Want to make your real estate investments more profitable?

Ok, that was a silly question. Of course you do. And you probably want to make the time you spend on real estate investing as productive as possible. While there are many, many ways to build wealth with real estate, there are some common techniques that can make investing in real estate easier, more productive, and most important, more profitable. So here are 20 real estate investing tips to help make your investments more profitable.

20 Real Estate Investing Tips

1. There is always another investment property: Keep emotion out of the buying and selling decisions. However great a real estate investment deal may be, even if it gets by you, another one is always just around the corner. And one of the great things about real estate investing is that the next deal is often better than the property you just lost.
2. Develop and nurture relationships: Relationships are the lifeblood of successful real estate investing. Whether it is a relationship with a bank, a plumber, or a real estate agent, good solid contacts can make your life easier and more profitable. And if you are looking for folks to help you with any aspect of your investments, start with a real estate agent with experience buying and selling investment properties. If they have been around for any length of time, they will have many contacts that can help you.
3. Avoid rental vacancies like the plague: Vacancies can turn a profitable property into a money-loser faster than just about anything. We work hard to avoid to keep rental properties occupied, and you can check out some of our tips on how to avoid vacancies. But one key to remember when forecasting profits is to include an allowance for vacancies, because no matter how hard you try, at some point your property will be unoccupied for some period of time.
4. Take advantage of free money (part I): Particularly during a rehab or when maintenance on a property is required, getting your hands on capital can be a challenge. While we do not charge up credit cards, we do take advantage of 0% balance transfer offers. They offer free money for up to 15 months, which is a great way to finance needed repairs or other expenses without paying interest.
5. Take advantage of free money (part II): Another way to get “free” money is to buy Home Depot or Lowe’s store gift cards at a discount. On my money management blog, I wrote about how you can by store gift cards online at a discount of 10% or more: How to Turn Gift Cards into Cash.
6. Respond to tenant calls quickly: When a tenant calls about a problem with the rental unit, responding quickly accomplishes several things. First, it reduces the risk that the problem will get worse, causing more damage and requiring more money to fix. Second, it can have a positive impact on the relationship with the tenant. And the problem is going to have to be dealt with anyway, so why not get it fixed immediately
7. Understand portfolio lending: For most mortgage lending, the originating lender will sell the loan to an investment bankers who package mortgages to sell as investments. For this type of conventional loan, the loan terms must meet certain requirements in order for the originating lender to be able to sell the loan. For these types of loan, for example, a 20% down payment is almost always required for investment property. Portfolio lending describes those banks that do not plan to sell the loan. The benefit to the real estate investor is more flexible terms. Mike and I have a relationship with a portfolio lender that enables us to borrow 100% of the purchase price and rehab costs. If you can’t find a portfolio lender, ask a local real estate agent experienced with real estate investing. He or she should be able to recommend several.
8. Overestimate rehab costs: Estimating rehab costs is as much an art as it is a science. It involves not only identifying everything that needs repair or replacement, but also estimating the cost of the work and materials. As with any estimate, the estimate of the cost of a rehab will come within some range. When forecasting your rehab, assume the high end of the range and include an allowance of 10-20% for unexpected costs. In almost all big projects, the unexpected should be expected.
9. Include maintenance costs in your financial forecasts: Maintenance costs are a reality of real estate investing. And unlike mortgage or insurance, they don’t come in regular intervals. You may go a year or more without spending a dime on a property, and then its air conditioner and roof may need replaced at the same time. So put aside a monthly allowance for maintenance costs both in your financial forecasts and in your bank account.
