How To Invest in Real Estate
Updated: Aug 30, 2020
In our last post we showed you some do’s and dont’s of the stock market for investing your money. This time we take a look at some more details.
There are many trading tools that can make money faster than traditional investing in stocks or ETFs, but they can also lose money faster.
It works both ways, keep that in mind all the time.
If it can bring gains fast, it can also lose money even faster.
I personally set aside a small amount of my portfolio to look for speculations. For instance, I look for stocks where the business has just had a crisis or who lost most of their value, or also penny stocks from various industries.
Sometimes this strategy wins, making it possible to return 30x your money or even more. And sometimes this strategy loses all money that has been invested because the stock goes to 0 and the business goes bankrupt.
While I have some specific numbers and data I look out for, I don’t want to give you detailed investment advice here.
It is possible and a dangerous path and you never know how it will work out.
The important thing is to stop as soon as you win and get out - never try to gamble and think you are super smart because you were lucky at some instant.
But if you happen to be lucky enough to receive some speculative gains and have suddenly turned 500$ into 50.000$, or recieved a huge sum from your job or business, our strategy here will help you to make the most out of these gains.
Lock-in Your Profits
Being invested in the stock market can give you a great form of long-term gains and increase your wealth exponentially, but there are also a few disadvantages.
First and most obviously, the market is always moving and you can never predict when the next crisis or big market drop is waiting for you around the corner.
That shrinks disposability of your invested capital, unless you want to sell with potentially huge losses.
On the one hand, a crisis does not automatically mean a disaster for your portfolio because only the book value of the stocks has decreased - to realize the losses you would have to sell the assets.
As long as you stay invested, even in the worst of downturns, you have no real loss as it is only generated if you sell at that point.
But, what if you relied on the capital gains as income and the crisis lasted for several years? What if you need the capital now for an emergency?
What if you had a business running well for years that suddenly loses money and you lose your income?
After you have been past the first stage of building a business, making great revenue and increasing your income all your way to the second stage of investing in the whole stock market, increasing capital gains and receiving interest, you now have the last stage to master for true financial freedom.
A business can run well today and make you rich, but even if it works great today in 10 years the business could go bankrupt for one reason or another.
Likewise the stock market can have great returns and can augment your investments but it can also crash for many years in a row, and you would still need the capital gains if you rely on them as income.
Luckily, once you have achieved great wealth there exists a way to kind of “freeze” your earnings, conserving them for the long run.
It has been the greatest wealth builder of the last centuries: investing in real estate.
Real estate by itself does not automatically grow or increase it’s value, instead it always stays quite at the same level of inflation. To generate a profit from our investment in real estate, you will usually have to do more than just buy it.
Clearly, also in the real estate market there are ups and downs, and sometimes objects will perform above market value and sometimes under it.
Over the long term, real estate did always keep it’s real value and sometimes even had slight gains.
The reason for the price-explosion we had on the real estate markets worldwide in recent years was that since the crisis of 2008 where prices dropped dramatically, the FED and other central banks did dilute the entire financial system by pumping trillions of dollars in the market and lowering interest rates to zero in order to encourage people to spend their money.
As you probably guessed it, this massive amount of additional cash led to huge real-value inflation on the one hand, and through the low interest rates wealthy people now had to invest their money in order to not see it being eaten up by this inflation.
And thus real estate and stocks have become the common investment vehicles of choice because their value stays consistent even with high inflation.
The negative side of this massive amount of capital moving into the markets is that particularly in city areas the prices for a standard apartment have skyrocketed in such a way that living in the city center has become unaffordable for the average citizen, making city centers an area where only the rich can afford to live in anymore.
Also at the time of writing this the stock markets are on an all-time high, the S&P 500 index has tripled over the last 10 years alone!
Meaning if you had invested 100.000$ you would now have 300.000$ in your account.
All just for being invested!
In the past, if an index only doubled it was a warning sign of an overrated market, we will see what all this will lead us to and especially what will happen if interest rates should go up during the next years.
Back to real estate, apart from the long-term price developments, what it perfectly does in all kinds of market conditions is generate a steady stream of income when it gets rented.
The classic form of use here are standard apartment buildings with multiple units, once they are bought and rented out they generate monthly earnings for their owner that can serve as income.
And the best effect of real estate investing starts as soon as you own multiple homes that are rented out and the income starts compounding.
While many praise real estate for being the ultimate passive income, pay attention as it is never totally passive.
First of all, you have to keep an eye on several utility costs that come with owning a property, then there is always the risk that the renter moves out or can’t pay the rent, and you will have to replace him or her, leaving you with the risk of vacancy and thereby zero rental income, while costs keep running.
In the worst case, people will have to be forced to move out if they don’t pay you and can leave the apartment in a horrible condition.
In such cases you are left with all the costs on your own for renovating the property and the lawyer needed to get the tenant out, which can quickly come to amounts as high as 10.000$.
