About Real Estate Investing

I know that for many people, buying a rental property still feels far off. But real estate itself requires a lot of preparation, and it often takes a year or two of learning before you can really get started, so I’m writing this as a basic introduction to the topic.

First, a quick introduction to my own investment situation. I entered the stock market at the end of 09 and started in real estate in 12. Right now, about 30% of my money is in the stock market. I also own one primary residence and two investment properties, and I’m still working on a third but haven’t bought it yet. I’ve also invested in a local Chinese barbecue restaurant and several ramen shops. I’m interested in anything that makes money.

Overall, real estate is a very good store of value and an asset that can resist inflation. But don’t let the surge since 10 mislead you. This has basically been a once-in-100-years opportunity. So in general, if you want to invest in real estate and expect annual returns above 10%, that’s unrealistic—unless you were lucky enough to buy before 12. That’s why real estate investing should be based on one very important consideration: cash flow. If a property can provide positive cash flow over the long term and does not require too much maintenance, then even if its actual market value is temporarily below the purchase price, that is not a problem. Flip house is a different topic entirely. The focus of this article is how to choose a normal investment property.

First, here is the single most important reference resource:

I recommend that anyone who wants to get into real estate read this book carefully 3 to 5 times. Generally speaking, except for the highly unusual real estate cycle from the end of 08 to the present, this book is the authority on normal real estate investing. I’ll cover three questions here: why invest in real estate, how to buy property, and how to rent it out.

Why Invest in Real Estate

First, and most fundamentally, real estate is different from other fields because as long as you can rent the property out, it can provide stable cash flow. To put it plainly, unlike stock investing, which can make you anxious and require constant attention, a rental property usually takes much less mental energy. Yet your wallet gets fatter every month, and then you spend it. It can feel like an endless source.

Second, because of inflation, homes tend to appreciate naturally. On average, real estate appreciation is around 5% per year. What’s interesting is that although this appreciation is only paper wealth, if used properly it can be turned into cash without being taxed. The simplest way is refinancing. You take out a new loan based on the updated valuation and use it to pay off the old one. Because the property has appreciated, you can borrow more, and after paying off the old loan you may still have a lot of cash left to take out and use. Since this cash is part of a loan, it generally does not need to be taxed.

Third, with a rental property, as long as you manage cash flow well, the tenant is effectively paying your mortgage and various expenses. So over the long term, you may have only put down the down payment, but eventually you end up owning the entire house. Of course, this is also part of the cash-flow story.

Fourth, there are tax advantages. In the U.S. market, real estate is one of the few things that is tax-favorable for the middle class. Generally speaking, the middle class gets hit hard: income tax keeps going up, and capital gain cannot become the mainstream. Setting up a trustee structure is often too expensive to make sense when you don’t have enough money in the first place. Real estate offers many tax advantages. First, for an owner-occupied home, mortgage interest and property tax can offset income tax. Second, if you live in a home for more than two years, up to 50 万 in capital gains from selling it can be tax-free. For investment properties, the advantages are even greater. A property can be depreciated over 27.5 years as part of your costs, and you can also deduct various maintenance expenses, HOA, utilities, repair costs, and so on. Very often, you may actually have income, but on your tax return each property shows a loss. Not only do you not owe tax on it, but it can also help offset part of your income tax. For the middle class, this is a very important practical benefit.

Finally, there is financing and leverage. Real estate is one of the few areas where banks are willing to lend. That is very helpful for individuals. Generally speaking, the total amount you can borrow is around 5 to 7 times your pre-tax income. For example, with an income of 12 万, you may be able to borrow 80 万. But there is a special rule: 90% of the rental income from your investment property can be counted to offset your loan cap. In other words, if your monthly mortgage payment is 3000 but you collect 2000 in rent, then the lender may count you as if your payment were only 1200. There are some specific details involved, but in many cases, as long as the rental can be rented out, you do not need to worry too much about qualifying for the next property. That’s why the first investment property is the hardest, and after that it gets easier and easier.

Real estate investing has so many benefits, but are there downsides? Yes, there are. The biggest one is liquidity: a house is not something you can buy or sell instantly. It may take several months to half a year to sell for a good price. When you urgently need money, you may not be able to rely on it. Of course, a home equanlity loan is one option: borrowing from a bank using your home as collateral.

