How to Invest in Real Estate with Little Experience
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Originally Posted On: https://www.dohardmoney.com/how-to-invest-in-real-estate-with-little-experience/
I love investing in real estate—that’s why I’ve been doing it for so long! But, what about new investors? People who see my passion often ask me how to invest in real estate with little experience. In other words, what’s the best way to get started?
New investors tend to underestimate the amount of work that goes into real estate investing. As such, new investors need to first educate themselves. Then, gain experience through the real estate investor lifecycle: wholesaling/bird dogging, fix & flip, rental properties, and, eventually, lending.
I’ll use this article to explain more about investing in real estate with little experience—and how to gain that critical experience. Specifically, I’ll cover each of these topics:
- My Thoughts on Experience and Real Estate Investing
- The Real Estate Investment Experience Path
- The Importance of Finding Properties
- Final Thoughts on Investing in Real Estate with Little Experience
My Thoughts on Experience and Real Estate Investing
When it comes to investing in real estate, most new investors make two mistakes. First, they underestimate the amount of work it takes for success. Second, they overestimate how easy investing will be. A little experience gets rid of both of these notions. Investors quickly learn how much work goes into real estate success.
I love watching HGTV shows about flipping houses. They’re entertaining. But, these shows do a tremendous disservice to inexperienced real estate investors. Unfortunately, these shows demonstrate a warped sense of reality. Investors don’t automatically find outstanding deals. Finding properties that make sense financially takes a ton of time and effort. And, once you do find one, rehabs take longer than a 30-minute time slot.
These realities lead into my general thoughts on real estate investing. For new investors, you’ll spend the bulk of your time finding good deals. Regardless of what investment strategy you choose, you’ll need to take time to educate yourself.
The Real Estate Investment Experience Path
Part of initial real estate education certainly involves the “academic” work. That is, you need to do some reading, listen to some podcasts, talk to some experienced investors. Bottom line, you need to build a general understanding of investing prior to diving headfirst into your first deal.
But, this “bookwork” can only take you so far. Eventually, to grow as an investor, you need to start getting actual experience. As the saying goes, good judgment comes from experience, and experience comes from bad judgment. You have to get your hands dirty, make some mistakes, and learn from those mistakes to gain experience.
However, this doesn’t mean you should try to start your real estate journey by developing a 250-unit apartment building. Instead, a common—and logical—investment experience path exists. While you don’t need to follow these steps exactly, the following investment strategies help you walk through the “investor lifecycle.” Each strategy is more complicated than the prior one, so learning them in a step-by-step approach allows you to gradually build your experience.
Bird dogging offers an awesome, low-risk way to get your foot in the real estate world. And, it doesn’t require any capital. Of course you’ll have to work hard to make any significant income, but if you make a mistake on a deal, you won’t lose invested money in the process.
Here’s how it works. A lot of real estate investors make money through wholesaling, which I’ll discuss next. But, in a nutshell, wholesaling requires investors to find deals to bring to other investors. While the wholesalers themselves can certainly do this searching legwork, they often pay other people—bird doggers—to do it for them.
Bird doggers spend their time looking for a certain sort of deal. They want to find distressed properties that won’t qualify for traditional financing. In other words, traditional mortgage lenders want to make sure a house is actually habitable. Bird doggers look for properties that don’t meet this standard. Next, the owners of these properties need to have A) some equity in the property, and B) some reason for wanting to sell—often to turn that equity into cash.
As bird doggers find leads on situations like this, they pass them along to wholesalers for a fee. They may receive a fee for every lead, or it could be a contingent payment based on the lead actually converting. It ultimately depends on the relationship you have with a particular wholesaler. But, regardless of payment structure, bird dogging provides you an outstanding opportunity to gain some real estate investing experience with little to no barrier to entry.
Once you’ve bird dogged for a while, you can make the jump into wholesaling properties yourself. This investment strategy lets you make money without needing to actually purchase properties. As a result, it represents a great approach for new real estate investors working on gaining experience.
As stated, with wholesaling, you don’t purchase an investment property. Instead, wholesalers find off-market properties and they enter contracts to purchase these properties. Rather than close on the purchases, they assign the contracts to a third party, typically a fix & flip investor. They assign these contracts for a fee. As such, wholesalers find deals, connect the sellers with investors, and collect a fee in the process—all without dealing with the headaches of doing any rehab work themselves.
