Have some money set aside and wondering how to best use it to start investing in real estate?
Maybe you’ve been scrimping and saving, or maybe you inherited some cash. Or perhaps you’re a rare lottery winner who didn’t go broke within a few years. You know that if it just languishes in a savings account, it will lose money to inflation every year. So it’s time to dress that money in overalls and put it to work for you!
How much is a “lump sum,” you ask? For the sake of argument, let’s say $150,000, but don’t get hung up on that number. You don’t need exactly $150,000 for this strategy to work. Maybe you have $15,000 put aside or perhaps a cool quarter million; that’s not really the point.
Think of this strategy as a broad-stroke approach on how to start investing in income-producing real estate with some cash in the bank, some discipline in your budgeting, and serious ambitions for passive income.
Phase #1: Start by house hacking.
House hacking is an excellent way to get your feet wet with investing and multifamily properties. You can use residential, owner-occupied financing for up to a 4-unit building, which means low interest rates and low down payments using conventional, FHA, or VA financing.
Speaking of down payments: Don’t blow your cash reserve on this purchase. Put only the minimum amount down—you’ll need a lot more cash for your next two deals. Take advantage of the low down payment requirement, and keep your cash for now.
Your new home’s rental income should cover your mortgage (no housing payment!) and ideally provide some positive cash flow to boot. The average person would just spend all that extra money they’re saving by not having a housing payment—a new ride, dinners out, new clothes, etc.
You’re not going to do that.
Take every penny that you’re saving by not having a housing payment and funnel it right in with your other savings. Heck, live on half your income, and really accelerate your savings!
Over the next 12 months, while you’re saving money like a champ, you’re going to gain experience managing rental properties. You’re going to practice filling vacancies, screening tenants, reading up on rental investing. You’re going to learn how to calculate cap rates, how to budget for CapEx, how to accurately predict rental property expenses.
In addition, you’re going to talk to lenders about investment property loans. You’re about to need one.
Phase #2: Buy another 3-4 unit multifamily.
By now, you should have developed some confidence that you can manage a small multifamily property. After all, you’ve been doing it for a year and taking every opportunity to learn even more.
It’s high time to double up and buy another one!
At this point, you have a choice. You can borrow an investment loan for this next property. Typically, investment loans require 20% down.
Alternatively, you can borrow another owner-occupied loan and move into the new property. Keep in mind, you usually can’t have two FHA loans simultaneously, so if you went FHA the first time around, you’ll need to either go conventional this time or refinance your prior FHA loan.
Once again, don’t allow any lifestyle inflation! You should be earning substantial income from your two multifamily properties now, but don’t spend a cent of it. It should go back into your investment fund because next time around, you’re going to need a lot more cash.
Your friends and family may be increasingly interested at this point about what you’re doing. Whenever they ask you about what you’re up to, tell them about your success with multifamily properties. If they express enthusiasm, tell them to let you know if they’re interested in investing funds when you buy your next multifamily property.
Give yourself another 12 months to acclimate to managing two multifamily buildings and set aside more cash. Keep devouring as much information as you can, particularly about investing in apartment buildings.
Start reaching out to commercial lenders. Your next loan will be a commercial loan, and the rules are different.
Phase #3: Buy an apartment building.
Start looking for 5-10 unit buildings. Commercial financing varies, but you’ll need a significant down payment. Hope you’ve been disciplined about saving all that rental income you’ve been earning!
Go back to all of your friends and family who expressed an interest in investing with you. Offer them a 7% return on their money, paid in interest payments every month.
Bear in mind that if you raise funding from friends and family, it’s an enormous responsibility. No matter what happens, you must pay that money back or you endanger the most important relationships in your life. Not everyone is comfortable with this responsibility, so follow your gut.
There is much less competition for multifamily properties with five or more units because they require commercial financing. You’re now competing with only serious real estate investors, not every Tom, Dick and Harry. While that might sound scary, it actually means you’ll have far less competition and should earn better yield and cash flow per door.
Managing your own rentals has served you well through this point. It’s taught you valuable lessons about what kinds of properties to buy, what kinds of renters and neighborhoods you want to work with, and countless other experience that will inform your future investments. Although you’ve been able to manage your properties on the side of your full-time job until now, it may be time to consider hiring a property manager.
After all, you now probably manage more than 10 units! Welcome to the big leagues.
To Infinity and Beyond
You’ve probably chewed through your initial savings (and then some), but you should now have significant income from your three multifamily buildings—what will you do with it?
One option is quitting your day job, maybe to invest in real estate full-time. Or not; you could go lie on a beach, volunteer, or take a low-pay, high-reward job with a cause.
But you don’t have to quit your day job. You could keep working while expanding your real estate portfolio. At this point, you’ve taken your initial savings and turned it into 10-20 rental units and some great passive income. The sky’s the limit!
Whatever you choose to do, think in terms of your long-term goals. What does your perfect life look like? Describe it in detail, on paper. Then work your way backwards from there. How much income do you need? What will it take for you to get there?
The less money you can be satisfied living on, the sooner you’ll achieve financial independence. But there are no wrong answers, as long as you’re actively moving toward your perfect life.
Have some other ideas about what you would do if someone handed you a check for $150,000? What kinds of goals are you aiming for with real estate investments?
Like we said, no wrong answers!