Intro to Real Estate Investing – 3: Starting Out
Christopher Shank NMLS 2562885
In the previous two articles, we started by discussing the reasons thatpeople get into real estate investing. We also touched a bit on some of the strategies investors employ to grow their empires. We’ve also gone over several real-world examples of successful real estate investors to not only demonstrate the varied investment tactics that are out there, but also hopefully inspire you by proving that this crazy world of real estate investing is one that you can be part of.
Now, I think it’s about time to really cut into the matter and begin outlining the first steps you’ll need to take in order to actually become a real estate investor! Break out your notepads (or at the very least, bookmark this page), because we’re going to break out some knowledge all up in here!
If there’s ONE thing that was painfully driven into my head over the years, it’s the saying “measure twice, cut once”. If I was to translate this to my younger self, it would go something like this:
“Hey, genius. Yes- you; the guy who just spent fifty bucks at home depot buying small gauge chain with the hopes of somehow turning it into ring mail (yes, my nerdiness extends well into my past). Do you have any idea how to make a suit of armor? Have you seriously looked online for validation to your plan? Have you spoken to a professional or two to get their input? No? Well… maybe you should keep your receipt…”
Fifty bucks wasted (I did not keep my receipt). Twelve hours down the drain. Turns out making armor is a lot harder than I thought. Thankfully, aside from a pinch in my wallet, the most I suffered was a bruised ego (well, that and a hammered thumb). Had I done my research beforehand, I would have learned that my particular approach was not feasible. Had I spoken to a professional, that person might have been able to recommend me a course of action that may have achieved my end goal of looking sharp for the upcoming renaissance fair.
When it comes to major transactions, such as purchasing a rental property and taking your first step into the world of real estate investing, you had better be extra sure that you’re operating on accurate, current data. You’re literally investing hundreds of thousands of dollars; should you invest poorly, your potential for loss is great.
When an aspiring investor approaches me about buying an investment property, I advise them to ensure they have a proper “investment foundation” before proceeding any further. I then quantify this term by breaking it down into its component parts: initial investment capital, proper advocacy, and accurate data.
Initial Investment Capital
The world of home financing is more structured today than ever before. Unlike in the years leading up to 2008, buyers must demonstrate their qualifications before they are allowed to borrow money from a lender. In many instances, lenders are compensated for following these rules by protections, put in place by various government agencies, to protect their investments against buyer default. Unfortunately, most of these protections don’t extend to the world of investment lending. In cases like this, investors hedge their bets by requiring buyers foot a sizable percentage (usually 20-25%, but I’ve worked with lenders who will go as low as 15%) of the loan’s value as a down payment. This way, should the buyer default on their loan, the lender can not only claim the subject property, but they can have a decent chunk of equity available to offset any additional losses incurred in the process.
What this means to a real estate investor is that in order to snag that first rental property, you’re going to need to be able to bring that sizable percentage of the property’s value as a down payment to the closing table. For clarity’s sake, I’m going to reference a client that I’m working with right now. Bob Fakename is looking to buy a $250k duplex out in Clarksville. I’ve already got a lender in mind that I’d like to connect with Bob. This lender’s ideal clients are first time investors, and as such, they have a few loans that might be ideal to Bob. Before that, though, I reached out to Bob to identify some of the base requirements to that loan. At an absolute minimum, he’ll need to put 15% down on that property ($37,500). If he puts 20% down ($50,000), his monthly payments will be reduced a fair amount. If he puts 25% down ($62,500), he’ll get himself the highest rate discount from this portfolio of products. All that said, Bob will need to determine how much capital he has available to invest; even if he likes the rates offered if he puts down 25%, it won’t really do him any good if he’s only got $40,000 available.
Most folks don’t have tens of thousands of dollars just sitting in a bank account, and Bob is no exception; he’s only got about $10,000 saved up. All hope is not lost, though, as there are a few common ways that I’ve seen investors expand their pool of capital. In Bob’s case, he’s got well over $70,000 worth of equity in the home he currently resides in. Should he decide to open a HELOC, he can borrow cash against this equity and use those funds to supply the down payment for his new property (full disclosure, this is what he’s going to do). Now, say that Bob decided that he didn’t want to go the route of a HELOC. In this instance, his best bet to financing this particular purchase would be to partner up with another likeminded individual to combine their collective pools of capital. In my experience, this method is a little less common, as the added complexity of involving another investor (not to mention the fears of future personality conflicts) scares away all but the most dedicated groups.
Now, this isn’t to say that the two methods I gave above are the only ways to increase one’s capital pool- far from it. In fact, there are many different means to secure additional financing, but a good number of those should be discussed thoroughly with a loan officer who understands your personal situation. As a general rule though, lenders frown on using borrowed money to make a down payment (meaning that Bob would have a very difficult time getting approved for his loan if he took out a personal loan to cover the down payment on his investment property).
Proper Advocacy
There’s a saying- “he who represents himself has a fool for a client”. This particular saying was intended for legal matters, but it’s doubly true when it concerns real estate investing. Simply put- there’s just too much information to consider without the expert assistance. At the absolute minimum, I recommend my clients secure themselves a loan officer and a realtor. Ideally, my clients will also bring in their financial advisor (if they have one) or secure the assistance of one trusted by one (or both) of the two other professionals.
