7 Powerful Ways to Invest in Real Estate (Plus: How to Analyze a Deal)

If you think about the wealthy people you know of (I mean within 2 degrees, not celebrities), I bet a large portion of them own investment real estate.

And if you think about the people you know of who own investment real estate, I bet most if not all of them are pretty wealthy.

I’m not talking Forbes 400 kind of wealth (for that, please go and start Facebook). I’m talking financial independence type of wealth, i.e., all the wealth a normal person would need to comfortably FIRE.

Wealthy people seem to own real estate, and people who own real estate seem to have wealth. The two are linked.

So, in this week’s podcast, I share 7 powerful ways you can invest in real estate, from classic buy and hold to tax lien investing.

What you’ll learn:

The 3 things that make real estate so attractive for building FI wealth
7 powerful ways to actually invest in real estate
The 4 levers where wealth is actually created using real estate
What I look for in investment properties and how I personally analyze them

Are there other powerful ways you invest in real estate? Any other factors you consider when analyzing a deal? Let me know by leaving a comment when you’re done.

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I’m really excited by today’s episode because we’re going to be talking about wealth building, which is in the earn pillar of my four by four FIRE framework, which I introduced way back on Episode 2 of the podcast, which I highly encourage you to go check out if you want the full commentary and explanation of what that is.

But basically, four pillars: earn, save, invest, and protect for creating and protecting wealth.

And one of the best ways to build wealth in the earn bucket is through real estate investing.

Right now, it happens to be that summer is going to be soon approaching. It’s pretty much right around the corner.

A lot of people tend to buy and sell homes during the summer because the kids are out of school and they’re able to move without disrupting the school calendar schedule.

If they move in the summer, then they’re all settled by the fall when the kids enroll in school again or enroll in a new school. And so you tend to see a big spike in real estate transactions that occurs during the summer.

So because summer is just around the corner, it’s also a good time to talk a little bit about real estate investing and how you can actually build wealth with real estate investing. And maybe this summer would be a good time to actually get started!

What This Post Covers: Overview, Different Types Of Real Estate Investing, How To Evaluate A Real Estate Deal

I’ll talk about some big picture concepts first related to real estate investing, what some of the pros and cons are of investing in real estate as a wealth creation strategy.

And I’ll also give a high level overview of the different types of real estate investments out there because there’s a lot of different ways you can invest in real estate beyond simply buying a house yourself and renting it out, which is what you might naturally think of first when you think of real estate investing.

Finally, for the most common type of entry level real estate investing, which is buying a physical real estate asset, usually a house or residential property, I’ll walk through the basics on how to evaluate a real estate deal as a potential investment, especially when there are plenty of other things you could invest in, like stocks, bonds, mutual funds, etc.

How do you actually compare a real estate investment compared to these other things? And how do you evaluate the tradeoffs? We’ll talk a little bit about how to analyze and evaluate a real estate investment if you are going to be buying and holding.

Freebie For This Post

Before we get to that, I want to also be sure to mention that, as a freebie for this episode, I’m going to be including the real estate valuation spreadsheet I personally use.

It’s templatized, but it’s the one I use for quickly analyzing and comparing properties side by side.

I use this to evaluate properties and can quickly compare several properties side by side in an apples to apples way.

And then for the ones I’m really serious about, like where I’m ready to write an offer or a contract on, I’ll do a more extensive financial analysis using a much more complicated financial model that I built.

But my quick analysis spreadsheet, which I’m going to be including as a freebie to this episode, will actually get you 90%-95% of the statistics you need to make good valuation decisions when analyzing deals.

And it’s much easier to use because you can spit out results in 10 seconds after punching in just a few inputs. So I’m going to be including that as a freebie to this episode.

I’m also going to include with this episode a video walkthrough of how I do an initial evaluation of a property using publicly available tools like Redfin and Google Maps.

So you can see the exact process I use to do an initial vetting of a property when a new listing comes on the market that catches my eye. So you definitely don’t want to miss that.

You can get both of those freebies at the show notes page for this episode, which is hackyourwealth.com/28.

As always, before we jump into the heart of today’s episode, I also want to take a moment to invite you to join the private Hack Your Wealth Facebook group which you can access at hackyourwealth.com/fb.

Get in there. Join us. It is a way for us to connect, have a two-way dialogue.

I’m in there every single day, multiple times a day. And I try to respond to every single comment and question that comes through there.

And it’s a place where folks ask about financial independence, early retirement, tax strategies, real estate investing, side hustle income, career transitions, or just advice about personal finance in general.

So I definitely encourage you to join the conversation there: hackyourwealth.com/fb.

Pros And Cons Of Real Estate Investing

I want to start off by talking about some tradeoffs, the pros and cons of investing in real estate.