10. Include automatic rent escalation costs in rental agreements: On a $1,000 a month rental property, even a $25 rent increase can go a long way. Unless other costs have gone up, that $25 goes right to the bottom line, and we’ve found that tenants do not object to modest rent increases. By putting the increase in the initial lease agreement, you avoid having to negotiate this point every year.
11. Aim for two or three year leases: As noted above, vacancies can kill your profit. A multi-year lease agreement can reduce vacancy rate. This can really increase your profit when you consider that a vacancy, in addition to lost rent, will cost you additional advertising expense and repairs to the property that are inevitable when no tenants come in.
12. Have capital available, even if its credit, not cash: Because the unexpected should always be expected, you have to have available capital. The ideal situation is to have cash in the bank, but real estate investors’ affinity for leverage sometimes depletes the bank account as they move into more and more investments. So whether its credit cards, a home equity, or cash, you need to have capital at the ready.
13. Invest in real estate located in good school districts: Homes in bad school districts are harder to rent and harder to sell. They also are worth less. At times we’ve been tempted to buy in questionable school districts because of the lower price, but the quality of tenants are also generally less.
14. Advertise rental properties on the Internet: With our first rental property, we spent about $500 in advertising, mostly with newspaper ads. With the last until we rented, we spent just $39 in advertising cost using the Internet. Advertising can really eat into your profits, so take advantage of online real estate advertising options.
15. Find a real estate investing mentor: An experienced mentor is critical when you begin your real estate investing journey. Mike is my mentor (God, help me!). And Mike’s dad, who has been in real estate forever, was his mentor. Learning from an experienced investor will save you time and money, and teach you things quickly that otherwise may take years to learn. If you do not know anybody in the business, reach out to real estate agents or attend a real estate investing club in your area.
16. Understand tax depreciation: Depreciation offers a significant tax advantage for real estate investments. But getting depreciation right can be tricky. Neither Mike nor I are experts in the field, but we know the basics. If necessary, speak to an accountant or tax expert to understand how depreciation works, even if you do not do your own taxes. You can also check out some of our articles on depreciation:
    • Calculating Depreciation for Residential Real Estate Investments
    • Real Estate Investors’ Potential Tax Trap: Depreciation Recapture
    • Tax Benefits of Depreciation for the Real Estate Investor
17. Do not make tax benefits the primary driver behind your your real estate investment decisions: I may take some heat for this one, but too many real estate investors let the tax consequences of their decisions lead around by the nose. Yes, the tax consequences of investments in real estate are important, should be understood, and advantage of tax breaks should be taken when they are consistent with sound real estate investing decisions. But I would never make a lousy investment in real estate just to take advantage of a 1031 exchange.
18. Do not over-improve or under-improve a property: Rehabbing a property, whether it is a rental unit or you plan to flip the home, requires just the right level of improvements. If anything, Mike and I tend to over-improve our properties. While much of this comes with experience, it is important to assess whether the improvements will (1) increase the sales price or rent, (2) decrease the time it takes to rent or sell the property, or (3) reduce future maintenance costs. If the improvement does not satisfy at least one of those three criteria, ask yourself why you are making the improvement.
19. Expect foreclosures to need new HVAC and a water heater: Time and again we buy a foreclosure thinking the HVAC and water heater look fine. Two months after our first tenants move in, the air conditioner goes. It’s happened repeatedly, to the point where we just expect to replace everything. If it turns out we don’t have to, we view it as a bonus. Foreclosures often sit unoccupied for months, and for whatever reason, this seems to take a toll on the mechanicals.
20. Understand 1031 exchanges: Tax-deferred exchanges offer a great opportunity to shelter profits from the taxman. But like everything else related to our beloved tax code, it can be a bit convoluted. As with depreciation, it is important to at least understand the basics of 1031 exchanges, particularly when you are planning to sell a property.