When you wholesale, you learn very quickly how to spot good deals for fix & flip investors. If you don’t find good deals, you won’t be able to assign contracts to these people. Simply put, you learn what to look for in a property. Additionally, you have to work closely with house flippers. This gives you the added benefit of learning from them. Pick these people’s brains. They have tons of experience, and you can learn from it. Lastly, wholesaling puts money in your pocket. If disciplined, you can allocate a portion of these funds for a down payment to purchase your own fix & flip property.
All of these advantages to wholesaling put you in a position to make the jump into the next strategy.
Fix & Flip
As a fix & flip investor, you need to understand everything wholesalers do about finding good deals. But, you also need to understand how to rehab and sell these properties. Broadly speaking, the fix & flip strategy works like this:
- Step 1, Find a distressed property: Investors need to find properties that need rehab work to qualify for traditional financing. These properties need to make financial sense, meaning that the purchase price and all rehab-related costs need to be less than the projected final sale price to make a profit.
- Step 2, Rehab the property: After purchasing a distressed property, house flippers need to renovate it to a standard that A) qualifies for a traditional mortgage, and B) appeals to potential buyers in that particular market. This requires an in-depth understanding of renovations, working with contractors, and creating accurate rehab budgets.
- Step 3, Sell the property: Finally, house flippers need to sell the property. Typically, these investors sell to primary homebuyers, meaning they sell to people looking to buy their home—not an investment property. This requires an understanding of sales and pricing strategies, and a solid analysis of the local market.
The above provides a simplified overview of the house flipping system. However, to be clear—this strategy takes far more knowledge and experience than bird dogging or wholesaling. But, it also provides investors far greater returns. During the house flipping process, you’ll inevitably make mistakes. As you work through a few deals, you’ll quickly gain a tremendous amount of experience.
After gaining experience in the fix-and-flip world, many investors make the jump into the BRRR strategy. This requires all of the experience and knowledge of flippers, but now you also need to understand property management and permanent financing. Here are the steps that make up the BRRR strategy:
- Buy: Investors buy distressed properties at a deep discount in need of major repairs. BRRR investors largely look for the same properties as fix & flip investors.
- Rehab: Investors then rehab the property. However, they don’t rehab it to sell it. Rather, they do their renovations with an aim to appeal to renters. Rehabbing a rental property usually means picking far more durable materials than if rehabbing for sale. You’ll need materials that can handle the wear and tear of multiple tenants. And, you don’t want to have to complete repairs every year. This rehab leads directly into the next step of the strategy.
- Rent: Once you’ve completed the renovation, you need to market the property for rent and secure quality tenants. You can certainly hire a property manager to do this. This saves you a ton of headaches, but it also costs money. And, from an experience perspective, I recommend investors manage at least one of their own properties. This provides you a solid understanding of the leasing and property management process, and you’ll be better positioned to hire and supervise property management companies down the line.
- Refinance: Once you’ve rehabbed the property and signed a tenant lease, you can refinance the property. Typically, BRRR investors (and flippers) use hard money loans to finance a property purchase and rehab. However, these loans have high interest rates, as they’re designed for short-term investment use. Once a property meets traditional mortgage quality standards and is rented out, you’ll want to refinance into a traditional mortgage. Part of this new loan will pay off the outstanding hard money loan. And if the deal’s executed properly, part will go into your pocket as profit, as the home’s after repair value (ARV) should be significantly greater than the original purchase price.
- (Optional) Repeat: Some investors add a fourth “R” to this strategy, making it the BRRRR approach. The final “R” stands for repeat. Rather than pocket all of the refinance proceeds from the above step, these investors roll them over into new deals. In this fashion, you can do this process over and over. However, it can become challenging securing more than 10 personal mortgages in your name. You may need to transition to commercial financing or another creative financing approach if you build a single-family home portfolio greater than 10 properties.
As these steps illustrate, BRRR investing requires all the experience and knowledge of flipping homes, with two additional wrinkles. These investors need to understand property management and they need to have a better grasp of real estate financing. The success of the strategy hinges on refinancing, so that’s crucial knowledge.