Real estate can be a tremendous asset class for wealth creation, but it also has numerous downsides too that you have to be aware of to invest wisely.

So let’s talk about some of the pros.

One, real estate is really powerful for building wealth, like financial independence type of wealth.

Think about some of the wealthy people you know or you know of.

I bet there is a strong chance that a large portion of them own real estate.

And if you think about the people you know who own real estate, I bet there’s a strong chance that a large portion of those are fairly wealthy.

The wealthiest people seem to own real estate. And real estate owners, especially ones who have investment properties, seem to be wealthy.

And while real estate is most likely not the path to pursue if you intend to become the world’s richest person or part of the Forbes 400 list of billionaires, if what you want is life-changing wealth, financial independence type of wealth, all the wealth that a reasonable person would ever need, then real estate is a really good investment asset class for that purpose.

If you DO need to make it onto the Forbes 400, then you need to start a company, plain and simple, because it’s very rare for real estate to create billionaires. It happens, but very infrequently.

Most of the wealth creation at that level is from starting, growing, and exiting a huge successful business.

So you hear about tech founders who become billionaires from apps like Instagram or Snapchat. And if you can do that, all the more power to you. Go do that. You should do that.

But that’s not most of the world. And statistically speaking, it’s probably not going to be you.

It’s really hard to do it. And there is a lot of pure luck involved, frankly.

But if you have your sights set on more realistic goals, and becoming a multimillionaire is quite realistic, for this crowd especially, then real estate is a very powerful way to do that.

It’s reasonably passive, so it’s not all-consuming like building a huge company is. And you don’t have to put everything on the line like that.

It’s predictable in that with straightforward but rigorous analysis, you can get pretty darn clear about the economics that WILL result if you invest wisely in a real estate asset and you execute a common sense operational plan to improve it.

And finally, it’s repeatable. So once you’ve done it once or twice, you have a pretty good framework in place and judgment and systems and processes to go do it over and over again.

And that’s where the wealth creation really happens: when you layer good real estate investments one on top of another.

Now, there are certainly risks as well, but they’re generally pretty manageable if you’re disciplined and rigorous.

And at the multimillion-dollar wealth level, the tens of millions of dollar wealth level, even breaking into the hundreds of millions of dollar wealth level, there are a disproportionately large number of people who own significant real estate in their portfolio.

How Wealth Is Created With Real Estate

So that begs the question, “How is wealth actually created with real estate?”

And the answer to that partially depends on whether you are investing in actual physical real estate itself or a financial instrument linked to real estate, like mortgage debt or tax liens.

But for most people, when they think of real estate, they think of a physical real estate asset. And there are basically four ways to build wealth with physical real estate.

Cash Flow

Number one, you get cash flow, and that’s rent.

This is what you most commonly think of when you think of passive income with real estate. You want to make sure rent is consistently paid and it’s high.

And the main way to do that is to maximize the percentage occupancy of your units. That’s the number of units that are occupied times the average monthly rent. And this generally requires skillfully managing tenants and operating the property well.

Appreciation

Second way to build wealth is through appreciation.

When you buy real estate, in addition to cash flow, you want to see appreciation in the underlying property. Just like if you buy a stock, you want to see capital gains in the stock.

And part of the capital gain will come from general market forces because real estate values tend to increase over time, just like most other things. And part of the gain will come from doing a good job analyzing and picking a good property.

And by that, I mean analyzing what the local demographic and economic and job trends are. You want to see good jobs flowing into the community, with good population growth, a clear path of progress when it comes to local development and redevelopment of the neighborhood and surrounding community.

And finally, part of your capital gain may come from improvements to the property that you yourself make through sweat equity, where you renovate and remodel the property to make it more marketable and appealing to higher paying, higher quality tenants.

Mortgage Paydown

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Third way to build wealth through real estate is through mortgage amortization.

And that just means paying down your mortgage. You’re basically getting your tenants to pay the mortgage, which is building home equity for you.

And after a while, you’ll finish paying the mortgage off. You’ll own the property free and clear. And your net rental income will jump since there’s no more mortgage debt to repay.

And that’s exactly how private equity works too. Whether you’re buying a company or a real estate asset, you’re buying an asset.

Suppose that asset costs you $100 and you only put in $20 of your own money and you borrow $80, that asset then produces cash flow which you then use to pay down the $80 you borrow. And eventually you pay the debt all down and you own $100.

So your $20 became $100. That’s a 5x return just on the debt paydown.

Meanwhile, you’re still collecting cash flow from the property every month. So mortgage amortization is really about putting a little bit of equity in, and then someone else grows that equity for you.

Depreciation

And last but not least, the fourth way to build wealth with real estate is through depreciation.

This is really about tax savings because depreciation creates a tax shield against your rental income.

You collect rent, but you record depreciation as an expense.

