As an investor just starting out, knowing where to begin can get a little confusing. You know you have the money and time, but what is the most effective way to leverage it? There are 4 strategies for entering the market and which you choose will depend on you: what are your long-term goals, what are your short-term limitations, how skilled are you in different areas, and what kind of (and how many) resources do you have? We break down the 4 most popular investment strategies below so you have a better idea of which plan might be right for you.
The Lipstick Flip
Thanks to popular T.V. shows, most people think of flipping as buying a run-down home, breathing new life into it (thanks to a decent amount of time, labor, and cost) and selling it for a much higher price. Not everyone has the time, finances, or crew to accomplish that. When you are just getting started choosing to flip a house that needs only minimal updates to sell can be a good foot in the door. Though not as profitable, it is a shorter turnaround and has less hassle.
It is important that you don’t just jump in without proper planning - it takes more than financing to accomplish a Lipstick Flip. You’ll want to do research into the real estate market in your area, build relationships with title companies, contractors and real estate agents, and have a good idea of what kinds of fixes are quick, easy, and inexpensive versus those that will take a larger investment of time and money. You’ll need to be pretty good at estimating cost of improvement by looking at the property in order to know just how much it will cost and to craft your offer. You need access to MLS listings and to have a knowledge of any real estate laws the property is subject to.
For financing, you don’t just need the down payment and pre-approval. You need to be able to pay for the improvements up front, as well as have enough cash on hand to cover owning and maintaining the property for at least 6 months. If you aren’t able to flip the property as soon as you’d like, it’ll cost more than the mortgage amount to keep the home ready for sale. You need to consider cleaning, lawn care, utilities and other aspects of upkeep.
When searching for a home to purchase, look for properties that don’t look good but are structurally sound. That won’t sell for market value without repair, but that don’t need heavy work done. Some examples of things to look for:
- Yard has not been cared for
- Weeds, overgrown grass, dead plants, and poor landscaping can all be fixed relatively cheaply and vastly increase the home’s curb appeal and value.
- Broken fence or stained siding
- You don’t want a massive undertaking like a bad roof, but dirty siding that needs a strong powerwash and/or repaint, and a fence that needs some repair or stain refresh are areas where you get a lot of return for your investment.
- Stained or worn flooring
- The state of the floor adds, or detracts, a great deal to the overall look and feel of the home. Look for houses with worn, stained, or discolored carpet or wood floors that are scratched or stained.
- Holes in the sheetrock
- Again, you don’t want severe structural damage. But a few holes that can be patched, or require just one or two areas to be replaced, is a great way to add value to the home.
- Paint or hardware that can be replaced
- Fresh paint, new fixtures, and new hardware does wonders for updating a home. Look for tarnished or broken fixtures and hardware or walls with ripped paper or damaged paint.
To calculate your offer price, multiply the value of the home after repairs by 70%, then subtract the cost of repairs. When calculating how much profit you’ll make, don’t forget to factor in closing costs and what will be spent on holding the property while it is upgraded and on the market. With an average timeline of around 45 days, Lipstick Flips are a great way to make a reasonable profit in a short time.
Buy & Hold
While the profit comes from resale when flipping a house, with the Buy & Hold method you make your money off renting the property. You can do this with a single property, or buy multiple properties you manage as rentals (if you have the funds for multiple down payments). This strategy allows you to have regular income flowing monthly rather than relying on repeated sales to generate profit.
The right type of financing is key with the Buy & Hold method, as you need to rent out the property for more than what you are spending on it each month in order to generate profit. Before deciding on this method, research rent amounts for your area and make sure you could secure financing that puts the mortgage below what you can rent the house out for. You will also likely need an LLC/business entity to set up as the property management company handling the renters, especially if you plan on having more than one property.
You want to search for homes already in good condition so you aren’t spending money on hefty repairs. It is important to build relationships within the community so you have leads for homes on the market coming to you, as well as people looking to rent. You also need the time to manage the property (or properties) - as a landlord you are responsible for meeting the needs of your tenants. If you don’t have time, you’ll need to hire a property manager, which is another monthly cost to consider when setting the rent. You’ll also need to keep funds available to make repairs or updates as needed to the rental properties.
To determine the profit you’d make, take the monthly rent and subtract the monthly operating costs (mortgage, cost of property manager if necessary, taxes, insurance, etc.). Take that amount and multiply by 12 to determine your yearly income. You can use the monthly amount to determine when you will be in the black after closing costs and down payments as well.
