Real estate ownership is the most critical driver of wealth creation in America. In fact, homeowners have 80 times the median net worth of renters. Home ownership is one thing but owning investment property sets you down a path of financial freedom. That’s why it’s no surprise that many people will be looking to start investing in real estate in 2021.
Most people view real estate investing as buying rentals or a fixer-upper to sell. While these are common approaches, they may present challenges for new investors. Luckily, there are lesser-known strategies to invest in real estate that serve novice and expert investors. Whether you have no experience or you are scaling a portfolio, consider how these strategies can help you start or scale your investments.
House-Hack
The first wealth-building secret strategy is to live in a 1-4 unit residential home and rent out the other units or rooms. If you are currently renting, this should be the No.1 strategy you explore. This approach has been popularized here on BiggerPockets, where it was coined as a “house-hack” by the community. In many instances, you can live rent-free as other residents pay down the mortgage and expenses.
The strategy is particularly popular with 2-4 units as you can have your own apartment and rent out the other units. These properties qualify for an FHA loan, where the required down payment is only 3.5% of the purchase price. Using this approach, you could buy a $200,000 property with a downpayment of just $7,000!
I used this strategy when I bought my first investment property, a 2-unit in Chicago. I lived upstairs and rented out the first floor. The first-floor resident covered most of my mortgage payment. I reduced my amount to less than I was previously paying in rent. This allowed me to save more money and create equity at the same time. I know dozens of people who have used the same strategy because it is such a powerful, efficient, and ideal way to acquire your first property.
1031 Exchange
A 1031 exchange allows you to roll your equity from an investment property into a similar investment while deferring capital gains. Think of it like Monopoly, where you trade up from houses to a hotel. In this case, you can exchange a property, allowing you to scale a portfolio, all while delaying the capital gains tax. The best part is that you can do this until you die. At that time, when your heirs inherit the property, they are given a new cost basis, which just means the capital gain is reset to zero. The bottom line is they will not have to pay any capital gains tax that you deferred, even if they decide to sell at that time.
Here’s an example: let’s say you buy an investment property for $400,000. In five years, you exchange it–not sell, but exchange–for $700,000 and acquire a new asset for equal or greater value. Instead of paying the capital gains tax on the $300,000 in profit, you defer the tax hit until a sale is realized. You can keep exchanging the property and rolling over the equity indefinitely. If and when you sell, you will pay the full capital gains tax. However, if you never sell and instead leave the property to your heirs, they will not have to pay the deferred capital gains tax.
This strategy is so strong at preserving wealth that it became a point of contention on the presidential campaign trail. Investors argue that this enables them to continue re-investing into properties and communities where there is little incentive to do so otherwise. It also encourages more transactions, welcomes new investors, and generates business for brokerage firms, architects, civil engineers, insurers, inspectors, and more. Either way, it incentivizes investors to trade up and create tax-deferred wealth in the process.
Note Investing
There are ways to invest in real estate without actually buying physical property. One advanced strategy is to purchase existing mortgages, known as note investing. Note investors purchase loans from lenders and then notify borrowers that they are the new loan holder. Now, instead of the borrower paying their monthly mortgage to the traditional bank, they make the payment to the investor.
On mortgage notes, one of the driving factors determining value is the payment status of the loan. A performing note is where payments from the borrower are current. All you have to do is send out invoices and collect the monthly payments. People refer to this as “mailbox money” for its simplicity and ease. However, non-performing notes are loans where the borrower has stopped making payments. Investors who buy non-performing notes hope to incentivize borrowers to get back to making payments, usually through a loan modification. These tend to require more work and patience but allow you to make money while helping a borrower stay in their home.
In addition, you can begin note investing with less than $5,000. However, the costs vary widely based on if you are the primary mortgage lender, holding a line of credit, or carrying a second mortgage. Lastly, make sure you understand the local governance around foreclosures. Judicial and non-judicial states have different laws and processes that must be followed.
Bonus Depreciation
Real estate has excellent tax benefits that supersede other investment vehicles. One of the core advantages comes from depreciation. This allows you to deduct the value of a property over time based on the fact that the property is getting older and losing value as it ages. However, typically properties go up in value, creating an excellent tax advantage.
Bonus depreciation allows you to accelerate the depreciation time frame for eligible elements instead of writing them off over their normal useful life. This applies to all the mechanicals, fixtures, appliances, etc. Instead of depreciating an item over the course of 15 years, you get to take it all in the first year. This allows investors to create more initial cash flow to spend or invest in other ways. This strategy works best on commercial real estate properties where an engineering study, known as cost segregation, can be performed to determine the remaining life expectancy of each component.
Apartment Syndication
Wealthy people have invested in apartments for decades, but did you know that everyday people invest in large apartments and get the same great benefits? You do not need to be a multi-millionaire to invest in large apartments. In fact, we partner with regular people to pool money together to acquire larger properties. This process is known as syndication.
Syndications allow qualifying participants to invest alongside others to acquire and own a property, like an apartment community. Casmon Capital and other private groups buy these properties and invite private investors in their network to participate in the investment. Most investments are issued through private offerings, so you will need to join a group’s investor list. The general partnership team handles all aspects of inspections, loan approval, and managing operations. You just need to review the opportunity, decide to invest, and collect distributions. The best part is that you get all the benefits of owning real estate without the headaches of being a landlord. This includes cash flow distributions, equity upside, and bonus depreciation.
Implementing the Strategies
These five strategies are not all-inclusive but help everyday people create and preserve wealth through real estate. They also show that you do not have to become a landlord or flipper to create wealth for your family. If you are starting out, consider house-hacking or note investing. You can get started in both of these strategies for as little as $5,000. If you own real estate take advantage of bonus depreciation. Be sure to consider a 1031 exchange instead of selling when you are ready to exit. If you are looking to earn passive income while diversifying your portfolio and reducing your tax liability, consider investing in apartment syndications. These investments qualify for self-directed retirement funds. Minimum investments are usually $50,000 with some being as low as $25,000 and others starting at $100,000.
As you look to invest in real estate in 2021, consider these alternative strategies to maximize your results. You already know that real estate serves as the most powerful driver of wealth, delivering cash flow, appreciation, and tremendous tax advantages. Using these secret strategies will position you and your family for success in 2021 and beyond. If you are looking to get started investing in real estate, check out our Target Market Insights podcast.