And depreciation is meant to estimate the wear and tear on a property such that at the end of the property’s useful life, it theoretically has no value anymore because it’s all been used up.

Now, that isn’t always true in reality because you’ll do maintenance and upgrades and upkeep which will continually prolong the property’s lifespan.

And actually, if you want to get really tactical about it, each of those upgrades gets its own little depreciation schedule that should be tracked separately.

But regardless, you’re still recording depreciation of the property’s original basis as an expense each year to reduce your reported income.

And between depreciation and your mortgage interest, it may often be enough to zero out all of your rental income.

So you still collect the cash flow from the rent, but on your tax forms, you report zero or even negative income. And that means you obviously won’t pay any taxes, certainly not on any losses, but you’re still collecting and keeping the actual cash flow that you’re collecting in rent.

And so what you save by doing this is taxes. So depreciation helps you build wealth by avoiding taxes.

So those are some of the pros and benefits of real estate.

Downsides Of Real Estate

Now, what about the cons? And there are some here that are worth pointing out.

Expensive

First thing I would say is that it’s expensive. There’s lots of different costs involved in investing in real estate.

For example, you’re going to have to pay property taxes. And depending on your state, property taxes can be insanely high.

In Texas, for example, there’s no state income tax in the state, but the local property taxes tend to be really high. They might exceed 3% per year, which means you’re effectively rebuying the property every 30 years.

Like you buy a house with a 30-year mortgage, and by the end of the 30 years, you’ve not only paid off the mortgage. You’ve also paid for the entire house twice, the second time all through property taxes.

In California, for example, the property tax percentages aren’t as high, but because property values themselves are insanely high, it essentially means you’re still paying an arm and a leg in terms of raw dollars toward property taxes.

And plus, on top of that, you’re paying crushing state income taxes too because California has a state income tax.

Wherever you live, property taxes are going to eat up a substantial part of your annual cash flow. And that’s just the cost of doing business when it comes to real estate investing.

You’re also going to be spending on insurance. You cannot invest in real estate without buying property insurance. You technically could, but that would not be a good idea.

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You want insurance to cover against things like fires, floods, water damage, destruction, things like that.

At least enough insurance that you could rebuild most of the building if it was largely destroyed. Otherwise, if something destroys your property, that’s your investment literally going up in smoke.

This is no different than buying health insurance or auto insurance. And it’s not trivial in terms of cost.

Another expense you’re going to pay is mortgage interest, unless you’re paying all cash, which I don’t really recommend if you’re doing real estate investing, because as I mentioned a moment ago, one of the key levers for creating wealth through real estate is through mortgage paydown.

You want to put a low amount of equity in and have your tenant pay off your mortgage for you.

Of course, doing that, the flip side is that when you have a big mortgage on your property, you have to pay a lot of mortgage interest as well. And that’s going to eat into your cash flow.

Maintenance And Repairs

The second downside or con that I would point out when it comes to real estate investing is just the maintenance and renovation and repairs involved.

You’re going to have to do ongoing maintenance and repairs on the property as wear and tear causes things to break down or need replacement.

And when you buy the property, you may very well have to do a big upfront investment in renovation and repairs in order to make the unit rentable to a high quality tenant.

In fact, a lot of the value in real estate is actually in finding dilapidated and fixer-upper properties that are in good neighborhoods since you can’t change the location, but you can always change the interior.

But between buying materials for renovations, like hardware, supplies, tools, which can get really expensive, to paying for contractor labor, you’re going to be spending a lot on upkeep and upgrades.

And plus, you might have to be the project manager coordinating and scheduling and contacting and responding to all these contractors and handymen. And that’s also going to take up precious time from your schedule.

So there’s not only a money cost. There’s also a time cost for you.

Tenant Management

A third downside is just dealing with tenants.

If you’re a landlord, you’re going to have to deal with and manage a myriad of tenant issues.

And that’s true even if you have a property manager.

The property manager may shield you from a lot of the day to day.

They’re also going to charge you. It’s not super cheap.

But eventually, if you do scale up your real estate investing, you should definitely get a property manager to help you leverage your time.

Even if you do have a property manager, there’s still going to be tenant issues that are going to come across your desk or that the property manager is going to escalate to you and that you’re just going to have to deal with. It is not entirely passive.

Additionally, you’re going to have to market the property to attract new tenants. You’re going to have to screen tenants or have somebody who can do a good job screening tenants and keep out uncredit-worthy or troublesome tenants.

And of course, time spent dealing with house calls for maintenance and repairs, clogged toilets, shower drains, broken faucets, appliances, electrical circuits, all these things.

And then finally, there’s tenant turnover. Every time a tenant vacates, you’re going to have to clean the unit, perhaps replace some fixtures, remarket the property, and start all over again.

