One of my brothers, Chris, is in town for a visit and we were talking about housing during dinner. He is saving up some cash because he is planning to buy a house in a year or two. He said a house is a good investment, but it’s just too expensive in the Bay Area. Currently he is renting a room in a friend’s home and he is thinking about moving to a more affordable location like Austin, TX.
Personally, I don’t think a primary residence is really a good investment. If you’re single, it’s probably better to rent and put your extra money into the stock market. When you have a house, your monthly expense can increase quite a bit. A bigger home will mean higher utility costs. You’ll have a property tax bill, homeowner’s insurance, yard work, repairs and maintenance expenses. It can also be quite expensive to furnish a house, too.
In my opinion, a primary residence should be a place to live and if you get lucky with the market appreciation, then that’s just gravy. There are many ways for regular people to invest in real estate, so let’s share them with Chris today.
Buy a fixer upper
One way to make money with your primary residence is to buy a fixer upper. You need to search in a good location for a house that needs work. Then put in a lot of sweat equity to bring it up to the neighborhood standard. After a year or two of working on the home every weekend, then the place would be ready to sell for a tidy tax-free profit*.
*note* You can profit up to $250,000 and don’t have to pay any capital gain tax if you’re single, $500,000 if you’re married. You also need to live there for at least 2 years to qualify for the tax exemption.
This works best if you’re single. I know this wouldn’t work for us because Mrs. RB40 doesn’t want to live in a rehab house for long. Once we fixed it up, then she’d refuse to move.
Rent out some space
Renting out a spare room is a great way to generate a little extra income. In expensive areas like Northern California, there are always people looking for a more affordable option. If Chris buys a 3 bedroom house and rents out 2 rooms, then he’d have a lot of help paying the monthly housing expense.
When we lived in our old house, we occasionally rented out a room to engineers and it worked out quite well. Just pick a workaholic tenant and you will rarely see him/her at home. Buying a multiplex and living in one unit sounds like a good plan, too. You get some tax benefits from occupying the property, but it can be hard to live with other families.
Rent out your old home
Another way to start making rental income is to rent out your old home when you move. This is a good option if you can afford the down payment for the next home without having to sell your previous one. This is what we did when we moved to our current condo. We refinanced the old house to a lower payment and were able to generate a little cash flow. Now that the market has recovered, I’m going to put it up for sale and take some profit. I need a long break from being a landlord.
Real Estate Investment Trust
REIT is a company that owns and operates income producing real estate. You can buy and sell shares of REIT through a brokerage, like stocks. REITs allow regular people to invest in commercial real estate without having to deal with the day to day operation of running the place.
We have some Vanguard Real Estate ETF and that’s a good way to get started in REIT. It’s a good diversification from stock and bonds. Generally, you want a little slice of Real Estate, Gold, Energy, and commodities to help balance out your portfolio. Here is our current asset allocation.
You can check your current asset allocation easily with Personal Capital. They also have tools to help you figure out your target asset allocation and cash flow. Check them out if you haven’t yet.
Sign up with Personal Capital for free through this link.
Crowdfunding
Crowdfunding real estate is the hot new way to invest in real estate. You can pool your money with like minded investors and invest in various projects like a B&B rehab, a mobile park, and a strip mall. Realty Mogul (realtymogul.com) started about a year ago and members already invested $14.6 million.
This is quite an interesting concept, but I don’t know if I’m ready to jump in. You have to do your own homework and it seems like there can be a lot of risk with these projects. The total return of 12-18% sounds really tempting, though. This projection includes appreciation. The cash on cash return seems to be in the 6-10% range.
*Update – I’ve been investing in commercial real estate with CrowdStreet for several years. It’s been great. You can sign up for free and see what projects they have available. There are projects across the USA so you can pick the perfect location for you. Check them out if you want to invest in real estate, but don’t want to be a landlord.
Real Estate Investing
Investing in real estate has never been easier and buying a primary home is probably the least profitable way to invest in real estate. I think we’ll stick with REITs for now and keep an eye on crowdfunding. Once that opens up to regular investors, I’m sure there will be a lot more money flowing in.
Do you have any investment in real estate? The real estate market is hot again and everyone is jumping on the band wagon. What’s your play?Â
Passive income is the key to early retirement. This year, Joe is investing in commercial real estate with CrowdStreet. They have many projects across the USA so check them out!
Joe also highly recommends Personal Capital for DIY investors. They have many useful tools that will help you reach financial independence.
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Great Article….thanks for sharing.
I wasn’t aware of Realty Mogal but the I believe there is a very bright future for crowdfunding. It’s very similar to peer-to-peer lending and our family is living proof that peer-to-peer lending can be a great alternative investment tool. For now, given the $1 million net worth or $200K income, we’ll be waiting patiently on the sidelines. Something will change, either they lower their requirements or others enter the market do, whichever happens…we’ll be ready! 🙂
In my opinion bay area provides the best opportunity to build net worth in a short period of time. We bought our primary home and 2 investment condos between 2010 and 2013 and are now sitting on million plus in equity within 4 years. Most places in Bay area have either crossed the 2006 peak or couple percentage away. Some place are up to 25% over 2006 price. I was not aware of reality moghul, I will check them out.