How to Buy Property

Buying your first investment property may be the hardest part of the whole process. As with stocks, there is also a mindset issue here. The first time is never easy. That was true for me as well. My suggestion is that if you plan to invest in real estate for the long term, it may be worth getting an agent license yourself and hanging it with a broker. It may cost a few thousand dollars, but you can learn a great deal about real estate and it also makes it easier to manage investment properties. More skills never hurt. But at the beginning, you should still find a reliable agent to help you buy your first property. A lot of people think rebates are very important when choosing an agent. But I’ve always believed you get what you pay for. Good agents—especially truly excellent ones—never offer rebates, but they can save you a lot of money in negotiations and contract terms, and you can also learn how to evaluate properties from them. That is very valuable.

The most appropriate metrics for investment properties are cash flow and return on investment. I usually use the following formula:

  • Real estate investment annual return: ( annual income - annual expenses (mortgage, repairs, etc.) ) / down payment

A rational return of around 5% per year is already very good. Why? Because the property itself also has natural appreciation, and the tenant is also paying down your principal. Those things are not included in this return calculation. If you can still get 5% per year under those conditions, that is a very strong return.

So how do you choose a property that can generate that kind of return? In my experience, investment properties are different from primary residences. The foundation is cash flow. The most important thing is whether the property can be rented out smoothly and at a good price. Whether it is in a great neighborhood or whether it will appreciate quickly is secondary. From that perspective, a condo in a college town or near a major company can be an especially good choice. Even though properties in these places are often run-down and have limited appreciation potential, they can provide excellent cash flow and ensure that you make money year after year.

I won’t go into the detailed steps of buying a house here. Any experienced agent can guide you through every stage of the purchase process. If there is real demand, I can write a separate article about that.

How to Rent Out Property

Once you’ve bought the property, you need to rent it out. The longer it sits vacant, the greater your loss. But if you accidentally rent to the wrong person, you can run into many problems. Here I’ll briefly discuss some considerations when renting out a property for everyone’s reference.

First, the United States is very serious about political correctness, and in rental ads you must avoid anything that could be considered discriminatory. Remember: anything that could be discriminatory. If you get this wrong and someone sues you, you will regret it. It can be very costly. So what counts as discrimination? There are protections at the federal level as well as the state and county level. At the federal level, this includes race, color, sex, nationality, religion, marital status, and disability status. For example, you cannot say that the neighborhood is nice because most of the residents are white. You also cannot say that the house is close to a church and convenient for worship. Likewise, you cannot say there is a temple nearby where you can burn incense and worship. In tenant background checks, you cannot ask whether someone is married, whether they have a disability, and so on. State and county rules can be even more complicated, so for your first time it is best to consult a lawyer. To give one simple example, in some states age is also a protected category. Also, let me add one more thing: in San Francisco, California, do not use rental property investing as your real estate strategy. That place is bizarre in every possible way and absolutely unsuitable for normal human real estate investment. So what can you ask? Generally speaking, job type, income, previous address, and previous landlord contact information are all acceptable.

Second, tenant screening needs to use fixed, written standards. Everyone should be evaluated under the same criteria. What you think privately does not matter, but when reviewing applications, make sure you strictly follow your written standards. For example, you cannot reject someone because Indians eat curry while accepting Chinese applicants who eat curry. As long as your standards are non-discriminatory and applied uniformly, legal disputes are much easier to defend and there is less to fear.

Third, background checks are very important. Income determines whether the tenant can afford the rent and pay on time. Employment history helps show whether the person is reliable. How frequently they move can tell you whether they are unusually difficult to deal with. A credit score above 700 is generally not a major issue. Criminal history is also very important. If someone has a criminal record, it is usually best not to get involved. Even if it seems like a minor issue, it is better to stay away. Most importantly, anyone with an eviction record should not be considered. An eviction record is a major problem and will definitely affect your rental business.

Fourth, previous landlord feedback. Every time, I require a reference from the prior landlord. It really is that important. Without a reference, it is often hard to know whether someone is reliable. A reference is not all-powerful, but having none is not acceptable either.

Note: This article was originally published on the forum flyerbbs.com. For various reasons, this site decided to stop maintaining the forum. We are now gradually moving some useful forum articles to the blog.