That’s time invested. That’s lots of back and forth messages with different parties, and not to mention lost rent while the unit is vacant. And also, all of the time that you have to invest from your schedule.

So there definitely are these costs, whether they are dealing with tenants or having to deal with maintenance and renovations, or just the financial costs of investing in real estate. And you have to be aware of these things.

7 Different Types Of Real Estate Investing

So now that we’ve covered the basics on pros and cons of real estate as an asset class, let’s actually talk a bit about the major different types of real estate investments out there, at least a high level overview.

Because there’s a lot of different ways you can invest in real estate beyond just buying a residential property and renting it out, which is what you might naturally think of at first.

And that’s definitely a legitimate way to invest in real estate, but there are other ways too. So let’s cover all the different ways.

And we’ll start first with the most common way, which is traditional buy and hold investing. And then we’ll get into some of the other ways to invest in real estate.

1. Buy And Hold

First, as you probably already know, the most common form of real estate investing to get started with for individual investors is simply buying a home yourself, much the same way you’d buy a home to live in, except that you’re going to rent it out instead.

So what this entails is finding a home probably on the MLS, which you would have access to through a website like Redfin or Zillow or Trulia.

And once you find a property you like, you go see it in person. You do an inspection.

If it looks good, you write an offer with a real estate agent. Negotiate that offer. Get it accepted.

And you might take out a mortgage from a bank, just like you would for your own home. And that mortgage will have a residential rate, if you agree to live there yourself for at least a year. Otherwise, it will probably have a slightly higher interest rate because it will be considered an investment property interest rate.

Either way, you’re going to get a loan.

You’ll close the transaction.

Then you might do some renovation or rehabbing to increase the appeal to high quality tenants.

And then you’ll market the property, hopefully get applications from tenants. You’ll pick a tenant and you’ll rent it out.

And that’s the most plain vanilla type of real estate investing. It’s tried and true. You can definitely build wealth that way.

And it’s what I’ve done with the fourplex that I’m house hacking, which I’ve written extensively about on the Hack Your Wealth blog.

That is, that house hacking allows wealth building by drastically reducing your housing costs, which is usually your largest expense after taxes.

2. Fixer Upper

The second way to invest in real estate is actually a derivative of the first way.

And what it involves is buying a value add property, a fixer-upper or a badly managed property, maybe where the current owner isn’t operating as efficiently and is leaving a lot of money on the table that way.

And here, you generally pay a lower price because of the problems that clearly exist in the property.

So there might be a lot of deferred maintenance. There might be problems with the roofing, the foundation, or whatever.

Or there might be a lot of vacancies or poor enforcement of policies, like rent collection.

Whatever it is, the property is clearly not performing as well as it could be.

So the purchase price is going to reflect a discount for that. So you receive the benefit of that discount.

And since the property may look like roadkill, it’s possible that a bank doesn’t want to lend on it. Certainly not at a low residential interest rate. Or they might lend you a very low amount like 60% LTV, which is loan to value ratio.

Or they might not lend at all. In which case, you might have to go borrow private money, which is called a hard money loan.

A hard money loan is a very short term high interest rate loan that is meant to just help you buy the property, rehab it, and then you pay it off by refinancing it with a proper bank loan once the property is fixed up.

So a hard money loan might charge 11%-12% interest for one year, and it will be due in one year or even six months. And it will be secured with a first position lien against the property.

So you buy the property, you fix it up, turn it around, actually improve the operations of it, and then over the course of, say, 6-24 months later, it’s now worth 1.3x or 1.5x what you paid for it, just from your sweat equity or labor.

Then you go to a bank. You get a proper loan. You get a cash out refinance loan from the bank, maybe now because the property is fixed up and they’re willing to loan you now, say, 70% LTV, loan to value ratio.

And because the value has also now increased from 1x to 1.3x or 1.5x due to your sweat equity, you might actually get all your capital back just from the bank loan.

And then you can pay back your hard money lender.

You get your own initial equity back as well.

And the home is now funded by 70% bank loan and 30% sweat equity, but no cash out of your own pocket.

And then you go find another property, and rinse and repeat over and over again.

Meanwhile, renters or tenants are occupying these properties and then paying down your mortgage over time.

So you basically use one pot of cash to buy property after property.

And that one pot of equity cash is just being used to seed each purchase, which you’ll eventually pull out when you refinance the loan into a long term mortgage.

Meanwhile, as I said, your tenants are slowly paying down each of your mortgages.

And once they’re all paid off, you have an array of long term income-producing investment properties that basically pay you a dividend in rent each month.

So you can probably see that you don’t need a ton of properties like this to be able to FIRE very comfortably, living off real estate rental income.

It does take a lot of work upfront, for sure, to set up each property, but over time, you’ll learn to build good systems and processes to help you scale.

