One of the exciting things about the financial independence community tends to be the hyper-focus on specific sub-topics such as retirement vehicles like a 401k, Roth IRA, etc. Not so much is mentioned about real estate. Sure, someone might reference the equity in their house relating to their net worth, but rarely is real estate discussed as investment modality.
Fortunately, before I found the financial independence/retire early community, I was involved with another community: BiggerPockets. BiggerPockets focuses on real estate investment education and networking. They also have podcasts, which were tremendously helpful when I was starting as a newbie to learn the ropes. More on this later.
Why Bother Investing in Real Estate?
That’s a great question. Sure, you could say stocks/mutual funds are much more passive and hands-off – which is true. A 401k and IRA (individual retirement account) receive tremendous tax benefits that almost make it seem like this is the only correct path to creating a large and powerful retirement nest egg.
The exciting thing is that real estate (specifically rental real estate) also offers its compelling advantages such as:
- Steady income
- Long term financial security
- Tax benefits
- Real estate appreciation
- Direct control over your investment
- Investing in real estate benefits the community
- Typically financed which provides leverage
Getting Specific on the Benefits
1. Steady Income
Owning a house, condo, or multi-family property gives you the option to rent part of or the entire property out to a tenant. This tenant, in turn, pays rent for the use of the property. This is the backbone of real estate investing. Once a property is ready to be occupied and a renter placed, the income is mostly passive. While there may be tenant and maintenance issues on occasion, the income made is generally passive.
2. Long Term Financial Security
Having a property with long term financing and generally stable values provides security. Sure, house prices can go down, but if you’re renting out a home and generating a profit – it doesn’t matter. Wait until the market is better, and then you can sell. Or keep renting it out and making money. You have options, and options provide you more control over your investment.
3. Tax Benefits
The government loves real estate investors. They give us plenty of advantages to keep doing what we do – providing housing and benefiting the community. Here are a few of the real estate tax advantages that we are presented with (in the U.S):
- Depreciation – A tax deduction for the perceived decrease in value due to wear and tear on a property
- Mortgage interest tax deductions from income
- Deferral of capital gains via 1031 exchange – A way of avoiding paying taxes on a property sale if the amount is used to purchase another investment property
- Deduction of repair and upkeep cost
- Property tax deductions
4. Real Estate Appreciation
Prices of homes tend to go up over time. While part of this may be a function of inflation, the prices of real estate assets tend to rise over time. S if you own a property as a rental, not only is it providing an income, having the mortgage paid down, but it is also increased slightly in value.
5. Direct Control Over Your Investment
Many people fantasize about being their boss, few if any get to do it. How would you like to make critical and important business decisions? Now, this isn’t for all personality types – the more independent you are as a person, the more “being your own boss” resonates with you.
I enjoy this part the most. Not being at the whims of the stock market or the mercy of a board of directors is very freeing. When you select a real estate investment, almost all aspects of it are under your control. If you want a better deal, you can change the terms. Where else will you find this level of control in the investment world?
How I got started
In 2016, I got the real estate bug. I was thinking of ways to create passive income and remembered that rental real estate was one of the main ways to do that. My father had two rentals from 2000 to 2008 and did well with them. I remembered the positive aspects of real estate as I was growing up – helping my parents pay for college, helping save for a new car and create financial security. That is something I never forgot.
Before sharing my intentions with anyone, I decided to educate myself on the subject and started with downloading some podcasts. I found the BiggerPockets podcast and got instantly hooked. Within a few months, I had listened to over one hundred episodes and felt like I had the basics of real estate understood.
After gaining all of this new knowledge, I was anxious to act on it. After talking about real estate for a few months, I attended a few real estate meetings and met some awesome people (some of which I’m still friends with). The topic of looking for a rental came up in a conversation with my father around this time. Discussing the idea for a bit, we decided that it would be best to team up on this adventure. This would let us split the costs, the work, and of course, the profit. Benefiting from his knowledge would be very helpful for our first rental.
