An Overview of Real Estate Investing Basics for Beginners
By Joshua Kennon, About.com Guide
When you invest in real estate, your goal is to put money to work today and make it grow so you have more money in the future. You have to make enough profit, or "return", to cover the risk you take, taxes you pay, and the costs of owning the real estate investment such as utilities and insurance.
In other words, once you understand the basics of the game, real estate investing really can be as conceptually simple as playing monopoly. Your goal is to buy properties, avoid bankruptcy, and generate rent so that you can buy even more properties. But "simple" doesn't mean "easy". If you make a mistake, you could find yourself broke or worse.
The 4 Ways Real Estate Investors Make Money
When you invest in real estate, there are several ways you can make money:
Real Estate Appreciation:
This is when the property becomes more valuable due to a change in the real estate market, the land around your property becoming scarcer or busier such as a major shopping center going in next door, or upgrades you put into your real estate investment to make it more attractive to potential buyers or renters. Real estate appreciation is a tricky game and is riskier than investing for cash flow income.
Cash Flow Income:
This type of real estate investment focuses on buying a real estate property, such as an apartment building, and operating it so you collect a stream of cash from rent, which is the money a tenant pays you to use your property for a specific amount of time. Cash flow income can be generated from well-run storage units, car washes, apartment buildings, office buildings, rental houses, and more.
Real Estate Related Income:
This is income generated by "specialists" in the real estate industry such as real estate brokers, who make money through commissions from buying and selling property, or real estate management companies who get to keep a percentage of rents in exchange for running the day-to-day operations of a property. For example, a hotel management company gets to keep 5% of a hotel's sales for taking care of the day-to-day operations such as hiring maids, running the front desk, mowing the lawn, and washing the towels.
Ancillary Real Estate Investment Income:
For some real estate investments, this can be a huge source of profit. Ancillary real estate investment income includes things like vending machines in office buildings or laundry facilities in low-rent apartments. In effect, they serve as mini-businesses within a bigger real estate investment, letting you make money from a semi-captive collection of customers.
How You Might Consider Purchasing Your Real Estate Investment Properties
There are several ways to buy your first real estate investment. If you are purchasing a property, you can use debt by taking a mortgage out against a property. The use of leverage is what attracts many real estate investors because it lets you acquire properties you otherwise could not afford, but it can be dangerous because in a falling market, the interest expense and regular payments can drive you into bankruptcy if you aren't careful.
You will almost NEVER purchase a real estate investment in your own name. Instead, for risk management reasons, you will want to consider holding real estate investments through special types of legal entities known as limited liability companies or limited partnerships (you should consult with a qualified attorney for his or her opinion as to which ownership method is best for you and your circumstances). That way, if the real estate investment goes bust or someone slips and falls, resulting in a lawsuit, you can protect your personal assets because the worst that can happen in some circumstances is you lose the money you've invested. This lets you sleep at night because unless you've screwed up somewhere, your 401(k) plan assets, Roth IRA investment, and other retirement accounts should be out-of-reach.
Which Type of Real Estate Investment Should You Make?
When you are ready to start the process of real estate investing, you will want to decide which of the real estate investment types is most appropriate for you. To help you understand the options, I wrote an article called The 8 Types of Real Estate Investments that explains the difference between REITs, industrial properties, residential investments, etc.