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Like finding a good property manager to help you with administrative tasks like rent collection, coordinating repairs, etc., finding your go-to handymen and contractors for maintenance and repairs, and things like that.

And so once you’re in a groove and you can actually build out a portfolio of these properties, it can help you actually achieve financial independence in a very tangible way.

3. Hard Money Lending

Third way to invest in real estate, which I actually alluded to just a moment ago, is that you can get into hard money lending or private lending yourself.

This is where you are the bank.

So you loan money to other real estate investors, like fix and flippers.

Usually on a short term basis, you’d loan, say, 60%-70% of the value of the home, your LTV ratio, and you would take a first position lien against the property.

Then the flipper or the sponsor would secure the other 30%-40% either from their own cash reserves or from other sources.

And the loan would be paid back over the course of 6-24 months, depending on the terms that you set.

You’d charge a pretty high interest rate for this, likely in the ballpark of 10%-14% annually because of the risky and illiquid nature of the investment.

And the loan would be due in 6-24 months, depending on the nature of how you structure the deal.

So viewed one way, it’s a risky deal. But if you know what you’re doing and you structure it the right way, and you actually diligence the investment property and location, you can really minimize your risk since you’re secured by the property itself in a first position lien.

And you should have enough cushion, given the relatively low LTV at 60%-70%, to be insulated from loss.

The rehabber then fixes up the property, thereby increasing its value, and maybe now it’s worth 30%-50% more than what he bought it for.

And then the rehabber either sells the property and pays back your loan and pockets the difference, or they rent it out, get a bank loan to refinance, and pays you back your loan plus interest.

So done with diligence, this can be quite lucrative. It can certainly earn you more than you’d typically get in the stock market.

But to do it well and to have consistent deal flow where you could deploy capital, you need to build relationships with a network of fix and flippers who are in need of money, who you also trust with your money to do a good job and to make a return on your investment.

And you can do that through local real estate investing groups or networks that you build with other investors through your own real estate investing or through contractors or something like that.

But it does take legwork and hustle to build up that network where you have a list of go-to investors who need hard money loans, that you trust and they also trust you.

You should also be aware that this form of real estate investing does not come with as many wealth building opportunities as direct real estate investing.

And that’s because the four ways that you make money with direct real estate investing that I spoke about earlier (cash flow, appreciation, mortgage paydown, and depreciation tax shield), those things are not available to you as a hard money lender.

You only make money on the interest you earn from your loan.

There’s no rent you collect.

There’s no appreciation you benefit from because you don’t actually own the property, unless the rehabber or fix and flipper fails the transaction and then you foreclose on the property.

There’s no mortgage paydown, equity expansion, and there’s no depreciation tax shield.

There’s just the interest you collect on your loans.

So that’s something to be aware of if you are going to be the debt lender.

4. Crowdfunding

Fourth way to invest in real estate is through crowdfunding platforms like RealtyMogul or Fundrise or CrowdStreet. These are all examples of crowdfunding websites.

I’m not necessarily endorsing any of them. I have no financial relationship or arrangement with any of them. And they don’t, among themselves, even have exactly the same business models.

But essentially, how they work is you go to their website, you sign up, you invest some amount of money into your account with them, and they then go and use that money to invest in real estate.

Hopefully, that real estate then produces a return through appreciation and rental income, which is paid as a periodic dividend to you, usually quarterly.

And then a few years later, you get your money back, plus capital gain returns on top, plus whatever rental dividends you collected along the way.

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And your IRR, your internal rate of return through the entire holding period from all your cash returns combined versus your cash outlay, should be in the range of 11%-15% or so.

It will vary significantly on what the underlying assets are, of course, and how they perform and how much the fees are that are charged by the crowdfunding website. But that’s essentially the business model.

So that was a really high level simplification of how real estate crowdfunding works, but it was just to give you a big picture idea.

If you want to double click one level down, you’ll see that the investment structures for these crowdfunding sites can come in a couple of different types.

One type is essentially a REIT, a real estate investment trust. And this is where you invest into an investment fund, just like you’d invest into a mutual fund.

So you’re not investing in the real estate itself, in other words. You’re buying into a fund. And that fund will go and acquire real estate, either acquiring entire assets or investing as a percentage shareholder in large assets.

Someone else will usually manage or operate the asset, like a property manager or an asset manager.

And the fund usually will not actually operate the asset themselves because there will be a lot of them and a single fund may hold hundreds or even thousands of properties in their portfolio, and the fund managers are not going to be operating all of those.

But they will either supervise the asset manager or have voting control as a shareholder of those assets. And they can invest in or liquidate the assets, just like a mutual fund can invest in or liquidate stock holdings.

The fund itself will have a share price, which should equal their NAV or net asset value, which is just their total assets minus their total liabilities divided by the number of shares outstanding.

So in this regard, it operates very similar to a real estate investment trust.