If you have more real estate investing tips, please leave a comment with your idea.

Flipping real estate involves buying a property, usually upgrading it, and then selling it (hopefully for a profit). Unlike investing in rental properties, flipping houses offers the potential for short-term gains and keeps your capital tied up for a relatively short period of time. Through this case study, Mike and I will be sharing with you in detail a foreclosure we just purchased and plan to flip.

As with all of our real estate investing, the investment property we purchased was a HUD foreclosure. HUD listed the property for $65,000, but we won the home with a gross bid of just $41,000. If you are wondering how we did that, check out our article on how to determine HUD’s minimum acceptable bid. In this case though, we just submitted a lowball offer and won. Sometimes it is better to be lucky, than good, not like Mike and I have much choice in the matter.

We expect to put about $23,000 in to rehabbing the property, but more about that later. Add a few thousand dollars in transaction fees, and our total investment will come in at around $65,000. The property appraised for $94,000 based on the improvements we intend to make, so there is a potential for a nice profit.

The property is a real “peach,” as Mike likes to say. It is a three bedroom, one bath home on a slab (no basement). It has a carport and a fenced 1/4 acre yard. Built in the 1950s, the home is in a good school district in a suburb of a large mid-western city. It won’t make the cover of Architectural Digest, but we do expect it to add nicely to our bank account. Here is a photo of the home taken a few years ago:

Flipping houses is not our primary real estate investing model, but it should provide additional capital as we continue to buy longer term rental properties. Stay tuned for more updates on our flip. The next article will walk through how we pick homes that we think make for a good investment in flipping homes.

A real estate investor’s own personal finances can play a big role in managing profitable real estate investments. One of the biggest mistakes anxious investors make is to take on a lot of leverage and financial risk with rental properties when their own finances are in shambles. Having your own finances in order is important to your real estate investments for at least three reasons: (1) you may need cash or available credit to address a major repair to the property; (2) you need to able to weather prolonged vacancies or non-payment of rent, and (3) you want to qualify for the best available financing when you buy or refinance a property.

So here is a quick primer on sound personal finance habits every real estate investor should know.

1. Supercharge your emergency fund: Most personal finance experts recommend keeping three to six months of living expenses in a savings or money market account. For the individual real estate investor, however, this isn’t enough. You should consider how much you would need to keep your properties afloat if rental income wasn’t coming in the door. There’s no magic formula here, but some suggest keeping a year’s worth of expenses (mortgage, taxes, insurance, repairs) for each property. That’s extremely conservative, but the point is that your emergency fund should be above to cover your rental properties for at least three to six months in addition to your own household expenses.

2. Pay EVERYTHING on time: Avoiding late payments on your debts is critical to the real estate investor. Late payments can have a major impact on your credit score, which can result in raising the interest rate you’ll pay for a mortgage on a rental property. In extreme cases, it can even disqualify you for traditional financing, particularly given the tight credit market we’re in now.

3. Maintain available credit: I have available credit on both my home equity line of credit and on a number of low interest credit cards. It’s never my intention to use this credit for real estate investing (except on perhaps a very short term basis), but the available credit is important for at least two reasons. First, having unused, available credit can improve your credit score. Second, it’s nice to have the available credit in the even of an emergency. Of course, you should be relying on an emergency fund when the air conditioning unit goes out, but some extra financial cushion never hurt.

4. Diversify your investments: I know I’ll take some heat on this one, but in my opinion, real estate shouldn’t be one’s only source of investment income. I have a fair amount invested in stocks and bonds. I also invest in REITs. These investments, along with my real estate holdings, provide a nice diversification that reduces the overall risk of my investment portfolio.

5. Shun consumer debt: Many Americans are buried in consumer debt. They use credit cards and home equity lines of credit to a fund a life style they can’t afford. Before long, they are mired in debt and working harder and harder just to stay afloat. The goal of real estate investing, at least for me, is to achieve some significant degree of financial freedom for me and my family. But I’ll never achieve that if I have consumer debt that is growing each month.

6. Maintain an updated personal net worth statement: It’s a good personal finance habit to know and track your net worth. With real estate investing, it’s doubly important because you’ll need this information when you apply for financing. In addition, a net worth statement will also allow you to see how your real estate empire is growing.

7. Stick with fixed rate mortgages: Particularly if you dabble in variable rate mortgages on some or all of your rental properties, financing your own home with a fixed rate mortgage is critical. Mike and I have financed some properties with variable rate mortgages, at least for a time. These investments expose us to enough interest rate risk; we don’t need to add to it by financing our own homes with variable rate mortgages. Besides, interests are still at historic lows, so with perhaps a few exceptions, there is little reason not to lock in the low rate now.

We could add many more to these, but these are seven of the more important personal finance habits I’ve found helpful to my real estate investments. Perhaps you can add to this list. If so, by all means leave a comment. If you disagree with any of these points, email Mike.

One of the toughest hurdles for an investor to grow his real estate investments is raising capital. A self-directed IRA may be the answer. The term “self-directed IRA” actually refers to the administration of the IRA rather than the type of retirement account. A traditional IRA, Roth IRA, or SEP-IRA can be self-directed. The principle difference is, with a self-directed IRA, the account owner is in charge of the investment of the IRA funds beyond the limited choices offered by traditional custodians, such as banks and brokers. Those investment choices, with the right account setup, include real estate.

