How to Invest in Residential Real Estate | Rentals and Realtors
“Real estate cannot be lost or stolen, nor can it be carried away. Purchased with common sense, paid for in full, and managed with reasonable care, it is about the safest investment in the world.” -Franklin D. Roosevelt
What is Residential Real Estate?
Residential real estate includes townhouses, condos, undeveloped land, singe-family homes, and any multi-family property that is four units or less.
Most people buy forms of residential real estate to live in, but you can make a living off of owning and renting residential real estate as well! Not just a living, you can actually become a multi-millionaire!
How can you become a multi-millionaire in residential real estate investing? Let’s discuss further.
Why Choose Residential Over Commercial?
There are obvious benefits in both residential and commercial. It all depends on what your goals are with your investments and what kind of lifestyle you want to live.
Lower Cost of Entry: Imagine buying an apartment complex, or a restaurant nearby. Those places are much more expensive compared to a residential property! Depending on your market, you can get 10-15 residential properties for the price of 1 commercial property!
Now imagine getting rent from 10 residential properties in your area… Sounds nice, right?
An example is here:
In Fayetteville, North Carolina, there is currently a very nice Arby’s for sale for $2,086,955. It grosses about $119,000 annually, which is around $10,000 per month.
Also in Fayetteville, North Carolina, there is a single-family home selling for $150,000, with an estimated rent of about $1200 per month.
Assuming $2,086,955 in cash, you can afford 13 of these houses and have some money leftover.
13 x $1200 = $15,600 per month.
You can see how it can be much, much easier and cheaper to begin in residential housing, and it can be more profitable unti you start becoming a major player.
Risk: In most cases, residential properties are lower risk compared to commercial. One of the biggest reasons, as mentioned above, is the lower cost to purchase. A smaller loan = smaller risk.
Another reason that residential real estate is less risky is time. Time is extremely valuable when you have a mortgage to pay and there’s nobody renting your property. It is much easier to get someone to rent a house than to get a business to rent a commercial space.
Lower Insurance: This one is pretty simple, and most people would generally assume that residential properties have lower insurance rates. When a property is classified as a commercial property, insurance immediately goes up simply for having that label.
Larger Customer Base: There are a lot more people looking to rent a house, or a residential multi-family property versus a commercial property.
It is easier to get someone to live in your home than it is to get them to move into the 4th floor of an apartment, right?
During economic downturns, commercial properties like retail and hotels suffer greatly, oftentimes going bankrupt. Homes may struggle, but people will always need a place to live, and renting a home is one of the most popular options out there.
Easier to Flip: Flipping properties has become all the rage, and houses are the primary target for a reason. Flipping a hotel or apartment can take hundreds of thousands, even millions of dollars— not including the price of the property!
Not to mention deals take a lot longer with commercial properties because they are typically bigger deals.
The point of flipping is to buy the property, fix it as quick as possible, and get it sold before paying a significant amount of the principal. Commercial properties are much more inefficient with this strategy.
Safer in Economic Downturns (Versus Retail, Office Space, Hotels):
Everyone knows that when economic downturns happen, retail suffers. People have less money to spend, why would they spend it at clothing stores? Craft stores? The only thing people are going to buy are the cheapest foods they can find.
In a pandemic, office buildings struggle. Why would someone risk getting sick in an office building when they can jsut work at home? We are seeing this with the COVID-19 crisis as we speak.
Hotels suffer in any downturn, from pandemics to economic: When people lose money, they can’t afford hotels. When there’s a pandemic, people don’t travel. People try and get away from the public. What is a hotel? Public.
Easier to Finance: It’s much easier to finance a residential property than a commercial property. Any loan that that the bank issues is issued to make money.
When you, the investor, make money, the bank makes money as well. A bank is more likely to issue a loan for a single-family home than an apartment complex, simply because residential properties are less risky, therefore meaning the bank has a higher chance of winning, and a lower chance of losing.
Better Financing: Not only is it EASIER to finance, you also get better financing as a beginner in residential properties.
As a beginner, what is the one thing you lack?
So with residential properties, you can apply for an FHA loan, where you typically put 3.5% down on a property instead of the 20-25% you have to put down for a commercial property.
