It seems that whenever I open a discussion with people about the value of investing in real estate to build wealth, pay for a child’s college education, or even as a pathway to something as mundane as more frequent and better vacations, the initial response is, “I don’t have enough money for that right now.” In some cases, it’s undoubtedly true. However, one doesn’t need to be wealthy to enjoy the many benefits of real estate investing.
Take for example the case of my son and two of his college friends. All in their mid-20s, each making roughly $80,000 a year at the time, all interested in someday building wealth through diversified investments in stocks, bonds, and basic savings, the three friends decided in 2021 that adding real estate would help diversify their portfolios. They knew nothing about real estate, but they knew they needed a solid plan. “We couldn’t have done it without someone with deep knowledge of the real estate industry to help us find the location, find the grant that covered our closing costs, and give us the peace of mind that everything was going well at each stage,” one noted.
Each had $16,000 they were willing to invest. Looking at the markets in the areas where they lived (in my son’s case suburban Philadelphia) $48,000 wouldn’t buy much. So the first step was to identify other parts of the country where their budget would go farther. There were a number of options, including Louisiana, but most were quickly rejected. Indiana proved to be the target state.
Morgantown, Indiana, a small town located 50 minutes from Indianapolis and 38 minutes from Bloomington, home of Indiana University, was selected as the target site for the investment. Despite having a population of just over 1,000 people, Morgantown was deemed to have growth potential due to its location at the crossroads of two state highways within a relatively short drive of two state hubs.
The purchase was not made in the town’s best neighborhood, but in an adjacent neighborhood that seemed primed for renewal in the coming years. With closing costs covered by a city grant designed to spur investment in the neighborhood, the cash purchase price of $38,000 left $10,000 for property improvements. That money was invested in kitchen and bath upgrades and in taking down several walls to create more open spaces. A local construction crew was hired to do the improvements with one of the crew becoming the first tenant while the construction was being done. That ensured that great care was taken with the quality of the upgrades.
Once completed, the $10,000 invested in upgrades added $18,000 to the appraised value. That allowed for a cash-out refinance in which all three partners recouped their original investment. Rental income on the property more than covers the small monthly mortgage payment and the property management fee.
The neighborhood has already seen an influx of new businesses. With new businesses came more police patrols and less concern over crime. Other houses have been purchased and improved, and appreciation in home values beyond inflation has already begun.
So what lessons can be learned from this example?
- Whether you are investing as an individual or as part of a group, you first need to have a detailed plan about how your goal can be achieved. Seek a qualified real estate advisor to assist in developing and helping you execute that plan.
- Establish a budget and decide whether you need financing to accomplish your purchase. Financing an investment property requires a minimum down payment of 25% in most cases. Some conventional lenders require as much as a 70% loan-to-value ratio.
- If you have limited cash and are unwilling to take on the burden of financing, you will need to be creative. In many cases it will mean purchasing a property in the interior states, not along either coast. It will mean purchasing a property in an exurban area.
- Think about possible growth opportunities for the locale. Is it within relatively easy reach of plentiful job opportunities that could attract tenants? A nearby university helps immensely due to the nearly constant turnover of a transient population. The larger the university, the larger the population of potential tenants. Universities with large postgraduate programs are a huge plus.
- Research the neighborhood where you want to buy and the neighborhoods surrounding it. Once you know everything there is to know about the schools, nearby businesses, and any planned infrastructure improvements, ask yourself whether the neighborhood is positioned for a rise or a decline in home values.
- Before you make the purchase, know precisely what renovations will be done, what they will cost, and who will do the work. Know how long the work will take so that you know how long it will be before the house begins to produce income. This is absolutely crucial if a loan has been secured to make the purchase.
- Before you make the purchase, line up an excellent property manager who will see to it that the investment is well taken care of. Make certain that the property management fees are sufficiently reasonable that they do not cut too deeply into your anticipated cash flow.
Only at this point will you be well positioned to make the purchase of a property that will be profitable.
Should you decide to put some of your portfolio into real estate, you will join a group of individual investors who own 38% of the country’s rental units, including 70% of the units in properties with four or fewer units, according to a December 2022 Congressional Research Service report titled “Ownership of the U.S. Housing Stock By Investor Type.” So what?, you might ask. The answer is that the median net income reported by landlords according to the Internal Revenue Service is roughly $10,000 per rental unit owned.
Being “rich enough” to invest in real estate is nice. Developing and executing a carefully designed plan is better.