The other type of investment structure these crowdfunding platforms use is essentially a limited partnership structure.

And this is typically only going to be accessible to so-called accredited investors, which simply means that your annual income is greater than about $200,000 if you’re single, or $300,000 if you’re married, or you have at least a million dollars net worth, not counting your primary residence.

If you satisfy either of those criteria, then you can be deemed an accredited investor and you can access this second type of investment structure on these crowdfunding platforms, which is where you’d invest directly in the physical real estate asset as a limited partner.

Now, the sponsor of the investment would be the general partner and would acquire the property, manage and operate it, and would issue periodic dividends for net rental income.

And then upon exiting the property, they would give you a percentage share of the distributions that is proportional to your percentage ownership in the capitalization table or cap table.

This functions a lot like private equity, except that the asset you’re buying is not a company. It’s just physical real estate.

And the structure is also different from the first type of structure I mentioned where you’re investing in a REIT, which is a fund, and that fund then goes and invests in properties but doesn’t actually manage them.

Here, with this limited partnership type of structure, you’re investing directly with the sponsor as a limited partner.

And that means there’s probably less liquidity because there’s no NAV or net asset value as such, and you really do have to wait until the property is exited to have a liquidity event.

There’s also less diversification because there’s probably fewer properties your money is spread across.

You probably have to do more careful due diligence then to really understand the property economics for every single property that your money is going to be invested in.

The plan for operational improvements that the sponsor or the general partner is proposing and what the path of progress for the local neighborhood or community will most likely be, whether the demographics and economics of the area are favorable, etc. All these things.

But if you analyze rigorously and you bet right and the sponsor is good, you can often earn a bigger return on this type of structure because the sponsor may be very skilled in extracting value from the asset.

That being said, you are also taking on more risk because you’re concentrating more money into a single property or a handful of properties.

And if something goes badly on one of them, it can really hurt your overall return.

So that’s why you have to be very careful and why this second type of structure tends to only be open to accredited investors.

But also why there’s more return potential too.

5. Syndication

The fifth way to invest in real estate is by joining real estate investment syndications directly.

This is just like the limited partnership structure that is offered by crowdfunding platforms to accredited investors.

But instead of doing it through a crowdfunding website, you would have a direct relationship with a real estate investor or sponsor, which you would then do the exact same thing by investing directly with these sponsors without having to even go through any kind of crowdfunding website and paying their administrative fees.

A real estate sponsor, in this way, works very similarly as the limited partnership structure you see on the crowdfunding websites.

They raise money from private limited partners like accredited investors. Then they act as a general partner to go identify, acquire, rehab, rent, manage, and eventually exit those real estate investments, usually large multifamily properties.

The only real difference here is that you’re not going through a crowdfunding website and you probably actually know the real estate sponsor, the general partner personally.

You have a personal relationship with them, and you trust them. And maybe you were introduced them through a trusted business contact or something like that.

Whereas on the crowdfunding websites, you probably don’t know the sponsor directly and you’re just making investment decisions based on the offering documents and marketing materials that they have uploaded to the website.

So you’re really just investing based on what you believe their past track record is and what their business plan is for the new real estate investment opportunity.

Whereas when you invest directly with the sponsor, you probably know them personally and you are factoring in what you know about them personally into your investment decision.

For example, aside from their track record, you may know from your personal interactions with them that the sponsor has strong relationships with the local zoning board or local city council members or local developers or what not.

You’re basically factoring in additional considerations besides just their past track record.

6. Start Your Own Syndication

A sixth way to invest in real estate (it’s related to syndication partnerships, as we’ve been discussing) is that you can start your own investment partnership.

There’s no reason you can’t start your own real estate investment syndicate yourself.

That means you are the fund manager and it’s your job to go find, close, and turn around real estate properties.

So you go raise money from other limited partners.

You coordinate the road shows, the fundraising, the prospecting, the diligence, the acquisitions, the operations, the asset management, and the dispositions of the real estate assets in the portfolio.

And in return for your troubles, you usually get paid a management fee, which is a percentage of the assets under management.

And you also get a portion of what’s called carried interest above and beyond some high watermark investment return that you’re usually guarantee to your limited partners.

So all of that is a lot of work.

It’s definitely not a hobby, not a side hustle type of job.

And you can’t really do that type of work, at least in a serious way, in your spare time.

It’s definitely a full time job, and then some, so you have to be really committed to it to do it with any kind of success.

7. Tax Liens

The last way I’ll discuss today for how to invest in real estate is by buying tax liens.

And this is where a homeowner has failed to pay property taxes, the municipality then puts a lien on the property for failure to pay their property taxes, and then the municipality will sometimes auction the lien off to the highest private sector bidder.

So you as an investor would bid in competition with other investors for that lien, and the highest bidder wins.