So if you find a $100,000 residential property, you would only have to pay $3,500 to obtain financing and the property would be yours, versus paying $20,000 or $25,000 if it was a commercial property.
Lower Expenses: For most commercial properties, there is a larger number of expenses to pay. Not even including insurance, taxes, etc. When running a hotel, you have to cover power, water, laundry service, cleaning service, hotel management, janitorial staff, and you need handymen on call 24/7 in-case something goes wrong.
A lot of apartments deal with HoA fees, it is much more common than with residential properties.
With residential properties, once the property is fixed up, there aren’t many fees to deal with. That’s why residential is generally considered the best way to go for a beginner.
So once you make a decision on whether you are going to go the residential route, or the commercial route, either way, you are going to need to enter a good market in order to find deals and profit.
Choose a Cash-Flow Positive Market
Some markets support commercial investing over residential. If you are interested in residential real estate investing, find a market nearby that you can learn about, that provides higher returns for residential properties.
Typically, you want to find markets with growth. If the area isn’t growing, then there aren’t many long-term prospects there. Try to find a busy place. A military base nearby, a university, things like that.
Some markets support cash flow better than appreciation, others support appreciation more than cash flow, and some are balanced. Find what works for you.
The BRRR Method
There are many different ways of getting into residential real estate, and one common method is the BRRR method. This stands for:
I’ll give a brief description of each step. I went into further detail in my article describing the BRRR method in detail.
When buying a residential property, you have to:
1. Find the Deal
You can find the deal through many places. Your local courthouse, auctions, online, or contact a broker.
2. Analyze the Deal
This is tougher to do in the beginning, so make sure to bring a trusted contractor with you, and an agent couldn’t hurt either. Make sure you know how much the property cash flows every month compared to expenses, and if you think the free cash flow is worth the payment.
Assume worst-case scenario in any situation when analyzing deals. There are plenty of deals out there, and there will be more every day.
3. Close the Deal
This is where your reputation is earned, or trashed. If you’re known as a guy that can close a deal quick, you typically get more opportunity and better deals.
The Fix-and-Flip Method
People like Ben Mallah have made hundreds of millions using this method. There are different styles to fix-and-flip, but with residential real estate it typically goes a bit like this:
1. Take out an Interest-Only Loan
An interest-only loan essentially means what it says. For a certain number of years, you will only pay the interest you owe in monthly payments. The principal won’t be paid until the interest-only period ends.
2. Fix the Property using Cash Flow from the Property
You use the free cash flow you get from not having to pay the principal to fix the property up, and let it appreciation in value while you continue to collect cash flow.
You don’t even need to fix it yourself. You can hire a contractor and still make a large profit.
After fixing it up, the property is now worth more in two ways: 1. You improved the property 2. The property will naturally appreciate overtime if you turned it into a good property in a good location.
3. Sell the Property
Now, you sell the property. Assuming you sell it at a profit, you pay off the old loan, and keep the profit.
The point of this method is, you didn’t pay anything for the house except the interest every month. By doing this, you had more cash to fix the property up, meaning you were able to sell it quicker.
So then, when you sell it, you pay off the interest-only loan, and keep whatever is left.
The House-Hacking Method
The house-hacking method isn’t a way to build wealth, but it is a way to get paid to live somewhere.
People do this with either duplexes, triplexes, or quadplexes.
Briefly explained, you purchase a property, and live in one of the units. You rent out the other unit, and the rent from the other unit should cover the mortgage.
If you own a triplex or quadplex, one of the units should cover the mortgage, and another unit should cover taxes and insurance. Easy money.
Build Your Own Residential Properties
- You Can Build It For The Market
- Depreciation Benefits
- The Potential For Instant Equity
- No Hidden Costs
Building your own properties is a riskier, more cash-involving method to build wealth. This is good once you are already familiar with the game of real estate and have passive income coming in.
You know exactly what is happening in the property, you know exactly how it works, and how to fix everything. And if you don’t, your contractor does.
You get more depreciation benefits, and can build it to maximize profits depending on whatever is popular in your market.
Things to Avoid in Residential Real Estate
- Chasing the Highest Yield
- Waiting for an Unrealistic Opportunity
- Not Accounting for Enough of the Costs
- Focusing too Heavily on the Appearance of the Investment Property
- Managing the Property Yourself