Believe it or not, when I first meet with an investor who wants to use me as their loan expert, I encourage them to grill me. Here’s the way that I see it. If I was about to invest hundreds of thousands of dollars into a venture, I would be heavily vetting every single person involved with this transaction. To better digest this information, I have broken it down below:
Realtor Vetting: Your realtor should be experienced in the area that you plan to invest in. They should also be familiar with the investment strategy that you plan to use, or else willing to better understand it so that they can identify properties that would best fit said strategy. I’m not one to harp on someone for not working in an industry for a long time (in fact, some of my favorite advocates were new to their industry- they had something to prove!), however, I would look carefully into their support system- are they a broker owner or team lead? If not, do they have ready access to that leader and their expertise? Beyond the realtor, I’d look to see if they have any reviews online. I’d also recommend either digging online or simply asking the realtor for references.
Loan Officer Vetting: Your loan officer should definitely be familiar with your investment strategy and with the loan products that might best suit your purchase. When it comes to loan officers, I’m partial to brokers. There’s nothing wrong with retail lending, but the more lenders your loan officer has access to, the better chance that they’ll be able to pair you with a lender who views you as their ideal client. When it comes to loan officers, their support system can make or break a deal. I would recommend getting into the nitty gritty as to whether your loan officer has in-house processors, or if they use a third party service. Same goes for peer support- I personally am fairly knowledgeable in my trade, but if there’s something that I don’t know, the ability to reach out and ask my team for guidance has proven regularly invaluable.
Financial Advisor Vetting: Your financial advisor should, first and foremost, actually be knowledgeable with your finances. Yes, this may seem like common sense, but not always has common sense been a common virtue. Past their knowledge about your financial foundation, your financial advisor should be knowledgeable as to how a large financial transaction might impact your future taxes or other ventures. It is also my firmest recommendation that, should you wish to utilize any retirement or investment account funds to contribute to the down payment of an investment property, you immediately bring in your financial advisor to advise you about any tax ramifications of that course of action.
In the title to this section, I use the word “advocacy” when referring to the people who will be helping realize your dream of real estate investing. To me, an advocate is someone who will act in your best interest at all times, not simply because you’re paying them to, but because they genuinely want to see you succeed.
After you’ve surrounded yourself with your advocates, ensure clear communication throughout your entire team, and then clearly outline your goals to this team. In my experienced, true professionals don’t need to be micromanaged, but they work best if they understand their objective and are given free reign to accomplish their tasks according to their own unique skills. By ensuring that your team is on the same page, you not only will make things easier on you in the long run, but you’ll also open channels of communication between your professionals, which will allow them to communicate directly with one another, without having to use you as a go-between.
Accurate Data
One of my favorite officers once told me that every effective operation is fueled by accurate data. By this point in the process, you already should have been preapproved for financing by your loan officer, and you should also have communicated your financial considerations to your realtor to better refine the list of properties they’re sifting through for you.
That said, it is very important to keep your team updated any time there is a notable change with the situation, so that they can more effectively respond. The same goes in reverse- your advocates need to know to keep you updated with any data they come across that might change the plan.
Quick example. One of the investors I’m working with got himself preapproved for a purchase with a $200,000 limit. As his realtor scoured the lists for suitable investing properties, he noticed that there was a fair number of properties in the $250,000 range that would have a more favorable cashflow than their $200,000 neighbors. This realtor communicated with both the investor and his loan officer, appraising them of this possibility. The loan officer, for his part, took the initiative and ran the numbers to approve the investor for a $250,000 purchase, should it be required. Now, even though the investor would still prefer to keep his purchase around the $200,000 range, he has the flexibility to make a larger purchase, should he so desire.
Even beyond the search, accurate data has a huge impact on the investment process itself. Up to date tax records can not only help a loan officer better estimate the upcoming taxes on a property, but it can also be used to determine the property value growth over time. On the other hand, a canary report can be used to estimate the condition of a property to determine the amount of money needed to modernize it or otherwise make it ready for use as a rental dwelling.
Moving Forward
The decision to become a real estate investor should not be taken lightly- hence the series of articles put out to educate potential investors about the concept before they pour heart and soul into the venture. Remember, investing is an inherently risky venture. If you put your money into stocks, there’s a chance that your stock could perform poorly. If you invest your money into real estate, there’s a chance that the property will not perform as you hoped.
In everything though, I find that proper planning on the front end can go a long way to offset the damage from future risks. More than that though, I find that building a strong relation with those advocates I mentioned earlier can give you a strong foundation with which to better take charge of your future. Take me, for instance- I have dozens of future investors that I maintain contact with. Full disclosure, statistically, a good three quarters of these folks will never own more than one structure at a time. That doesn’t change the fact that, as long as they want, they are free to use my services and my crazy obsession with the world of lending to help them make the decisions that will shape their future.
Curious? Feel free to hit me up!