There are, however, some significant practical limitations to using a self-directed IRA to invest in real estate, so care should be taken before embarking on this approach. Here are the basics, along with some potential pitfalls.

Setting up a self-directed IRA

A typical IRA at a brokerage house or bank typically does not allow the flexibility of investing in real estate or other non-traditional assets for one reason. Their own institutional rules do not allow it. These accounts limit you to stock and bond mutual funds, certificates of deposit and similar investments. Now, some may still hear from bankers or brokers that using an IRA to invest in real estate is not permitted or “illegal”. We’ll give them the benefit of the doubt and say that they’re misinformed. Whatever the reason might be, they’re wrong.

So, to use an IRA to invest in real estate, you have to open an IRA with a company that is setup to handle real estate investments. There are several national companies that provide these “custodian” services for self-directed IRAs, such as The Entrust Group. We’re not going to offer an endorsement of any particular company, and there are many out there. I would suggest finding one that has been around for a good while and consulting with your legal or tax advisor and other real estate investors for recommendations.

Typically, administrative fees will be higher than the typical bank/broker custodians, but the whole purpose here is to use the IRA funds in higher return investments that, invested properly, will more than offset the cost differences. However, even among the self-directed custodian companies, the fees will vary significantly, so be prepared to shop around for the best deal.

How to fund a real estate investment with a self-directed IRA

The types of permissible real estate investments in a self-directed IRA are virtually unlimited. Commercial property, single-family homes, apartment buildings, and even the purchase of mortgages are all allowed. If your IRA buys a property for cash, the transaction presents little difficulty.

But there are some restrictions. We all know that an IRA owner can’t withdraw funds willy-nilly to pay for personal expenses. So, Mike couldn’t use his IRA funds to, say, pay for writing lessons. The reason is that, at their essence, tax regulation of IRAs, self-directed or otherwise, have a common theme–to treat (and to insure the investor treats) the IRA as separate from the owner. That concept carries through in the restrictions applicable to IRA purchases of real estate. So, the purchase transaction must be between your IRA (as distinguished from you) and an unrelated seller. That’s where the custodian comes in. The custodian, acting on behalf of the IRA and at your direction, will execute the purchase contract, as well as deed and other closing documents, on behalf of the IRA. So, other than that, you’re pretty much good to go.

Most of the potential pitfalls arise in structuring financing for real estate purchases where part of the purchase price is borrowed. Again following the concept of separating the you from the IRA, the mortgage loan to finance the purchase must be a “non-recourse loan,” meaning you can’t be personally obligated to repay the loan. So, mortgage funding will be more challenging. Commercial lenders do make non-recourse mortgage loans. But since they will have to look solely to the property’s income and value for repayment, the down payment requirements will likely be higher than an ordinary mortgage loan. You might also consider trying to find private lender funding or pooling your IRA’s funds with self-directed IRA’s owned by others in partnership, which, other than the prohibited transactions (relatives and such) is permitted under the regulations.

There are at least two other things to keep in mind when considering borrowing a portion of the purchase price:

• You can’t pay the mortgage payment or expenses: Just as you cannot guarantee repayment, you cannot step in and pay the mortgage payment for the IRA or, for that matter, any other expense. Consequently, the IRA must have sufficient cash flow or assets to pay the mortgage and expenses. And no floating personal loans to the IRA to get it to payday either. Apart from ordinary contributions to the IRA, it’s on its own.
• Unrelated business tax income (UBTI): The details of this tax are a little outside the scope of the article, but suffice it to say that Congress gets a bit out of sorts when a bunch of money’s lying around un-taxed. Suffice it to say that an income tax may apply to income generated from real estate investments in an IRA on the the portion of the investment funded through debt. With available deductions, this may or may not be a reason to stick with a cash buy, but on this front, I’d suggest you consult with your tax adviser.