Finding an Actual Deal
This was somewhat of a challenge. I had learned the metrics of what made a good deal from BiggerPockets. The problem was that in my area, many homes did not fit this mold completely. Usually, the houses were too expensive, required too much work, and would not rent for an amount that would be worth the effort. Over the next few months, we sifted through plenty of duds, which created plenty of entertaining conversation.
Eventually, we found the deal. It wasn’t stellar, but the numbers worked. We were trying to find something with a cap rate of 8% (net annual income/value) and cash on cash ROI (ratio of annual before-tax cash flow over the total amount invested) of 12%. This deal fits the bill.
Due to the house being newer construction, the rehab was mostly cosmetic. Over a few months, we worked on the painting, replacing fixtures, appliances, and flooring. At the end of it, we had a house that was ready to go and in great shape. If you would like to read about the rehab process in detail, I recommend checking out my post here:
Getting Past the Nay-Sayers
“Don’t take criticism from someone you wouldn’t take advice from.”
Plenty of people told me this wouldn’t work. I heard every reason in the book, too:
- “What are you going to do if the renter stops paying?”
- “What if something breaks?”
- “That sounds like a lot of work.”
- “My (friend/uncle/nephew/father) had a rental, and it was nothing but a pain in the behind. They never paid on time and destroyed the place. That’s what will happen to you if you get a rental.”
Honestly, it’s just funny to me at this point. Initially, I was concerned because when a bunch of people are telling you the same thing, you begin to believe it. However, I always do my research. After listening to months of podcasts, you can learn from other people’s mistakes. I started to develop a plan to find the ideal renter.
Get Better Standards
Thankfully, logic took over in this decision-making process. I realized that we were the ones selecting the renters, and as long as we did our due diligence, luck was on our side. So, with the knowledge combined from my father and the BiggerPockets podcast, I created a list of renter qualifications that must be followed (no exceptions). They are as follows:
- Income – Minimum of 3x rent amount (gross income)
- Employment – 2 to 3-year history in the same job or field
- Self-employed – Provide last year’s tax return with two previous months of business bank statements
- Reference from the previous landlord (if applicable)
- Pass background check
- Pass credit check
- No smokers
- Pet fee for all pet owners
At first, these rules seem harsh, but let me tell you – they’ve saved me from some terrible possible tenants. If someone can’t meet these rules, it does not make sense to do business with them, and that’s what a landlord/tenant relationship is – a business. Ideally, you want to be paired with someone who is equipped to deliver on their promise, in this case, to pay the rent on time and take care of the property. All your work rehabbing a property will be completely wasted if you put a terrible tenant in there. That is the part that matters.
Using these standards, the renters in our first rental property have been fantastic. Not only do they pay the rent on time, but they take excellent care of the property. Of course, if anything goes wrong with something in the property, we step in immediately to fix it (it is a good business practice to be a prompt and ethical landlord). The feeling seems to be mutual, and we are happy to have them rent our investment property.
Finding renters of this quality was not accidental. It comes from high standards. If you’re someone who is thinking seriously about this business, remember this one thing – have high standards and never compromise.
Why I Decided to Invest in Real Estate
Real estate provides multiple tax advantages and ways of producing income. It is a physical asset that can be changed, upgraded, and improved – which increases its value. You can rent it out, flip it, “Air BnB” it. Mostly, you have options and, most importantly, control. Not many investments provide this kind of security and flexibility.
Real estate provides you with the opportunity to operate your own small business with a proven business model. As long as your rental research is stable (a real estate agent is great for assessing recently rented homes of similar size and features), you will do just fine.
Buying a home for a below-market price, repairing/updating it, and placing quality tenants in it has another fantastic feature as well – it helps the community. By taking a property that was in terrible shape and making it great, you are enriching the community of that area. Aside from all the money talk, this is the other part of real estate investment seldom talked about:
Real estate investors are community changers
And I think for me, that’s the part I enjoy most. Sure, you can donate to causes, volunteer, etc. but it means so much more when you have multiple neighbors thank you for fixing that “eyesore” of a house that was on their street. Helping the community and receiving a healthy income for doing so is the ultimate win-win. If you are someone who is thinking of investing, I recommend real estate investment. When done correctly, it is profitable, ethical, and beneficial to all parties involved. Feel free to reach out if you have any questions