigger gains that accrue to patient buy-and-stick-with-it investors. Because you can’t track the value of investment real estate daily online, and because real estate takes considerable time, energy, and money to sell, you’re far more likely to buy and hold onto your properties for the longer term.

Although real estate investments are generally less liquid than stocks, they’re generally more liquid than investments made in your own or someone else’s small business. People need a place to live and businesses need a place to operate, so there’s always demand for real estate (although the supply of such available properties can greatly exceed the demand in some areas during certain time periods).

Capital requirements

Although you can easily get started with traditional investments such as stocks and mutual funds with a few hundred or thousand dollars, the vast majority of quality real estate investments require far greater investments — usually on the order of tens of thousands of dollars. (Part 2 shows you how to raise capital and secure financing.)

If you’re one of the many people who don’t have that kind of money, don’t despair. We present you with lower-cost real estate investment options. Among the simplest low-cost real estate investment options are real estate investment trusts (REITs). You can buy these as exchange-traded stocks or invest in a portfolio of REITs through a REIT mutual fund (see Chapter 4).

Diversification value

An advantage of holding investment real estate is that its value doesn’t necessarily move in tandem with other investments, such as stocks or small-business investments that you hold. You may recall, for example, the massive stock market decline in the early 2000s. In most communities around America, real estate values were either steady or actually rising during this horrendous period for stock prices.

However, real estate prices and stock prices, for example, can move down together in value (witness the severe recession and stock market drop that took hold in 2008). Sluggish business conditions and lower corporate profits can depress stock and real estate prices.

Opportunities to add value

Although you may not know much about investing in the stock market, you may have some good ideas about how to improve a property and make it more valuable. You can fix up a property or develop it further and raise the rental income accordingly. Perhaps through legwork, persistence, and good negotiating skills, you can purchase a property below its fair market value.

Relative to investing in the stock market, tenacious and savvy real estate investors can more easily buy property in the private real estate market at below fair market value because the real estate market is somewhat less efficient and some owners don’t realize the value of their income property or they need to sell quickly. Theoretically, you can do the same in the stock market, but the scores of professional, full-time money managers who analyze the public market for stocks make finding bargains more difficult and even elusive. We help you identify prospective “value-added” properties that you can improve and more efficiently manage to achieve better financial results in Part 3.

Being aware of the tax advantages

Real estate investment offers numerous tax advantages. In this section, we compare and contrast investment property tax issues with those of other investments.

Deductible expenses (including depreciation)

Owning a property has much in common with owning your own small business. Every year, you account for your income and expenses on a tax return. (We cover all the taxing points about investment properties in Chapter 18.) For now, we want to remind you to keep good records of your expenses in purchasing and operating rental real estate. (Check out Chapter 17 for more information on all things accounting.) One expense that you get to deduct for rental real estate on your tax return — depreciation — doesn’t actually involve spending or outlaying money. Depreciation is an allowable tax deduction for buildings because structures wear out over time. Under current tax laws, residential real estate is depreciated over 27½ years (commercial buildings are less favored in the tax code and can be depreciated over 39 years). Residential real estate is depreciated over shorter time periods because it has traditionally been a favored investment in our nation’s tax laws.

Tax-free rollovers of rental property profits

When you sell a stock, mutual fund, or exchange-traded investment that you hold outside a retirement account, you must pay tax on your net gains or profits. By contrast, you can avoid paying tax on your profit when you sell a rental property if you roll over your gain into another like-kind investment real estate property.

The rules for properly making one of these 1031 exchanges are complex and involve third parties. We cover 1031 exchanges in Chapter 18. Make sure that you find an attorney and/or tax advisor who is an expert at these transactions to ensure that you meet the technical and strict timing requirements so that everything goes smoothly (and legally).

If you don’t roll over your net gain, you may owe significant taxes because of how the IRS defines your gain. For example, if you bought a property for $200,000 and sell it for $550,000, you not only owe tax on the gain from the increased property value, but you also owe tax on an additional amount, the property’s depreciation you used during your ownership. The amount of depreciation that you deduct on your tax returns reduces the original $200,000 purchase price, making the taxable difference that much larger. For example, if you deducted $125,000 for depreciation over the years that you owned the property, you owe tax on the difference between the sale price of $550,000 and $75,000 ($200,000 purchase price – $125,000 depreciation).

Deferred taxes with installment sales

Installment sales are a complex method that can be used to defer your tax bill when you sell an investment property at a profit and you don’t buy another rental property. With such a sale, you play the role of banker and provide financing to the buyer. In addition to often collecting a competitive interest rate from the buyer, you only have to pay capital gains tax as you receive proceeds over time from the sale that are applied toward the principal or price the buyer agreed to pay for the property. For details, please see Chapter 18.

Special tax credits for low-income housing and old buildings

If you invest in and upgrade low-income housing or certified historic buildings, you can gain special tax credits. The credits represent a direct reduction in your tax bill from expenditures to rehabilitate and improve such properties. These tax credits exist to encourage investors to invest in and fix up old or run-down buildings that likely would continue to deteriorate otherwise. The IRS has strict rules governing what types of properties qualify. See IRS Form 3468 to discover more about these credits.