It’s pretty amazing down there. Great job!
I’ve taken all of my money out of the market and poured it into real estate investments. Over time I’ve found that real estate offers more flexibility, better returns, and you can use other people’s money without needing a license.
Real estate allows cash flow, pay down of principle by someone else, appreciation, you can depreciate the asset over time, higher rights offs (you can only right 3k in loss with stocks per year), more leverage, and you can use less money of your money.
Now you won’t get rich in real estate over night but you will build and secure wealth over time. I think that’s why people put money in the market. They’re looking for an investment vehicle that will deliver high rates of return and need very little work on their part. Which we all know doesn’t exist.
For me, I would choose to buy a multiplex, it’s a good source of income. We had a rental property before, but my mom decided to sell it to buy another investment property.
I know it would help my financial circumstances to rent a room but my peace and quiet is worth more to me than being able to retire one or two years earlier because of the rent money.
Renting out room is really a young person’s game. 🙂
If I was going to buy my first place, I would get a place with a roommate. if a duplex could be found, even better. A roommate and a duplex.
I have 24 rentals, RE has been very, very, good to me. I average ~25% return now.
I lived shortly at my first place and keep renting it years after. I don’t know about the US but you have to get a buy to let mortgage which requires a bigger deposit and generally has a higher rate if you do that in the UK.
We have to pay a little higher deposit and a little higher point, but it’s not huge. It’s a better deal if you can live in the home before renting it out.
Joe,
Great article.
I’m one of those people with almost all of their worldly wealth tied up in equities, while I continue to rent my primary residence. I realized long ago that stocks outperform housing over the long haul by a wide margin, so I’d rather buy the former and rent the latter. It’s working out pretty well so far!
REITs are definitely my preferred method for exposure to real estate. 6%+ yields with no cutting grass of shoveling snow. 🙂
Best wishes!
6%+ is quite nice. We do need some RE to diversify our portfolio and REIT is a great way to go. Rentals are actually quite good because you can use leverage ie. get more mortgages. Primary resident on the other hand is not a good investment at all. Renting is great when you’re single. 🙂
Have a great weekend!
Capital gains tax on the fixer upper profit unless you live in it for at least 2 years.
Thanks for the reminder. I was assuming everyone knew that. I’ll update the article.
There is the turnkey investment option for those of us living in high priced areas where the housing market can be saturated. REITs are interesting but I don’t see how its all that different from an index fund. The idea behind property investment is to create a monthly cash flow, do REIT’s provide regular “rental income” (i.e. dividends)? In reading this forbes article: http://www.forbes.com/sites/moneybuilder/2013/06/28/choosing-the-right-reit-etf/
It seems like you have to be very careful about picking the right REIT as some of them seem more inclined to get into the speculative game of price appreciation instead of just good ol’ rental income that we can bank every month, which is what I would think most people sign up for in the first place.
Most REITs provide good dividend. They need to return 90% of the income to share holders to qualify as REIT. You can get index REIT like VNQ and VNQI. That’s the easy way. Or you can do more research and get into specific sectors like apartments and hotels.
The mortgage REITs are more risky and I avoid those.
That’s really good to know, thanks for the info!
That Realty Mogul site looks cool, thanks for sharing! Now that I’m an “accredited investor” I guess I could throw some dough that way if I want an easier method of investing than direct ownership and management.
So far, we have a fairly modest single family home for our primary residence (about 10% of our net worth) and 11% of our portfolio is in REITs (equal parts US and international real estate). I think we are pretty well allocated to real estate already.
One idea I have had over the last few years is buying a place and renting it on Airbnb or a similar site. There are studio and 1 BR condos a block down the street from me that sell for $35-45k and would be perfect for the short term rental market (near the bus line, near shopping and restaurants). It’s a different angle on the real estate game, and would be much more intensive management than renting for a year at a time under a standard lease agreement. Even with a 50% vacancy rate and not jacking up prices for special events (like the NCAA tournament and graduation weekend), I could gross $10k/yr. But I figure that kind of short term rental would be a hassle. So I’ll stay on the sidelines for now!
I like it too. It’s seems like a good compromise between REIT and direct ownership. Everybody wins. $5,000 per investment seems a bit high, though. I’d probably get 10 investments to diversify and that’ll take $50,000. I don’t know how to evaluate the investments either so it’s tough.
You need to check the city code and the HOA code. Many places don’t like short term rentals.
I was thinking $5k was too low! I’d want a big enough stake to make due diligence and paying attention worthwhile.
Although I guess if you could do like lending club/prosper and put in $100 on 100 different RE ventures, you’ll hit some big ones and have a few go into receivership.
