If you are reading this, you may be seeking a way to build wealth in the next couple of decades without having to work extra long hours at your job. You may also have narrowed it down to real estate investing, among other options, as the best way to do this.
But how does real estate investing work, and what do you need to get started as a property investor? These questions are critical because “assumption is the lowest form of knowledge.” Thinking you know how something works without actually learning it is a recipe for failure.
This post will take you through the step-by-step process of how an investment property makes money for its owner and how you can start as a property investor. Note that this article is only a primer; you will need more education and a trusted mentor if you want to succeed as a property investor.
What is real estate investing?
You may have heard that “your home is your biggest investment.” That saying is true for most people; their home is the biggest purchase they will ever make. That purchase is so large that most Americans will spend their lifetime paying for it. But real estate investing is not about owning your own home.
You’ll want to start by familiarizing yourself with real estate investing terms. Real estate investing is about buying a property not to live in but to generate passive income. That property could be residential or commercial. It could also be a self-storage unit, RV park, industrial property, raw, undeveloped land, agricultural land, and lots more.
As a beginner property investor, you may be more interested in residential or commercial real estate than other types of real estate investing. The rest of the article will focus on these two types of investment properties. When investing in real estate, there are several approaches you can use.
Real estate investment strategies
The most common property investment strategies are:
- Buy-and-hold: Here, you find a property, rehab it (if necessary), lease it to tenants, and collect rents. That is a long-term investment strategy.
- House flipping: This is a short-term strategy. It involves finding a property priced below market value, rehabbing it to increase its value, and selling it for a profit.
- Live-in flip: This investment method involves buying, rehabbing a property, and then living in it for a few years before selling it. With this method, you can avoid paying capital gains tax.
- Wholesaling: Wholesalers connect property sellers and buyers for a fee. Strictly speaking, this is not a property investment strategy. But it could be a starting point if you lack capital or have bad credit.
- Real Estate Investment Trusts (REIT): REITs are similar to mutual funds; they pool investors’ funds and invest the money in properties. They are traded just like stocks.
- Real Estate Investment Group (REIG): These are groups of private real estate investors who pool funds to buy real estate. REIGs let you become part-owner of a property you would not have been able to afford as an individual.
Getting started as a real estate investor
Here are the things you need to get started as a property investor.
1. Good credit
Your credit score is how lenders evaluate you before approving you for a mortgage loan. A poor credit score will disqualify or subject you to stringent loan terms. Most lenders expect you to have a credit score of at least 620, but a score of 680 and over is best.
2. Proof of income
You must show evidence that you earn enough money regularly to make the monthly payments on the loan. It means you have to have a job or business, and the job or business must pay you enough money to cover all your living costs, plus a little left over.
3. Proof of down payment
Lenders will always require you to put some money down when buying an investment property; they will not give you 100% of the money to buy the investment. The required down payment is usually 20% of the cost of the property, and you must have this in your bank account
4. Proof of additional funds
In addition to having enough money to make the down payment on the property, you need to have enough money to cover the closing costs for the mortgage (typically 3%-6% of the home’s value). Some lenders also want you to have enough savings to cover six months of mortgage payments for your primary residence and the investment property.
5. Get pre-qualified
Getting pre-approved for a loan means talking to your lender before you start shopping for a property. The lender can look at the information you provide and tell you how much loan money you qualify for. You can now use that rate sheet as a guide for finding your property.
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