The 2017 Tax Cuts and Jobs Act created “qualified opportunity zones” to provide tax incentives to invest in “low-income communities,” which are defined by each state’s governor and may comprise up to 25 percent of designated “low-income communities” in each state. (States can also designate census tracts contiguous with “low-income communities” so long as the median family income in those tracts doesn’t exceed 125 percent of the qualifying contiguous “low-income community.”) See Chapter 18 for more details.

20 percent Qualified Business Income (QBI) deduction for “pass-through entities”

The 2017 Tax Cuts and Jobs Act includes lower across-the-board federal income tax rates, which benefits all wage earners and investors, including real estate investors. If you spend at least 250 hours per year on certain activities related to your real estate investments, you may also be able to utilize an additional tax break targeted to certain small business entities.

In redesigning the tax code, Congress realized that the many small businesses that operate as so-called pass-through entities would be subjected to higher federal income tax rates compared with the 21 percent corporate income tax rate (reduced from 35 percent). Pass-through entities are small businesses such as sole proprietorships, LLCs, partnerships, and S corporations and are so named because the profits of the business pass through to the owners and their personal income tax returns. To address the concern that individual business owners who operated their businesses as pass-through entities could end up paying a higher tax rate than the 21 percent rate levied on C corporations, Congress provided a 20 percent Qualified Business Income (QBI) deduction for those businesses. See Chapter 18 for more information.

Determining Whether You Should Invest in Real Estate

We believe that most people can succeed at investing in real estate if they’re willing to do their homework, which includes selecting top real estate professionals. In the sections that follow, we ask several important questions to help you decide whether you have what it takes to succeed and be happy with real estate investments that involve managing property. Income-producing real estate isn’t a passive investment.

Do you have sufficient time?

Purchasing and owning investment real estate and being a landlord are time consuming. The same way an uninformed owner can sell his property for less than it’s worth, if you fail to do your homework before purchasing property, you can end up overpaying or buying real estate with problems. Finding competent and ethical real estate professionals takes time. (We guide you through the process in Chapter 6.) Investigating communities, neighborhoods, and zoning also soaks up plenty of hours (information on performing this research is located in Chapter 10), as does examining tenant issues with potential properties (see Chapter 11).

As for managing a property, you can hire a property manager to interview tenants, collect the rent, and solve problems such as leaky faucets and broken appliances, but doing so costs money and still requires some of your time. Of course, if you hire a competent and experienced property manager, you will be rewarded with less time required for oversight.

You will inevitably have to deal with government regulations as a rental property owner, especially if you buy and own property in an area where politicians who support aggressive pro-tenant regulations, such as rent control, are in charge. Robert strongly recommends that all rental income property owners and managers become an active member of your local affiliate of the National Apartment Association, which will provide you with regular updates on proposed and new legislation that becomes law, as well as all of the forms and information you need to stay fully compliant.

If you’re stretched too thin due to work and family responsibilities, real estate investing may not be for you. So, unless you want to locate, interview, hire, and pay for a qualified property manager, you may want to look into some of the less time-intensive real estate investments discussed elsewhere in Part 1.

Can you deal with problems?

Challenges and problems inevitably occur when you try to buy a property. Purchase negotiations can be stressful and frustrating. You can also count on some problems coming up when you own and manage investment real estate. Most tenants won’t care for a property the way property owners do.

If every little problem (especially those that you think may have been caused by your tenants — think bedbugs and plumbing backups!) causes you distress, at a minimum, you should only own rental property with the assistance of a property manager. You should also question whether you’re really going to be satisfied owning investment property. The financial rewards come well down the road, but you live the day-to-day ownership headaches (including the risk of litigation) immediately.

Does real estate interest you?

In our experience, some of the best real estate investors have a curiosity and interest in real estate. If you don’t already possess it, such an interest and curiosity can be cultivated — and this book may just do the trick.

On the other hand, some people simply aren’t comfortable investing in rental property. For example, if you’ve had experience and success with stock market investing, you may be uncomfortable venturing into real estate investments. Some people we know are on a mission to start their own business and may prefer to channel the time and money into that outlet.

Can you handle market downturns?

Real estate investing isn’t for the faint of heart. Buying and holding real estate is a whole lot of fun when prices and rents are rising. But market downturns happen, and they test you emotionally as well as financially.

Consider the real estate market price declines that happened in most communities and types of property surrounding the 2008 financial crisis. In many parts of the country, the impact was still a reality several years later. Such drops can present attractive buying opportunities for those with courage, a good credit score, and cash for the down payment.

None of us has a crystal ball, though, so don’t expect to be able to buy at the precise bottom of prices and sell at an exact peak of your local market. Even if you make a smart buy now, you’ll inevitably end up holding some of your investment property during a difficult market (recessions where you have trouble finding and retaining quality tenants, where rents and property values may fall rather than rise). Do you have the financial (and emotional) wherewithal to handle such a downturn? How have you handled other investments when their values have fallen?

If you enjoy looking up the current price of your stocks daily, you may be frustrated that accurate pricing for real estate is not available. Although there are several online services (for example, Zillow.com, Redfin.com, Realtor.com,