Prohibited transactions

As I’ve alluded to, tax law restricts certain transactions with a self-directed IRA. Prohibited transactions include those between the IRA and a disqualified person. In rough cut, “disqualified person” includes the custodian of the account, relatives, and companies where the disqualified person has a substantial interest. In more IRS-like lingo, here is a more detailed laundry list of examples of prohibited transactions:

• a transfer of plan income or assets to, or use of them by or for the benefit of, a disqualified person;
• the sale, exchange, or lease of property between a plan and a disqualified person;
• lending money or extending credit between a plan and a disqualified person; and
• furnishing goods, services, or facilities between a plan and a disqualified person.

A disqualified person includes, among others, the following:

1. a fiduciary of the plan;
2. a person providing services to the plan;
3. an employer, any of whose employees are covered by the plan;
4. an employee organization, any of whose members are covered by
   the plan;
5. any direct or indirect owner of 50% or more of any of the following:

• the combined voting power of all classes of stock entitled to vote, or the total value of shares of all classes of stock of a corporation that is an employer or employee organization described in (3) or (4);
• the capital interest or profits interest of a partnership that is an employer or employee organization described in (3) or (4); or
• the beneficial interest of a trust or unincorporated enterprise that is an employer or an employee organization described in (3) or (4);

6. a member of the family of any individual described in (1), (2), (3), or (4) (i.e., the individual’s spouse, ancestor, lineal descendant, or any
   spouse of a lineal descendant);
7. a corporation, partnership, trust, or estate of which (or in which) any direct or indirect owner described in (1) through (5) holds 50% or
   more of any of the following:

• the combined voting power of all classes of stock entitled to vote or the total value of shares of all classes of stock of a corporation;
• the capital interest or profits interest of a partnership; or
• the beneficial interest of a trust or estate;

8. an officer, director (or an individual having powers or responsibilities similar to those of officers or directors), a 10% or more shareholder,
   or highly compensated employee (earning 10% or more of the yearly wages of an employer) of a person described in (3), (4), (5), or (7);
9. a 10% or more (in capital or profits) partner or joint venture of a person described in (3), (4), (5), or (7); or
10. any disqualified person, as described in (1) through (9) above, who is a disqualified person with respect to any plan to which a multiemployer plan trust is permitted to make payments under section 4223 of ERISA.

For most, what that list of disqualified persons means is that you can’t buy a rental property in Florida through a self-directed IRA and rent it to your parents. You also can’t buy a rental property near your child’s university and rent it to them.

Using the rental property for personal use may disqualify the entire self-directed IRA

Using a rental property for personal use may disqualify the entire self-directed IRA. So, assume you use $100,000 from a $1 million self-directed IRA to buy a condo at the beach. Even if you use the condo just two weeks a year, the entire $1 million IRA could be disqualified. Here’s how the IRS explains it:

However, in this case, with an individual retirement account, instead of imposing an excise tax on the parties to the transaction, the Code provides that the account is no longer an individual retirement account, and it is treated as if the assets were distributed on the first day of the taxable year in which the prohibited transaction occurred. (Code §408(e)(2))

The result would be a hefty tax bill and penalties. And that’s not good for anybody. So, as I noted at the start, a self-directed IRA can be a source of capital for investing in rental property. But the rules are complex, so you should seek the advice of a tax and self-directed IRA specialist before launching full bore. But here’s the thing. Like any investment strategy, there’s a certain learning curve. A good tax adviser can help you through the learning curve to help you see what’s possible in putting some of those real estate returns to work growing a retirement plan.

In the meantime, if you’d like to read more about using a self-directed IRA to invest in rental property, check out these books:

• Retire Rich With Your Self-Directed IRA: What Your Broker & Banker Don’t Want You to Know About Managing Your Own Retirement Investments
• All About Self-Directed IRA Investing

When Rob and I started our joint venture or “adventure,” as the tag line suggests, I had more experience in dealing in real estate. If Rob had posed this question, my answer would have been easy: “How much you got?” I’ll try to be a bit less glib with your money. But the fact is, it’s a little more difficult to answer the question in the abstract and it depends on several factors particular to the investor. As a result, I want to look at three approaches to the question–the guaranteed way, the conventional way, and, for lack of a better term, the TwoWiseAcres way.

