If you’re reading this, you probably already understand the value of homeownership and the long-term buildup of equity that comes alongside it. While a home is a great tool for building financial security for you and those who matter most, there are also several ways to invest in income-producing real estate. The barriers to entry are likely lower than you think.
Why Invest in Real Estate?
There are many great real estate quotes out there, but Franklin D. Roosevelt perhaps summed it up best:
“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.”
Sure, there are potential pitfalls in real estate investing. But when done right, real estate is a tangible, income-producing asset class that tends to appreciate in value. Let’s examine five ways to invest in income-producing real estate, starting with one of the most accessible ways: REITs (Real Estate Investment Trusts).
Investing in a public REIT is just like buying stock in any other public company. REITs, however, must pay out at least 90% of their taxable income (75% of which must come from real estate income) back to their shareholders in the form of dividends. While becoming a REIT shareholder isn’t as brick and mortar as the other investment methods we’ll get to in a minute, there is a REIT out there for practically everyone. REITs typically specialize in a single asset type (e.g., offices, apartments, data centers or even cellphone towers). There are also diversified REITs and even mortgage REITs that pay dividends from income earned from interest.
If you like the idea of investing in a single property you could point at and brag to your buddy “Hey, I own part of that building,” but aren’t quite ready to be a landlord, then crowdfunded real estate could be right for you. Typically, investment amounts are in the $10,000 – $20,000 range, but minimum buy-in can be as low as $100 depending on what state you live in and where the property is located.
A quick internet search for “real estate crowdfunding” will provide no scarcity of marketplaces. Keep in mind that you are looking for strong deal sponsors with significant equity in their deals.
Purchasing a home with the sole goal of renting it out is how many real estate investors start out. A cash-out refinance on an existing property is one method investors can use to come up with the funds needed for a down payment on a rental property. Depending on the amount of equity in the home, you might be able to outright buy an inexpensive investment property. In other instances, a group of burgeoning real estate moguls will team up and go in on a deal together. Financing terms tend to differ slightly from what you’ll find with a single-family home you plan to live in, and some experience as a landlord could be required, depending on the loan source.
Owner-Occupied Rentals (2 – 4 units)
Investing in an owner-occupied rental – that is, a small apartment building you also live in – is one option for first-time home buyers who are also looking for a bit of income to help cover mortgage payments. Many investors get started using an FHA loan to purchase a 2- to 4-unit property with a down payment as low as 3.5%. Yes, you will have to live in the same property with your tenants, but at least it’s a short commute when they call with a plumbing issue.
Multifamily Rentals (5+ units)
Now we are getting into the big leagues. Once you are looking at acquiring a property with 5+ units, you are no longer shopping for a residential mortgage. Multifamily properties with 5+ units require a commercial loan, and there is no shortage of options out there to choose from. Loan requirements for commercial loans differ from residential loans as they are underwritten based on the income a property produces.
That doesn’t mean you can just grab a large loan simply because there is a great apartment investment opportunity. Loan requirements often call for a net worth (excluding your primary residence) equal to the loan amount. First-time multifamily buyers will often partner with veteran investors to meet the net worth and income requirements needed.
Terms differ depending on the source. Let’s quickly compare the two most common loan sources for multifamily loans: banks and agencies (Fannie Mae and Freddie Mac).
Multifamily bank loans are typically recourse, meaning the borrower is personally liable for the full loan amount in the event of a default. Agency loans are non-recourse, meaning that in the event of a default, the lender can only recoup the pledged collateral (i.e., the apartment building).
Agencies typically only work with multifamily borrowers who have FICO scores of 680 or higher (640 for veterans), though banks are somewhat more relaxed depending on their existing relationship with the customer. Traditional wisdom would steer you toward a bank loan if you were looking for speed of execution above all else. However, recent developments in online technology have allowed some lenders to streamline the documentation process on agency loans.
There is a growing number of online resources dedicated to helping investors start building a multifamily portfolio. Take your time, do your research and find the property and loan that make the most sense for your financial goals.
Mike Ratliff is editor of ALEX Chatter, a blog providing multifamily investors with the news, research and insight needed to get deals done.
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