I think I’d have to “go rogue” on the short term rentals. Unless the neighbors ratted me out, I’m not sure how the city would know about my little enterprise (unless the Inspections office scans Airbnb!). I guess the HOA might be more likely, but the target property seems to be mostly rentals anyway, with very few owner occupants I imagine. Good point on the city code and HOA though. That’s probably the biggest sticking point, and could immediately shut down my short term vacation rental scheme and force me to rent long term.
One of the cool aspects of the airbnb type rentals is the unique interactions you can have with people around the world who show up to rent your place. I’ve been trading emails with this guy in Canada I’m renting from this summer. Seems very friendly and open to chatting (and letting me practice my French!). He’s an older guy, and maybe this is his social outlet (via a “business-like” relationship). I’ll probably put the airbnb idea on hold for now and maybe pick it up when I have more time (ha!).
$5k is just the minimum. you can invest quite a bit more if you’d like.
The neighbors would definitely rat you out. Who would want to live next door to an Airbnb rental? 🙂
Oh, I guess if it’s mostly renters, then they probably wouldn’t care that much.
We have our old condo where we used to live as a rental plus some REITs plus our primary house. That’s enough RE exposure for now. Once I’m at a point where work is optional I plan on dabbling in real estate a lot more.
What’s percentage of RE is your net worth? I’m just wondering how much is too much.
It’s a lot : ) but we are also trying to pay off our expensive mortgage so it makes sense considering. Once that’s done I plan to pour money into the market. Should be relatively easy with a paid off house and zero debt!
I’ve contemplated buying a home in another, less expensive, state as an investment property. I’m still bouncing that idea around before taking the plunge, but I definitely would say that property is a shot in the dark when it comes to investing. Unless you hold on to the property for 10+ years, you can’t expect to make a ton of dough off of it.
Yeah, 10+ years seem like almost a sure thing as long as you don’t keep refinancing. It’s tough in those expensive states. sorry!
I’ve been thinking about moving some of my IRA money into REITs. I’d like to buy a place here in NYC…can only afford a co-op. Houses are too expensive…even a fixer upper in a decent neighborhood will be well north of $500,000. And they are pretty tenant friendly in the courts so it would be hard to get rid of a bad tenant. I’ve also contemplated buying rental property in a cheaper location where it makes sense, but with little experience, I don’t think it’s a good idea.
REIT is an easy way to get into real estate. It’s tough in NYC. I guess that’s the price you pay for living in a great city. I wouldn’t want to buy a rental out of town either. I like to see how my place is doing.
I personally think that primary residence can be a good investment, however we shouldn’t make it the main purpose for buying a home. Buying a home is to have place that you call ”home’, and sometime decisions you make will be different if you treat it as an investment (e.g. I personally don’t take baths, but I hesitate to take out the bathtub since I worry about the re-sale value…).
We rented out a room in our house to engineers for a few years, during the early part of our marriage when things were tight. While it’s not a ‘bother’ per se, we just don’t do that anymore since our privacy is now worth more than a couple hundred dollars monthly income and we just don’t want to live with ‘strangers’. (We housed co-op students who are interning at the place my husband works).
We have some REITs and as you know we got a rental property. So far things are going well and we are planning on buying a 2nd one in the next 2-3 years. If we don’t have enough savings for a down payment we may consider taking out HELOC on our primary residence. Still doing the research.
I think you are doing very well. Do you think the market is too hot to pick up another property? I’d hate to pick up something in this high priced seller market.
Primary resident is a form of forced saving, but it doesn’t always work out. You just have to be a bit lucky when you buy.
I think in Texas real estate prices are fairly stable, even during the downturn we didn’t lose something crazy like 40% of the value. The main reasons we don’t buy another property right now are 1) we just started renting out the property for 2-3 months, and want to give it more time to evaluate its long term performance before diving in another one, 2) need some time to save up money for another down payment 😉
I like the multiplex idea the best. You can rent out the other places and stash that money away if possible. It might be frustrating for a while, until you see the bank account and interest that it is getting after a few years.
It’s a lot of work, but if you can do it, I think it’s a great idea.
Buy a multiplex, live in it, save capital for your next downpayment. Right now, the market is so hot there is no play on pure investments that aren’t fixer uppers or otherwise hairy, but that will change eventually.
I like that plan too, but Mrs. RB40 doesn’t. It’s also difficult to find the right multiplex in the area we like. That’s why I’m getting out of real estate for now. The market is too hot so we might as well take some profit. When things are down again, then I’ll think about getting back in.
Why not just refi?
“Just pick a workaholic tenant and you will rarely see him/her at home.”
That’s hilllarius!
I would:
1) Stick with REIT.
2) Avoid crowfunding (unless you use it as a part of a diversified real estate portfolio).
3) Do not think as the place as you are living as an investment.
Thank you for posting
-Robert
That’s true, though. 🙂 I like all 3 of your points.