And you often can’t demand the costs from the former renter if they are on the verge of bankruptcy already.
Similar to stock market investing, the best way to not get intimidated in real estate by those scenarios is through diversification.
You can always have bad luck with a single apartment that you rent out, but if you own 10 properties, usually 9 out of those 10 will run smoothly and maybe 1 of them will make problems long in the long-term.
Also investing in real estate offers a variety of tax advantages, for instance if you finance the property the interest you pay in the mortgage is tax-deductible, just like many other of the costs regarding owning properties.
That makes it a lot easier to generate a net cash flow, and the demand for living space is always rising due to our rising population.
The most lucrative part about real estate is if you can buy property below market value or from an owner who has no professional background on how to create more value from construction work.
Many properties can be upgraded or renovated to increase their value, resulting in additional profits for you as the owner.
Also buildings with multiple units can generate extra income from renting out parking spaces, washing machines or other things that residents could use.
It always pays to look out for potential in rental units to increase the income, and in many cases there are a lot of ways to do this if you are creative enough
It gets particularly interesting if the real estate investment income has reached an amount, where you can cover all your living expenses from it.
The rent comes in every month and you do not actively have to work for it.
But remember, while the overhead work will be small, real estate will never be completely passive!
To make the most out of your capital you can make use of leverage.
As already mentioned the loans you take for buying real estate investments are in many countries either fully tax deductible or at least the interest rates the bank charges you will lower your tax burden.
So paradoxically if you totally own your property even if it sounds more reasonable than to have a loan on it, you will end up paying more in taxes.
But if you have too much mortgage on the apartment and interest rates begin to rise, you might lose all your earnings to the bank!
In addition to that loan contracts themselves have always backdoors hat allow the bank to change it’s rates and interest claims, sometimes even the whole sum is callable upon the bank’s demand.
Be very careful about that - banks are NOT your friends!
So where do we find the optimum compromise between those 2 sides?
Among real estate investors it is said that the optimum amount of debt on a rental property is at 60% loan, meaning you have paid 40% of the total sum for the property in cash and the rest stays in debt to enjoy the tax benefits, regardless how much money you have.
Even if you happen to have lots of money in your bank account, you should not continue to pay back more from the loan on the rental property. It makes more sense to only pay back the annual interest - which is fully deductible.
With that constellation you will be at the best possible point to, one the one hand own the property and have cash flow, and on the other hand to have as much as possible tax deduction.
However, you have to pay attention to the natural deterioration that buildings have.
You can assume that approximately every 10 years a building will need major repair work like new doors, windows, sometimes also the heating or cooling systems, plumbing, piping and many other factors will have to be replaced or at least renovated from time to time.
Painting a property should be also done at least every 10 years, ideally more often as the paint alone can improve the building’s appearance and perception a lot, and therefore justify higher prices.
Without such repair works and proper maintenance, you not only make your building look in a bad state, but also set yourself up for trouble with your insurance companies in case damage results out of lacking maintenance, such as damage caused by water.
If they can prove that the damage happened due to poor care or maintenance, they are not liable to pay you anything!
Therefore the calculation you will have to make for investing in any rental property basically is as follows:
- amortization and/or interest on loan
- operating expenses
- costs for repair work every 10 years
= your income
Rental prices in real estate differ from various regions and countries, and so will the calculation that you have to make on each object.
The most important factors to consider for any property are:
potential to increase earnings (renovations, add extra income like parking lots etc.)
the rent price itself
the conditions on the loan you receive
the demand on the market for your property, meaning how fast can you find a new renter
Every object will have to be observed specifically, as the factors can already differ vastly from one neighborhood to the other.
It is also a must to observe every property with a building expert before you buy it, ideally someone you know you can trust and who has your best interest at heart.
He or she will see details you would not notice normally, and can give you an overview if the building is in good condition or if you should stay away from it.
A crack in the wall for instance can mean nothing, and at the same time it could mean disaster for the property and huge costs to fix it.
Choose your experts wisely for your investment!
Once you have achieved it to have a large amount of money from your business, from your investments or also just from the lottery, investing in real estate can help you conserve the amount of money and transform it into a monthly income you can live by.
That means if you are lucky enough to have a few millions in the bank, whereby inflation normally would eat up a certain percentage every year automatically, you can instead invest the money into real estate and you will see it at the minimum keep up with inflation or even rising.
At the same time you can enjoy the rents coming in as a source of income to cover for your lifestyle.
That means for you:
No matter where you stand, if you are in your 20s worrying about how to ever build a secure future or if you are in your 50s, worrying about a safe retirement, there is always and still a way for you to make it.
Clearly, the more time you have, the better. In our other blog post we talked about how only 10 years can put you in a position where you can enjoy true financial freedom, imagine now what 20 or 30 years can do!
Are you still worried? Or is there still something that you are not sure about? Any other experiences? Lets us know in the comments below!