Investing in real estate has long been the dream of many an American. One glance at the schedule on HGTV will yield 24 hours’ worth of half-hour segments devoted to this very concept. Fixer-uppers, tear downs, demo day, it’s all very exciting to watch. However, the average American knows little about what real estate investing is really about: building wealth with equity.
Buying the house is just the first step in your real estate investing approach. When you first buy a house, whatever amount you put down on your mortgage is the equity you have in the home. So if you put 20% down, as your parents probably instructed you to do, you begin with that 20% in equity. Some people are able to get a mortgage with a smaller percentage, such as 7% or 10%, but 20% is still the gold standard.
Growing equity is the name of the game in turning that initial investment into real wealth. Some lucky people buy at just the right moment in just the right market. Anyone who bought a house in San Francisco in the 70s can safely say they are a millionaire, given that the average home value in that city is now over $1.6 million. The land alone can be worth more than the house, which is why you see a lot of brand new construction on 100-year-old lots.
Not all of us can be in that exact right moment at that exact right time, so smart real estate investing takes some research and critical thinking. That cheap bungalow in the flood zone? There may be a reason why it’s so cheap. There are plenty of books and websites that can teach you about real estate investing, but in order to build wealth with equity, you can start by following these guidelines.
Buying and holding your home for a number of years allows the value to appreciate over time. As with San Francisco, certain cities are growing rapidly, and are therefore popular places to buy and hold. If the average home price increases from $100,000 to $150,000, your 20% equity has increased from $20,000 to $30,000 without you having to lift a finger.
Given that most homeowners carry a mortgage, the equity calculation gets a little more complicated. As you pay down your mortgage, your percent of ownership goes up. As the house appreciates that means your equity grows too.
So, for example, you are paying your mortgage payments on an $80,000 loan, but the person buying next door needs to come up with a higher down payment ($30,000) and pay a mortgage on a higher loan amount ($150,000). You bought at the right time!
Homes are a lot of work to keep up, so just sitting tight and waiting for appreciation to increase the value of your house is not enough to build wealth.
This is where HGTV gets all of its ardent viewers. Knocking out an old kitchen looks really fun with swinging sledgehammers and picking pretty tile. It’s a little more complicated than that, but investments such as these can really add to the value of your home.
What many people don’t realize going in, however, is that all aspects of the home will need improving over time. Things like dry rot, mold and termites are not as exciting as kitchen tile, but they absolutely need to be kept in mind when considering your equity. Staying on top of these potentially costly conditions may mean spending some money, but in the long run, a well-kept home will naturally have a higher market value.
Another way to build equity in your real estate investment is to pay more than is owed on your monthly mortgage payment. You can opt to make payments more frequently, such as every other week, or you can put large chunks of money against the principal balance owed. Many people will use their annual bonus or tax return to pay down the principal balance and thus build more equity that way.
If you can afford it from the outset, you can also take a shorter term loan, such as a 15-year vs. a 30-year mortgage. Your monthly payments will be higher, but you will achieve 100% home ownership in half the time.
A Note on Risk
The most important thing to remember when considering real estate investing as a way to build wealth is how much risk you are willing to take on in order to achieve this goal. You know the saying, “No risk, no reward.” Well, the bungalow in the flood zone is probably too much risk, but other homes may be worth it if you do your homework.
In 2006, people began to buy houses willy nilly because it seemed that there was nowhere to go but up, given rising home prices across the nation. So many people went under because they thought real estate investing was easy: just buy, hold for a few months, and flip. While this worked for a little while, as we all know, the bubble burst and many people lost everything.
Sensible risk, in this case, involves researching the city you are looking to invest in. Where are the most expensive areas? Usually nearby will be areas that are up and coming, with lower cost homes that may need a little work. Proximity to schools and commercial areas is also an important consideration.
Looking at economic patterns is also important. Is Google building a big complex in the neighborhood? Likely the value of your real estate investment will rise given that fact. Where are the jobs? How bad is the commute? A solid list of pros and cons can’t go wrong when making this kind of momentous decision.
Real estate investing can be a very worthwhile pursuit if you have even just a small amount to start with. If you do your research, you should be able to find a home that will grow in value and bring you wealth through equity.