And that means the highest bidder will pay the municipality the amount of taxes owed plus any interest in penalties, and they pay it right away.

They then turn around and try to collect it from the homeowner.

And if the homeowner doesn’t pay, then the lien holder, the investor in this case, can foreclose on the house, just as the local city government would have been able to do.

The tax lien is secured by the house, so the homeowner cannot sell it or refinance the property without paying off the lien first.

Now, this is definitely not a beginner’s investing strategy because it’s not a liquid market.

You can definitely lose money, especially if the home is worth less than the lien amount or if the home is in bad shape or in a bad part of town.

If you foreclose, you also have to deal with the legal requirements and formalities of evicting the homeowner. You may have to do substantial repairs if they destroy the house on the way out.

And you have to try to sell it or rent it out to a better tenant afterward.

You can definitely make good money by doing tax lien investing. I don’t do it myself, but I know of other people who find it a lucrative strategy. But it’s not without risk, and you can definitely lose money if you don’t know what you’re doing.

It takes diligence and research to do it profitably.

It probably takes less work than owning the property outright because usually if you foreclose, you probably aren’t looking to hold it as a rental. You just want to flip it for cash profit.

And if you know how to do it and your research and analysis are rigorous, you can definitely make outsized returns for the amount of time spent, at least compared to traditional buy and hold real estate investing.

But it’s definitely a niche strategy.

Not a ton of people do it. And you really have to know what you’re doing.

How To Evaluate A Real Estate Deal

So now that we’ve walked through the basics of the different ways you can invest in real estate and get exposure in your portfolio to real estate, let’s talk a little bit about how you actually analyze a real estate opportunity.

And I’ll just talk here about the most common type of real estate investing, which is buy and hold real estate investing, where you buy a physical asset like a residential property.

I’ll just walk through the basics here of how to evaluate a real estate deal as a potential investment.

First, the Numbers

First, I tend to look at the numbers first.

I use a quick spreadsheet valuation tool that I built, which, as I mentioned, I’ve included with this episode as a freebie, which you can get at hackyourwealth.com/28.

I punch in some inputs into that spreadsheet, like the square footage, list price, how much down payment I would likely put down if I purchase the property, a SWAG estimate for renovation costs, an estimate for how much rent I think the property can bring in based on similar rentals I see in the area on sites like Zillow and Craigslist.

I’ll also punch in some mortgage rate and term assumptions, as well as insurance and property tax and maintenance estimates.

Then I look at the statistics output of the spreadsheet. And the main statistics I’m paying attention to here are NOI, which is net operating income, and net operating margin.

Net operating income is just gross rent minus all expenses, but before you actually pay any mortgage principal or mortgage interest.

It’s just the pure operating income left over after backing out all operating costs from gross rent.

And the net operating margin is just the NOI divided by gross rent.

I also look at the cash flow and cash flow margin after mortgage servicing or mortgage paydown. So that’s NOI minus mortgage payments.

And I look at it both from the perspective of NOI minus mortgage interest only, which is just the pure cost of the mortgage itself, and NOI minus principal and interest combined.

Even though the principal is technically a return of capital to me, I still look at it both ways because I want to see if I’m actually net cash positive after everything at the end of the day, or if I’m net cash negative.

It would be a really bad thing if I’m net cash negative after only paying mortgage interest.

The rental income should definitely be able to support all the operating expenses plus the mortgage interest and ideally the principal as well.

And really ideally with some additional cash flow left over.

So from here, I then look at the cash on cash return, which is just the net annual cash flow divided by the amount of equity I invested in the property.

And then I also look at the cap rate, which is the annual NOI or net operating income divided by the purchase price. I use net operating income here when looking at the cap rate.

One should use net operating income because the cap rate should be agnostic of whether you took out a mortgage or not.

It should just be looking at the pure performance of the property without any capital structure or debt structure details attached to it.

Finally, I look at the purchase price to gross annual rent ratio. And my rule of thumb here is just that I’m looking to see if it is above or below 20x.

If the purchase price is more than 20x the annual rent that I believe the property would be able to earn, then it’s pretty richly priced.

I probably will not buy that property. It’s probably actually cheaper to rent that.

If it is far under 20x, then it may be a good investment because it seems like the cap rate will be pretty high.

But of course, you need more information. You need information about what kind of neighborhood it’s in, what’s the path of progress for the community.

But just on that heuristic alone, if it’s less than 20x, that’s usually a good sign to do a little bit more digging and investigation.

And if it’s right around 20x, you really have to evaluate those situations case by case.

In a place like California, you’re probably not going to get too far under 20x, if at all.

And in places in the Midwest, it will definitely be much more achievable.

Then you’re looking more at just the community dynamics, the economic and job growth of the community, what the rental market really looks like, etc.

So those are all pretty much the basic statistics you need to determine if the economics makes sense or not.

