For years now I’ve been interested in real estate investing. I like the idea of a tangible asset that I can see and touch, versus stocks and ETFs. I enjoy working on homes and can put sweat equity into it “someday” if I choose. And as the saying goes, they aren’t making any more land (random volcanos and wealthy Middle Eastern countries aside)…
So I set myself a summer job task of learning about it, talking to people who’ve done it, and making the leap myself.
Research mode: You’re reading what?
I went to my local library and browsed through several books on the topic. My favorite from skim-reading, and the one I bought to take notes in, was none other than Real Estate Investing for Dummies. It may sound basic but it was a dense read with a lot of great information, it took me from May to September to work my way through the whole thing. Once I did, I developed my own spreadsheet to calculate NOI (net operating income) and start experimenting with valuations as the authors do. I found it an invaluable tool, often properties that looked amazing in pictures didn’t make sense at all once you run the numbers, while others that were not at all impressive were much more attractive “on paper”. It was a fantastic sanity check.
Another great resource is BiggerPockets.com, both through their podcasts and their forums. The local sub-forums are a wealth of information, particularly for researching an area you’re interested in or determining the improvements that give you the highest return on investment.
Guess what: Your friends are doing it, they just aren’t talking about it
Another approach I took was to openly share with friends what I was doing. I found that many had a big interest in hearing more about the process, and that many others were doing real estate investing and not talking about it. Old friends divulged they had four properties down the street they were renting out. Coworkers I had lunch with opened up about out of state properties in Idaho they’d bought largely on a whim ten years ago. Whenever this came up, I took the opportunity to ask questions about their strategy and process, and found a large amount of enthusiasm to discuss it now that the topic was broached. Cash flow or appreciation? Local or out of state? Property manager or self-managed? Tenant issues or horror stories? I wrote each interview down in my journal and it was surprising to me how different each story was.
In late fall I started considering how I was going to do my own approach. I had many decisions to make.
Long term versus short: Long term. I had no interest in flipping homes, I wanted a longer-term asset.
Cash flow versus appreciation: Cash flow, with a goal of having a steady passive income once mortgages are paid down.
Mortgaged: Yes, this gets into the concept of leveraging someone else’s money to build your equity, which is covered extensively in real estate books. However, I’d be willing to put up to 25-30% down to secure better rates.
Location: Out of state. Immediately violating the “invest in your backyard” tenet, I couldn’t justify trying to purchase an investment property in the San Francisco Bay Area (one of the most expensive markets in the country). Not only would it be a massive capital outlay with a lot more risk, current rents don’t even come close to matching mortgage payments, so my cash flow would be negative for the foreseeable future, despite the opportunity for huge property appreciation on paper. This made my now open-ended decision particularly difficult because there are a thousand opinions out there on the “hottest” real estate markets. Ultimately I chose an area with low property tax rates, no rent controls, good economic diversity, an airport with a direct flight to mine, and family/friends nearby in the event of any problems that required boots on the ground: Raleigh, NC. I’d also considered Seattle, Austin, and Orlando.
Property Manager: Yes. Especially being remote, this eats into profit but I saw it as a must. I looked at reviews online, asked for and contacted references, and met in person with the one I selected when I flew out to visit. Rates are 7.9% a month in this area, with an up-front tenant placement fee of 0.5 – 1 month’s rent depending on the manager. I also chose a backup in the event things didn’t work out or they were unavailable for any reason.
Type: Lower-risk, lower-reward. Being my first foray into the field, I wanted something “easy” and predictable. I didn’t consider foreclosures or short sales. I didn’t look at distressed properties in distressed neighborhoods with better cap rates (a metric comparing rent to purchase price) but a higher chance for vandalism/vacancy. I was shooting for a stable suburban tenant new to the area and commuting to work for a year or two before deciding if they’d stay.
I set an upper limit of $325k and looked at three and four bedroom homes in the Cary/Apex region. For this area, there’s a lot of competition under $300k, so the homes available go fast and and are generally a bit older (1980s to early 2000s). I had a lot of trouble finding a good property I was happy with. Some had PB piping, which I wasn’t keen to take on. Two were directly in the path of a planned highway expansion (my realtor gave me the heads up on that one, it’s important to have local folks helping you). Others couldn’t command enough rent to justify their purchase prices. On top of it all, I’d wanted to purchase in these areas for the good schools, but as it turns out the districts are so overloaded that there’s a lottery system to determine who gets to go to a certain school – location is no longer a guarantee of your school zone.
Around January, I shifted my search to southeast Durham – ten minutes to Research Triangle Park (the business zone where many people work) and the airport. This area would traditionally cater to more of the single professional/working couple crowd; however, as other areas have been fully developed, this area is growing for families, and there are plenty of new builds. Money goes farther here as well, with lower housing costs and lower taxes. I could finally find homes that felt like I was getting a lot for my money, and the rentals comps for the area were good as well.
I chose to go after a new build in a large “master planned” community of almost a thousand homes, five different builders, ~$220k townhouses ranging up to mid-$500k semi-custom homes. The cost spread made me comfortable that my home wouldn’t be overvalued and that it would be a safe, desirable area in a complex great for families, with community swimming pools, nature trails, tennis courts, and so on. After customizations and finishes, my purchase price will be about $299k, but I only had to put down $7500 in earnest money until the house is completed. Initial rental comps are around $1850/mo., which is relatively good for this area – depending on final numbers, the house should be close to neutral or even slightly cash flow positive from day one, on a brand new property that should have very low maintenance costs for the future.
If there’s interest I’ll post updates in the future as the process moves farther along. Thus far it’s been a great learning experience.
Update November 2018:
Closed on August 10th, purchase price just under $300k, house appraised for $315k. I ended up putting down only 20%. Strong tenant interest, had a signed lease two weeks after the property manager listed it, $1950/month (higher than anticipated). I get $1795 a month after the 7.9% management fee, the mortgage payments with escrow are $1600/month.