Real Estate Investing Basics: What You Need To Know
Real estate investing is one of the smartest and safest ways to invest your money. It’s a tried and true investment that has been around for centuries - and it’s not going anywhere. When done correctly, real estate investing can provide you with a steady stream of passive income that unlocks financial freedom.
And lucky for us - it’s the 21st century, and real estate investing has been democratized like never before. Software like Leadflow is putting the power to invest in the hands of everyone.
But with everything…there’s a catch. If you don’t understand the basics of real estate investing from the beginning - you could be in hot water fast.
There are five basic concepts to understand when getting started in real estate investing:
- Location
- Timing
- Terms
- Equity
- Cash Flow
Let’s dive into these fundamental basics of real estate investing below!
Investing Concept #1: Location
The saying goes that “location, location, location” is everything, and it’s the foundation for every beginner real estate investor.
If you want to see a good return on your investment, you need to make sure you buy in a desirable area – one that will be in high demand no matter what the economy is doing.
But if you really want to maximize ROI - you need to be able to predict which locations will be more popular in the coming years.
Learning to predict this future takes time - but the return on knowledge investment is well, well worth it.
Investing Concept #2: Timing
If you want to see a good return on your investment, being able to time the market is one of the most important - and challenging - aspects of real estate investing basics to acquaint yourself with.
If you invest too soon - you may be stuck with a property that hemorrhages cash while you wait for the market to turn. Invest too late - and you missed the boat on the best time to buy.
Waiting until the perfect moment to invest can mean the difference between success and failure.
To time the market, you have to understand two things;
- How the area you’re interested in will develop in the coming years
- How the larger economy is doing
While there are many more nuances to timing the market, these are the two pillars of understanding real estate investing that every investor should work into their “timing” calculations.
Investing Concept #3: Deal Terms
The terms of a real estate investment are everything, and terms can make or break the deal.
When you’re negotiating a property purchase, it’s important to pay close attention to the terms of the agreement. Get a lawyer to help you understand the deal terms - especially when you’re just beginning to understand the basics of real estate investing.
You have to understand the gravity of your final signature on the dotted line - understand what you’re signing.
When we say, “deal terms”, we mean things like;
- Purchase price
- Down payment amount
- Interest rate
- Length of the loan
For instance - you may see the words, “fixed interest loan'' on the document and think you’re all set. But there are instances where the first part of the loan is “fixed interest” for a certain amount of time, and “variable interest” for another amount of time.
Don’t lock yourself into unfavorable terms - and what’s more - negotiate your way to better terms! Don’t be afraid to say “no” to terms that don’t make sense to you. This is business, and you need to negotiate for what you want.
Investing Concept #4: Equity
“Equity” is a term you’ll see everywhere as you start understanding real estate investing. It’s the value of a property minus the amount of money that is owed on the property.
For example, if you purchase a property for $100,000 and you have a down payment of $20,000, your equity would be $20,000.
If the next day the value of the property went up to $120,000, your equity would increase to $40,000.
It’s important to understand equity because it is what drives the actual value in real estate investing. The more equity you have in a property, the more money you stand to make when you sell it. That’s why it’s important to make sure you pay off your mortgage as quickly as possible – so you can minimize interest payments, increase your equity and maximize your profits.
Investing Concept #5: Cash Flow
Even though real estate is a long term investment - you likely need to see some return on the investment in the next few years. Especially if you’re renting something out short or long-term.
Maintaining cash flow is one of the basics of real estate investing that often goes overlooked - and it’s what causes many good investments to fail.
What is cash flow? Cash flow is simply the amount of money that comes in each month from a property after all expenses have been paid. If the property generates more money each month than it costs to maintain, then it’s said to have positive cash flow. If the property costs more to maintain each month than it brings in, then it has negative cash flow.
How Can A Good Real Estate Investment Fail?
Above, we mention how a good investment can fail if there is no cash flow. Here’s what we mean.
Scenario Where Good Investment Fails
In this (very simplistic) scenario, you take out a 30-year, fixed-rate loan of $300,000 with a 5% annual interest rate to buy a duplex. You plan to renovate and live in one end of the duplex while you rent out the other end.
This means the principal and interest will run you $1,610/month.
You got a great deal because you bought before the market matured (i.e. - buying in a suburb of Austin, TX 15 years ago). You’re proud of yourself - you nailed #1 of real estate investing basics - location.
But it turns out - the market isn’t picking up as quickly as you thought. You can only get $1200/month for the other part of the duplex. Plus - you’ve got HOA fees, homeowners insurance and property taxes. Here’s what your monthly spend looks like;
Cash In
$1200/mo (rent)
Cash Out
$1610/mo: Loan Principal + Interest
$198/mo: Property taxes
$50/mo: HOA fees
$70/mo: Homeowners Insurance
Total: $1928 Monthly Expenses
In this scenario, you’re running a $728/month deficit.
Now, maybe you have a job and can afford to absorb this cost. But can you absorb it on top of the cost of repairs to the side you’re living in? How about the repairs to the tenant’s side when a pipe bursts or the fridge needs replacing?
If you can absorb these costs, then this is probably a good investment, as you’ll gradually be able to charge more for rent and eventually sell the duplex for a large profit.
But if you can’t absorb these costs, this is a well-intentioned, but poorly timed, investment that will likely fail because you didn’t adhere to the real estate investing basics, and you didn’t make sure your investment was cash flow positive.
