Contents
Without an inheritance, winning the lottery, or crypto
It’s a well known fact that real estate can be an incredibly powerful tool for building wealth and financial independence. However, there are also an incredible number of misconceptions and even outright false beliefs that people have about real estate that hold them back from taking advantage of this asset class. The intent of this article is to clear up some of those misconceptions and falsehoods and to lay out a plan for one of the absolute easiest strategies for building wealth with real estate.
This strategy has the added advantage of eliminating what is likely your largest monthly expense: your rent or your mortgage.
One of the biggest misconceptions in real estate is that you need 20% down to buy a property. This idea is so engrained in our society that you would be forgiven for thinking that the Eleventh Commandment was “Thou shalt not put down less than 20% down.”
Mention the possibility of putting less than 20% down and you’re likely to be greeted with one of two responses: a blank stare from the person who thinks it isn’t possible or a lecture from the person who thinks it’s foolish.
To those who don’t think it’s possible, it is. There are all sorts of programs available that require 10%, 5%, 3.5%, or even 0% down. These are loan programs developed and backed by the United States federal government and established banks — not loan sharks.
To those who think it’s foolish, it depends. There are properties at price points where 25% down is incredibly foolish. But there are also properties at price points where 3.5% is a sound business decision and an incredible opportunity. It all depends on the situation. To dismiss out of hand any deal that requires less than 20% down is a foolish oversimplification.
Myth 1 to dispel: you need 20% down.
This myth states that buying a single family house is a great investment because you won’t be wasting money on rent anymore. If your primary residence is a single family home, it is not an asset — it’s a liability. When you buy a single family home to live in, you will still be paying money out each month — just like you were when you were renting. And there’s a good chance it’ll be more money than when you were renting.
You’re going to be paying the interest and principle of the mortgage, property taxes, insurance, maintenance, and capital expenditures.
All of that with the same amount of income that you had back when you were renting. It’s still a liability coming out of your paycheck every month.
In addition, most people make decisions about whether to buy a home on subjective preferences that have nothing to do with making a good investment decision. Marble countertops in the kitchen, terrazzo tile in the bathroom, and luxury wide plank hardwood floors have nothing to do with good investments. Good investments are all about spreadsheets and numbers and formulas.
Myth 2 to dispel: single family homes are a great investment.
To make a home an asset instead of a liability, it has to bring in income. That’s what assets are — property that brings in income. Ideally enough income to cover all the expenses plus some every month.
So how do you do that?
Well, what if you could buy a house, live in it, get someone else to pay the mortgage and all the expenses, and pocket some money on top as well? You can.
In the United States, any residential property with four or fewer units is considered a residential property just like any other. You can buy a two, three, or four unit property with the exact same mortgage that you would buy a single family home with.
Couple that with a low down payment mortgage program, and you’re set. Consider a hypothetical. You find a four unit property for $500,000. FHA loans are an incredibly popular mortgage program backed by the federal government and require a 3.5% down payment, which would be $17,500. You then move into one of the four apartments and rent out the other three. You’ve done your homework, so you know the rental rates for the property and that they’ll cover everything. So you start collecting rents from the three tenants, paying all the expenses from those rents, and pocket $500 extra each month. Not a bad deal.
You’ve done it — you don’t have to pay a mortgage or rent for the rest of your life. You’ve turned a house from a liability into an asset. If you’d bought a single family home you would have had to shoulder all of the expenses alone. Now you don’t have to shoulder anything — you’re getting a free apartment and some cash out of the deal.
You can also use this strategy with a single family house if you’re willing to rent out the other rooms in the house.
That all probably sounds pretty straightforward. But this is buying a house — a multi unit house — so it isn’t necessarily easy. Pulling this strategy off is simple, but it isn’t necessarily easy.
Here are some of the prerequisites to being able to pull of this strategy successfully. They’re meant to be things that you can start working on today.
You have to have decent credit
Buying a multi unit property isn’t cheap. And, as we discussed above, you’re likely going to be putting significantly less than 20% down, so you’re going to have to borrow a decent chunk of change. Banks don’t just hand that out to anyone who walks in the door. So you’re going to need a decent credit score.
It doesn’t have to be a perfect credit score — just a respectable credit score. Low 600s and up tends to be good enough. Higher is better, of course, but 620 will get you in the door.
If you have bad credit, start working on improving it it immediately. You can’t use this real estate strategy (or many real estate strategies, for that matter) if you can’t qualify for a mortgage.
You have to have some savings
There are 0% mortgages out there. They tend to be for special cases like in rural areas and for teachers and firefighters. If you can find one that you qualify for, great! If not, you are going to need some savings. But like we discussed above, it doesn’t take six figures or some crazy pile of cash to get into a multi unit property.
When the right deal comes along, you’re going to want to have the cash to move on it. So start saving now. Make a budget. Cut expenses. Sell that cryto.
You have to do a lot of research
When you buy a home, you use your heart and feelings. Do you like the location? Is it your style? Can you see yourself raising your family there?
When you buy real estate as an investment, you use you brain and analysis. You need to get to know your market. You need to know what market rents are. You need to know which amenities will increase rents and which ones won’t. You need to know what your property taxes, insurance premiums, vacancy rates, CapEx expenses, and maintenance are going to cost. This is a business decision. Make spread sheets and know your numbers.
Finding an investor oriented real estate agent will be helpful for all of this. An investor oriented real estate agent is one who specializes in procuring real estate for investment purposes rather than just for use as a primary residence. They know that this is a business decision and will help you figure out your numbers.
Not every property is going to work with this strategy. The only way to know if a property is going to work is to dig into the numbers.
You have to become a landlord
Renting out the other units in your multi unit property means that you’re going to become a landlord. This freaks a lot of people out. But it shouldn’t. It’s just like running a business.
Everyone is afraid of the late night call about a leaking toilet. This is unlikely, but it could actually happen. But it’s not going to happen every night.
Screen your tenants, clearly set expectations, and stay on top of maintenance and record keeping and you’ll be fine. And if you hate being a landlord, you can just hire a property management company.
Congratulations, you’ve pulled off this real estate investing strategy! Now what? It’s time to repeat the process. Fortunately, this will be easier the second time. Why?
- You’ve been through this process once already, learned a ton, and know how to manage your fears.
- You don’t have to pay rent or a mortgage anymore. That means your expenses are lower. That means you can save up for the down payment on the next one much faster.
- You’re going to have a little extra income each month from those rents. Set it aside for your next down payment.
- Once you move out of your first multi unit, you’ll be able to rent out that last unit, which will significant increase your income from the property.
Repeating this property is one of the most straightforward ways to build significant wealth and financial independence. After those first two multi units, you can see significant income coming in on top of that fact that you don’t have to pay rent or a mortgage anymore. That’s the compounding power of wealth.