However, while requiring more experience, this strategy also provides more profit. With a house flip, you have one-and-done profit. That is, once you sell a property, that’s how much you make—for better or worse. BRRR investing creates long-term wealth. In addition to profiting up-front by pocketing a portion of your refinance proceeds, you continue to make money in three ways:
First, you pocket any rent payments in excess of operating expenses and debt service. Second, you gradually build equity in the property as your tenants’ payments pay down the amortizing mortgage. And, third, houses appreciate over time. While they may fluctuate in the short-term, over time (especially a 30-year mortgage horizon), home appreciation historically has outpaced inflation.
Become a Lender
The final step in the real estate investing progression requires expertise in all of the previous strategies. Once investors understand these systems, they often decide to become hard money or private lenders. Of note, both of these lenders function similarly, but hard money lenders act as formal businesses, whereas private lenders act as individuals.
At face value, lenders appear to do far less work. And in some ways, they do. Lend money, sit back, and profit. But, to do that successfully, you need to have an in-depth understanding of how to analyze deals. Lenders only make money on successful deals. If you lend to anyone for any deal, you’ll fail. As such, before issuing loans, these lenders need to fully analyze a deal—the same way they would as a fix & flip or BRRR investor. However, now the loan interest is their income not expense.
But, lenders need to know more than just analyzing deals. They also need to understand the legal, administrative, and financial requirements of originating and administering loans. Unfortunately, part of this means understanding the foreclosure process as well. Proper up-front due diligence mitigates the likelihood of a borrower foreclosure. But, sometimes a series of unfortunate incidents leads to borrower default. As a lender in this situation, you need to be prepared to execute foreclosure procedures to recoup as much loan principal as possible.
The Importance of Finding Properties
The above progression represents a way to build experience as a real estate investor—but it’s not the only way. However, whatever route you choose, you’ll need to develop a strategy for finding properties. More precisely, you need to build a strategy to 1) find potential deals, 2) market to owners, 3) set up interviews, and 4) convince owners to actually sell their properties. I highly recommend using our Investor’s Edge software for this process. In building a marketing strategy, this software helps investors do the following:
- Find deals: We include a database of over 160 million properties, giving you massive deal potential. We also include information about how much equity owners have in these properties. This will help you find potentially motivated sellers—all from the comfort of home.
- Save preferences: As you filter through hundreds of potential deals, you need to stay organized. If not, you’ll quickly become overwhelmed—or simply commit far more time than necessary. Our software lets you save all of your preferences with a click, keeping you organized and focused on what matters—closing deals!
- Market instantly: Once you find a deal, you still need to contact the owner. With Investor’s Edge, you can automate this process. Our software lets you print postcards with pre-filled addresses and send voicemails to your saved list of potential deals.
But, you’re not done after this initial outreach. Once you connect with a potential seller, you still need to convince him or her to sell. I like to look at this as problem solving. Typically, motivated sellers have a need that they must meet. Frequently, they need cash for something or other but can’t sell their house due to its current condition. It may be significantly distressed, or it may just require a major repair that the owner cannot afford.
As a result, these owners can only sell to all-cash or hard money loan investors. Enter you as the problem solver. You can purchase this property, and you provide the owner the cash he or she needs by securing a hard money loan. But, I always want to emphasize to new investors: don’t pretend you’re doing this out of the goodness of your heart. This is disingenuous, as you’re doing it to profit—not for charity. Rather, you’re looking for a win-win situation. By purchasing the home, you solve the owner’s cash-need problem. But, you also gain a good deal in the process. Win-win.
Here’s the major takeaway: when looking for properties, remember that you’re a problem solver. But to solve problems, you must first understand the seller’s needs. If you take the time and effort to do this—which requires a little empathy and communication—you’ll find great deals. You’ll also be helping people out in the process.
Final Thoughts on Investing in Real Estate with Little Experience
If you’re just getting started in real estate investing, I recommend following a system from someone you know and trust. You can always go with the school of hard knocks approach and only learn from your mistakes. But, I’d far rather learn from someone else’s mistakes than make my own.