The Guaranteed Way

If you’re looking to buy real estate for rental income, the fact is, you’re virtually guaranteed to make money if you pay cash. At the very least, it’s a low risk approach. Even if you make mistakes, such as over valuing the property or if property values or rents decline or if you entered a partnership with Rob, the fact is you’ll be able to rent the property, cover your expenses, and make an income.

The obvious problem, however, is that you just might not have the cash lying around. But as importantly, even if you do, paying cash for a rental property is probably not even advisable. While it’s a guaranteed way to make money, it’s also a likely way to make low returns because it foregoes any increased returns through leverage.

The Conventional Way

An alternative approach is to finance the majority of an investment purchase with a conventional mortgage. Conventional mortgage lenders generally require a minimum 20% down payment (without private mortgage insurance) for investors, as well as owner-occupants. A conventional, secondary market mortgage will have a lower interest rate than a loan from a portfolio lender. So, investors looking to obtain the least cost way to finance an investment property will have to come up with the 20% cash down payment. The 20% down payment requirement is a percentage of purchase price, not value. In other words, despite lenders’ use of the misnomer “loan to value ratio”, the requirement is really loan to purchase price. Investors going this route also have to pay out-of-pocket for the costs of improvements.

Obtaining conventional financing for a real estate investment purchase provides some cost savings, and it also lowers risk. While this approach takes advantage of leverage to increase returns, for the individual investor, it still has substantial limitations on growth. Consider an investment property with a price of $100,000, minimal rehab costs of $7000, with closing costs and prepaid expenses of 4%. An investor financing the purchase with a 20% down, conventional loan will have to come up with about $31,000. While that may be do-able, a second property will not be, at least not for some time.

The TwoWiseAcres Way

Rob and I went with a more aggressive approach. We purchased our first four properties with about $20,000 out of pocket. Our goal was quite simply to acquire the most property in the least amount of time given the amount of cash that we could devote to real estate investments.

The approach is not new and our method is not complicated or exotic. In obtaining the loans, we worked with a portfolio lender that was willing to fund a purchase and rehab based on the improved value of the property. In other words, we would enter into a contract to purchase a distressed property, such as a HUD foreclosure, provide the lender with a detailed improvement plan and, of course, our estimation of the improved value. The lender would then obtain an appraisal of the property, based on the work being completed–i.e. the improved value–and approve the loan based on an 80% loan to value ratio. The lender would hold a portion of the loan to cover our estimate of improvements in escrow until the improvements were complete and the property was re-inspected.

Revisiting our example, this approach means that we could borrow the full purchase price and improvement costs of $107,000 if the property had a value, once improved, of $133,750. By and large, we made sure they did. With our purchases, we might fund closing costs and prepaid expenses with cash or even a portion of the improvements or holding costs. With each purchase, the total cash was somewhere between $0 and $7,000. For three of four of our properties, we later refinanced the properties with conventional, secondary market loans. After a year (occasionally less), we could obtain a conventional loan at 80% loan to value–improved value this time, not purchase price.

The advantage to our higher leverage approach is exactly what we set out to do–grow quickly. However, there are downsides to the approach as well. Higher leverage means higher risk–risks such as unexpected expenses or underestimating rents more easily putting a rental property in the negative cash flow territory. Also, the interest rate charged by a portfolio lender is likely to be higher than a conventional, secondary market loan. Doing a two-stage financing, like we did, also means higher costs due to the costs of refinancing.

At its core, the question of how much you need to begin is really a question of return and risk–both your perception of risk and your tolerance. In our case, we felt comfortable with using high leverage because we had experience that gave us confidence that risk resulting from error in projecting rents or assessing improved value was low. However, we also had other resources that we could draw on–whether credit or income from the day jobs–that provided options if some of these risks came about.

For new real estate investors, a more conservative approach is probably warranted. While I don’t think it is necessary, even for a new investor, to begin the conventional way (funding a 20% down payment and rehab costs), a slow start is advisable. Consider using more available cash to fund the first property, thereby improving cash flow. Make sure you spend the time to truly learn the market and the investment. Look for the best deal, and be willing to allow a decent deal pass you by. There’s always another. Finally, have reserves–cash and credit. Real estate investors can make mistakes, but having no backup source of funds is the way to make a manageable mistake an unmanageable one.