And as I mentioned earlier in this episode, I literally use this spreadsheet to evaluate every property I’m considering and I can quickly compare different properties side by side in it.

And then for the ones I’m serious about, I will then do a more in-depth financial analysis with a much more complicated financial model that I built, which actually breaks down operating forecast by month and projects for years and years into the future.

But in my real estate financial modeling, I spend almost all my time in just this quick analysis spreadsheet that I just described because it gets me the vast majority of the statistics I need to make a good decision when analyzing real estate deals. And I can generate that analysis within 10 seconds of punching in a few input assumptions.

And again, I’m going to include that as a freebie. hackyourwealth.com/28.

Qualitative Factors

But analyzing numbers is just a first step for evaluating a deal. And I also wanted to look at a bunch of qualitative factors for the property.

Online Research

So here I’m looking for information on websites like Redfin, Zillow, Trulia, Google Maps, even public records, and even in person through property visits.

Now, what I look for on Redfin is a few things.

First thing I look at is the listing remarks from the seller’s agent because I want to see how they’re describing the property.

Then I look at the property details table. So I’m looking at the structure and features of the property, the type of construction, the lot details, the APN number, which is the parcel number, if I want to look up the listing in public records.

I also will pay attention to the price history on Redfin to see when the property was last sold and the times before that, and at what sale price because I want to see the trajectory of the property’s price.

I look at the schools that the property is zoned for to see how good they are, since school quality often drives property prices.

And I also look at the module on Redfin where you can see the number of views and the number of favorites by other users, because that gives me some indication as to how popular the property is by actual users who are at least considering the property and looking at it.

If it’s highly viewed and highly favorited, that might influence me in how fast I move. And if it’s not as much, maybe I have a little bit more time. So that’s why I look at that module.

And finally, I look at the section in Redfin where it shows comparable transactions. It will show recent sales that are in a nearby radius of the property, so I can get a feel for whether the pricing of this property is in line or whether it’s above or below. And I can do some additional digging, depending on what I’d read from the comps analysis.

I will also look at Trulia, another real estate website.

But for me, the only thing that I really try to get from Trulia is the crime heat map. This is a color overlay on top of the map that shows, based on public police records, where there are high or low areas of crime.

Now, if you’re investing in your own neighborhood, you probably don’t need this because you probably just know from living there and driving around where the good parts of town are and the bad parts of town.

But if you’re investing out of state in a community that you’re not super familiar with, this can be directionally helpful in giving you some sense about where are the safe areas and where are the less safe areas.

Inspection

So then comes the in-person inspection.

I recommend doing property inspections for most properties that you will buy, especially if you are in the early stage of your investing career and you don’t have a lot of properties under your belt.

It’s a really good practice and exercise to actually go in person to inspect the property yourself.

It will strengthen your own analysis skills as well as teach you about what to look for when you do a property inspection.

So if I’m local or I plan to be in the area anyway, I will go try to tour the property in person wherever possible.

And if I’m able to access the inside of the property, that’s the best case scenario because I can inspect the interior and start to really estimate renovation costs.

But even if I cannot get inside the property, I’ll at least drive by to check out the exterior of the home and the surrounding neighborhood.

I’ll get a feel for the street, the neighbors.

I’ll even randomly ask people nearby on the street about their experience living in the neighborhood, what they like about it, what they don’t like.

And that gives me a bunch of additional data points about the desirability of living in that neighborhood and in the property itself.

And what I try to do is imagine whether I myself would be willing to live in the property with my family, because that’s usually a good heuristic.

If I’m not willing to live there myself, then why should I expect someone else like me, who I believe will be a good tenant, to live there themselves?

If I’m not comfortable there, then I shouldn’t expect that somebody like me will be comfortable there.

So that’s what really ultimately I’m trying to gauge when I walk the property and walk the neighborhood around it.

48:38

So before we close, I wanted to just remind you to grab the two freebies for this episode.

One, my real estate valuation spreadsheet that I use for quickly analyzing and comparing properties. You get results in 10 seconds of putting in inputs.

And second, my video walkthrough of how to actually do an initial evaluation of a property, where I show you the exact process I use to vet a new property using Redfin and Google Maps.

If you like this episode, please hit that Subscribe button to get new episodes automatically sent to you.

I would love for you to not miss any episodes because the Hack Your Wealth Podcast has a mix of solo shows where I walk you through strategies and tactics step by step, like this one, as well as guests who share their expertise about specific areas of personal finance.

And finally, profile interviews of business owners who are trying to turn their side hustles into financially self-sustaining passive income streams.

So be sure to hit that Subscribe button so you don’t miss any of that great content.

That’s it for this week. Thanks for tuning in, and we will see you next time.

Related: be sure to also check out our series of posts on house hacking!

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