This process involves contract assignment. Here you basically act as a middleman and get paid a fee when the sale closes. With wholesale you find a house being sold significantly below market value. You go under contract at an agreed upon price, then find a willing buyer at a slightly higher price and you make the difference in profit. This is a great way to get fast cash without a hefty upfront investment, but it needs to be handled properly, and likely include a lawyer, to make sure there are no legal ramifications from the transaction.
The first step is to find a very motivated seller. This means someone who needs to sell. Someone that has a deadline for being out of their house and has to get it off the market as soon as possible. People who want to sell have less of a sense of urgency - they can wait for the best deal. People who need to sell are motivated to get what they can and get out. You also want to look for properties that are not in great shape and need repair, as your primary market for another buyer is going to be other investors looking to flip.
The next step is going under contract. This is the part you want a lawyer to review, because certain terminology regarding assignment needs to be included. Without this verbiage, you cannot assign the contract to the new buyer. Once you are sure the title is clear and the contract is signed, you find a new buyer to purchase the property at a higher price than your offer to the seller. For example, if you offered the seller $75,000, you’d find a buyer willing to pay $80,000. You would then assign the contract to the new buyer. At closing, the seller gets the $75,000 you promised, and you get the $5,000 difference between that price and the price the new buyer agreed to.
This method requires a great deal of knowledge before getting started. You need to have a good way of identifying highly motivated sellers. You need to have a good network to find buyers to assign the contract to. You need to have a lawyer you trust review the contract to make sure the verbiage is correct and legally binding. It also takes a bit more backbone and confidence than other methods, as some sellers are going to be upset when they see that clause and discover that you aren’t looking to buy but act, in essence, as an intermediary.
The max profit from Wholesale contract assignment is generally $5,000 - you don’t want to go over that in most cases. Usually taking about 20 days, the Wholesale method is a way to get quick profits with minimal risks.
Buy, Renovate, Rent, Refinance, Repeat
Similar to the Buy & Hold method, the BRRR&R strategy is a way to create an ongoing revenue stream through rentals. With this method, the 1st rental property provides the down payment for the next property, and so on, until you are happy with the amount you have to manage and create revenue. This is a multistep strategy that creates a recurring revenue stream rather than one lump sum of profit.
Financing is key with this strategy, as you need to make sure you are getting the property at the right number. This is to ensure that you can cash out and remain profitable from the rental income. Before you begin the process you need to make sure you have the funds for downpayment and closing, any needed repairs, marketing the property as a rental, and ongoing monthly fees until the property is rented.
You need to choose the right property as well. Look for homes that meet these criteria:
- Properties in gentrifying areas
- Look for properties that are in areas that are seeing active renovation. This means you can get the house at a lower cost than it will be valued at after repair and have a wider pool of possible renters
- Minor cosmetic repair needs
- This isn’t a flip situation, so you don’t want to put too much into renovating the house. Look for properties that only need minor cosmetic repairs such as new flooring, new paint, or updated hardware/fixtures.
- Properties where home values are increasing quickly
- Look for properties in areas where home prices are rising at rates higher than previous years. This will allow you to set a more profitable rental rate.
Once you have purchased the property, perform any needed repairs and then secure renters. It is a good idea to build up a network to help you find renters, especially if you plan on purchasing multiple properties to rent out. You’ll also want to research best practices for marketing to renters, and have a budget for that up front. Don’t forget that renters means property management. If you don’t have the time to manage the property yourself, you will need to hire someone to manage it for you. That needs to be considered when setting the cost of rent.
To determine the profit you’d make, take the monthly rent and subtract the monthly operating costs (mortgage, cost of property manager if necessary, taxes, insurance, etc.). Take that amount and multiply by 12 to determine your yearly income.
With this method, once the home has earned some equity, you refinance and use that cash as a downpayment on another property you plan to rent out. Repeat the above process - find a property, purchase it (using the cash out from the first property for downpayment and closing), make any needed repairs, and rent it out. You can repeat it again and again, as long as the refinance rates don’t raise the monthly costs above the monthly rents. The idea is to have multiple properties providing recurring income via renters.
Becoming a real estate investor takes research and planning, but can be very profitable when you find the strategy that works best for your finances and skill level. Some investors find one method and perfect it, others prefer to use multiple methods, choosing the strategy that best fits the property and current market.
Here's a useful infographic from Offer Climb Houston on 4 Real Estate Investment Strategies for New Investors.
Adam founder of Offer Climb, with locations in Houston and Phoenix. With his co-founder Corey, they are driven towards finding the best deals.