From banking to automotive to tech, major industries continuously make a select few people incredibly wealthy. But there’s one path to building net worth, however, that’s transcended education levels, industry and even personal income — and that’s real estate, one of the biggest wealth builders in America.
While most people hear plenty of news about real estate markets fluctuating, the secret to real estate investments that most people don’t understand is simple: leverage. Some of the most popular ways to make money in real estate are buy and hold for rental, buy and hold for speculative, and fix and flip.
I’ve personally followed these strategies and have invested in multiple properties over the last 20 years. Having seen the compounding impact over time, I wholeheartedly believe that every person, with a little research and hard work, can invest in real estate as a great way to tip the scales and increase net worth beyond just an income.
If you want to buy a $300,000 house, you probably know you don’t need $300,000 cash to purchase it. It’s generally understood that a mortgage and a 20% down payment is the norm, which in this case would be $60,000.
In a buy and hold situation, let’s assume the rental income covers the mortgage payment each month — ideally, it should be higher, but let’s use a basic example. Now we’ll look at the value of your investment property over a nine-year time period. If you bought a house in 1995, that house would have appreciated 73% by 2004. According to data from both the National Association of Real Estate and the U.S. Census Bureau, average sales prices of new and existing homes has increased by 5.4% per annum from 1963 to 2008.
The problem with primary residences is that if you sell your home to buy another, all home values go up approximately the same percentage. However, for an investment property, if you purchased that house for $300,000 (and made no rental income), in just under a decade, the same house would be worth approximately $519,000, in theory ($300,000 increased by 73%). Now if you sold that house and paid back the mortgage of $240,000, you would be left with $279,000, all from your initial investment of $60,000. That means that over nine years, you grew your initial investment of $60,000 to be $279,000. For every $1 you invested, you received $4.65 back — not a bad investment.
Now add annual rental income profit of a modest 3% of the purchase price. Year one would be $9,000 (3% of $300,000), and this would grow 5.4% per annum, totaling a little over $100,800 in rental profit over those nine years. Add this to the $279,000, giving a total net profit of $379,800 for your initial $60,000 investment. That means that in just under 10 years, you grew your initial investment of $60,000 to $379,800 — in other words, for every $1 you invested, you received $6.33 back.
Now let’s assume you want to renovate and sell at a profit, commonly known as fix and flip. This is another way leverage kicks in. For $60,000 you are able to purchase a property that is worth $300,000.
Let’s assume renovation costs of $40,000 and a sale price of $380,000 12 months later. The mortgage payments (or carrying costs) would be approximately $1,181 a month (assuming a mortgage of $240,000, an interest rate of 4.25% and term of 30 years), as per Google’s Mortgage Calculator. This would give a carrying cost of a little over $14,000.
Most people see an $80,000 increase, and while that is correct, that’s not the most important number. The most important number is known as return on investment (ROI), or how much you earned back for your initial investment. The total investment was a $60,000 down payment plus the $40,000 renovation cost and the $14,000 carrying cost, giving you a total cost of $114,000.
You have a total investment of $114,000, and the property sold for an $80,000 “profit” for a property initially worth $300,000. You invested $114,000 to increase the value of the house from $300,000 to $380,000, $80,000 of which is pure profit, so that’s a 70% ROI. For every $100 you invest, you receive your investment back plus an additional $70 in one year.
Until now, we’ve talked about the acquisition of one single property. What happens when you acquire a new property annually for 10 years? This is how generational wealth is created. However, you need funds. There is no one way to fund a down payment, as everyone’s situation is different. Here are a few quick tips for saving for a down payment that have worked for me:
- Find additional work
- Live frugally to save more
- Bring on partners
- Start and build a small business over time
Plus, after you have your first property, you can leverage the equity you’ve accumulated in that first property to make a down payment on the next property.
Obviously, there are many options, and making a decision toward the right path can be daunting. Here are a few helpful tips:
1. If you are limited for time, fix and flips might not be ideal for your first investment.
2. Start with small renovations on your first few projects to learn the process. Always get multiple quotes from vendors; it’s amazing the difference comparison shopping can make. Never tell them the quotes you already have.
3. Remember, construction has many surprises and can take longer than expected, so budget accordingly.
4. Get daily updates from your contractors so you can catch changes or issues immediately and work through them quickly without them dragging on.
5. The market is always changing, so the biggest key to combat fluctuations is to always invest in an area that has an increasing population. Let increasing demand be your driver and your safety net.
The key to real estate investment is the ability to leverage your money. I highly recommend using resources like seminars, websites and books about successfully investing in property. The first step is always the hardest, but understanding that you can leverage your money through real estate investment is where it all begins.