Popular Investment Plays for First-Time Investors
If everyone had the means and the skills to do so, many of us wouldn’t mind building and owning the next billion-dollar skyscraper in New York City! But as private investors, we will be limited in our resources and skills. So as new investors, what are the options? Better yet, what are the best options for beginner real estate investors?
We’ve covered the indirect way previously (i.e., investing in REITs or buying stocks in publicly traded companies tied to real estate), but we’re going to look only at the direct options, since that’s more exciting.
One good way to think of your options is to answer these two questions:
1. Do you have good amount of investment capital to start with (i.e., could you easily come up with the down payment needed?)
2. Are you looking to generate as much cash immediately, or are you looking to build up long-term passive cash flow and equity?
Let’s take a look at popular options for new investors based on your answers to our previous two questions.
Have capital: Maximize short-term cash. If you have enough investable funds for a downpayment and want to maximize short-term profits, then rehabbing (i.e., doing fix and flips) is a popular place to start. These projects require startup capital (i.e., downpayment) to secure financing to purchase and rehab a property. Post rehab, the properties are immediately sold for (hopefully) a profit. A&E shows may try to convince you otherwise, but fixing and flipping can be very risky for first-time investors—not a good first investment to get your feet wet.
Have capital: Maximize long-term cash flow. If you have enough investable funds for a downpayment and want to maximize long-term cash flow, then landlording will fit your needs. Here, you buy a property and lease it to a tenant to collect rents on it for the duration of your investment, typically for many years. As the mortgage is paid off, the investor gets to keep 100% of the rents after expenses. This is lower risk and is a good option for first-time investors.
No capital: Maximize short-term cash. If you have no capital and want the potential to generate some cash (so that you can have capital!), you may want to explore wholesaling. It’s not technically investing, since you’re not owning a property, but rather facilitating the exchange of a property. Essentially, you play a middleman. You find an motivated seller, negotiate an all-cash sale price, along with a long enough time window for you to “review” the property, while simultaneously shopping the property to investor buyers willing to pay you MORE. The difference is your profit. Why is this attractive? Well, you don’t need specialized skill and can start with no money of your own. Why is tougher than it looks? Many markets are saturated with competition from those looking to build cash for their flips or rental investments.
No capital: Maximize long-term cash flow. If you have no capital but want to build long-term cash flow, you’ll have to get creative and employ the less common strategies, such as lease options (where you lease a property with the “option” to purchase an agreed-upon price by a future date), seller financing (where you convince a seller to finance a portion of the purchase price), and Subject-to Deals (where you take over an existing loan for a homeowner through an agreement that allows you to control the home, such as taking a loan on the equity or renting it out for a profit). We won’t get too much into these; they’re often presented by “no money down gurus” to be far more simple, far more lucrative, and far less risky than in reality.
So, where do first-time investors typically start? If you have enough capital, do a rental to get your feet wet. If you have no capital at all, explore wholesaling, but know that this becomes more of a transaction-based business than investing. It will require you to master marketing to homeowners, finding and closing leads, and finding and securing investor buyers.
Tomorrow, we will explore the different stages of the real estate market cycle and why understanding where we are and where we’re heading could make you a better investor.
Have a great day!