Ask Brian is a weekly column by Real Estate Expert Brian Kline. If you have questions on real estate investing, DIY, home buying/selling, or other housing inquiries please email your questions to [email protected].
Question from Bret outside Bakersfield, CA: Hi Brian, I inherited an aunt’s house in Minnesota almost a year ago. I’ve already sold the house because it was so far away. However, the experience sparked my interest in real estate investing. I’m interested in something close by but I don’t have a clue how to get started. I’m 52 years old with a modest income. I have about $134,000 from selling my aunt’s house but I don’t want to use my limited income for investing and I don’t want to use all of my inheritance. Am I too late to the party? Where should I start without risking what I already have?
Answer: Hi Bret. Great questions but there is no such thing as a risk-free investment. Risk and reward is the general rule of thumb. With that said, last week’s stock market crash is a clear example of why so many investors prefer real estate over the stock markets. Unless I’m missing something important, I don’t see how the coronavirus is going to collapse the value of real estate for small investors. Bret, the biggest piece of missing information in your note is how active you want to be with your investment. You probably want to start by deciding if you want to be an active investor or a passive investor. Also, make a firm decision about how much of your inheritance you want to invest.
Once you make those basic decisions, you are ready to start thinking about real estate in terms of goals, strategies, and tactics. I like doing this with an analogy of climbing a mountain. The peak of the mountain is your goal. At age 52, you’ve already been climbing the mountain for a while. So what is your goal Bret? Do you want to risk $50,000 of your inheritance with the goal of turning it into $150,000 over the next 10 years? You can probably do that at relatively low risk. Low risk implies that even if things don’t go as expected, you’ll probably come out of it with a financial gain but less than you hoped for. That could mean you only turn the $50,000 into $75,000 after 10 years.
On your climb up the mountain, you’re also going to need strategies and tactics. Your strategy is the route you take to get up the mountain. You can pick a safe route that takes longer but gives you more confidence that you won’t slip and fall down the mountain. Or you can pick a riskier route where you will have to work harder but will reach the top faster if you don’t slip. There are also other routes that will get you there with different levels of risk and speed. The tactics are the tools and skills you choose to scale to the peak. The safest route is when an experienced climber shows you the way and tells you what tools you’ll need. An intermediate route involves a map, walking stick, and backpack of supplies. The riskiest route requires advanced mountain climbing skills and gear to get over a rock hanging above your head.
With the mountain peak (goal) in mind, you need to decide what route (strategy) you are going to use to get up the mountain. Rental houses are a reliable low risk strategy as long as you do your research. Keeping the risk low means investing in middle-of-the-road houses in good neighborhoods where dependable renters want to live. Stay away from cheap gang war houses that you can buy for almost nothing but where you will also collect nothing in rent for many months at a time.
Once you have a rental house, you need tactics. This involves deciding if you are going to be an active or passive landlord. Are you going to screen all of your tenants and make all of the repairs to minimize costs? Or are you going to be fully passive by hiring a property manager to take care of everything for a cost? In between is where you hire contractors as needed to do the maintenance and repairs.
But keep your long term goals in mind. This means you may want to change strategies as you gain experience. There are still several low risk strategies that you can use to achieve your goal faster. A single rental house is likely to achieve that $75,000 goal in ten years with a combination of value appreciation and cash flow from rent money. But if you want to stretch for $150,000 or more, you can take on more tenants as you gain experience. A low risk way of doing this is by selling the single-family rental and investing in a multiplex such as a duplex or triplex. Another proven strategy is keeping the existing single-family rental but adding another rental to your portfolio. You can buy up to a better personal house and turn the house you are now living into a rental. That gives you ownership of three pieces of real estate.
Bret, there are other ways you can increase the number of rentals that you profit from but these are riskier. Instead of buying up to a better house, you could venture into flipping houses. You could rent out your existing house and move into a fixer. Once you fix up that house, you can either sell it or turn it into a rental and repeat the fixer process again. Of course, you need different tactics with fixers. Are you going to fix it yourself or contract it out? The risks involve you not having enough time, you not having the needed skills, and/or contractors running seriously over budget. But if you get into rehab and flipping, you’re more likely to pocket a big chunk of money in a short period of time. That’s the risk-reward equation.
So, Bret it comes down to understanding the moving parts. The recent stock market crash again reinforces the security that comes by investing in real estate. But that doesn’t mean there is no risk in real estate. Getting up the mountain means balancing your goals with the risks that you’re willing to take. Once you decide on the goals and risks, you’re ready to choose from the several investing strategies available. Once you have a strategy, you select tactics to match. You get up the mountain one step at a time.
Please comment with your risk/reward analogy for real estate investing.
Our weekly Ask Brian column welcomes questions from readers of all experience levels with residential real estate. Please email your questions or inquiries to [email protected].