Elizabeth Yu – Real Estate Broker at Berkshire Hathaway HomeServices
As a homeowner, you may consider your property to be an investment. You’re putting money into it that you hope to get back when you sell. But there are other ways to invest in real estate that will give you a nice profit. It’s just a matter of finding the best way to do it that is comfortable for you and your budget.
Start with a starter home. First-time and lower income homebuyers have great opportunities to build wealth through buying a home and living in it long enough to build equity. If your home is also your homestead, there are many government supports that will help you gain wealth more easily, such as lower down payment requirements on mortgage loans, lower interest rates, and lower property taxes. Non-homestead properties such as second homes are considered riskier by lenders, so they have stricter rules about down payments, income to debt ratios, and the types of loans you can qualify for.
Build equity. Equity is the percentage of the home that you own VS the amount the bank owns. There are four ways to build equity:
1. Down payment. You gain instant equity when you put a down payment. If you put 20 percent down, your equity ownership is 20 percent. The larger your down payment, the less you’ll pay for your loan in terms of interest rates.
2. Purchase price. You can gain instant equity by buying your home below the market. Homes don’t typically sell below market unless there is some sort of problem, such as poor condition, lack of updates, short sale or foreclosure. You’ll have to invest in updates and repairs to bring your home up to neighborhood standards, so make sure the cost of the home plus improvements keeps your home competitive among similar homes.
3. Paying down principal. As you pay your mortgage, little goes toward reducing the principal while a lot goes to paying interest. The longer the term of your loan, the less quickly you’ll build equity. But as your salary increases and housing costs rise, your mortgage will appear less and less formidable. If you can, put extra money toward paying down your principle.
4. Time. Historically, home values beat inflation by one or two percentage points, which means the market will go up in price, giving your home more equity without your doing anything further. Your goal should be to build enough equity in five or so years that you can rent out your home and make a profit.
Buy, hold and lease. Real estate seldom goes down in value, and if it does, it soon recovers, as proven by the Great Recession. Your goal should be to pay off your mortgage so that you own the home outright. If you want to buy another home, the debt on the home you already own won’t count against you as much as you may think – especially if you already have the home leased. To see if you qualify to buy a second home, the lender will see if your proposed rent is enough to cover weeks or months that the property may go unrented. There may be lag-time between renters and you also need a little time to clean up, repaint, make repairs etc. before your renter moves in. You can also pull money out of your first home with an equity line of credit to put down on another property. Another way is to lease a room in your home as a short-term rental.
The ideal time to lease your home is if you can rent it for more than you’re paying in mortgage, taxes and insurance. You also need some savings that will cover the mortgage while the home isn’t rented, as to pay for repairs that may come up.
To help you decide if leasing is a good idea, talk with your Berkshire Hathaway HomeServices network professional. They will have comparables for other rentals in the area, so you’ll know how good the market is for homes like yours and how much you can expect to get for your home.
Become a good landlord. You’ll be doing the job of a property management professional, which means you’ll have to perform background checks on potential renters including credit scores, rental and eviction history, criminal and sex offender checks, motor vehicle checks, and employment verification. You can hire a property manager to find and qualify a renter for the cost of approximately one month’s rent. If you decide to rent your home yourself, there are companies online that specialize in background checks for landlords.
Your rental agreement should include penalties for late payments, as well as outline clear terms – length of the lease, possession date for move-in; terms for extending the lease, fees for late payments, pets or no pets and so on. You need to be very clear about what the renter is responsible for doing and what you will do as the owner. This will prevent disputes over who pays utilities, who mows the lawn and who calls the plumber.
Make sure the renter also pays one month’s deposit so you can cover the costs of cleaning, repainting and other make-ready steps. Last, make sure your renter has renter’s insurance.
Flip homes for a living.
A hot market, with a low supply of homes and rapidly escalating home values is ideal for flipping because buyer demand and price appreciation are “built-in.” But if homes to buy are hard to find, you may have trouble staying within your budget. You have to know the market and adhere to a strict acquisition formula to meet your estimated after repair value (ARV).
The flippers who make the most money are full-time professionals who use cash to buy homes, do all the repair work themselves, and sell the home themselves. They know the market well enough to negotiate the right purchase price and have the skills and experience to estimate improvement costs accurately and do the improvements that appeal most to homebuyers. They know how to minimize out-of-pocket expenditures such as mortgage payments, utilities, property taxes, insurance and other costs.
Invest in REITS. Real estate investment trusts area good solution if you don’t want to be a landlord but still want real estate in your investment portfolio. According to Nerdwallet.com, publicly-traded REITS are a lot like mutual funds and tend to pay high dividends.
Become a real estate crowd-funder. With as little as $500, you can invest in real estate online along with others in the “crowd.” Some platforms, however, require accredited investors only, which means you must have an income of at least $200,000 or $300,000 if you’re married or a net worth of $1 million. These investments are private rather than publicly-held REITS, or private real estate developments. For a list of Nerdwallet’s favorite crowdfunding sites, click here.