Real Estate For Complete Beginners (Must Watch)

Have you ever heard of the direct capitalization technique? If you haven't, then you have no business ever investing in real estate. Lucky for you, I'm going to explain it in detail in this video. But the first thing I want you to understand about investing in real estate is that real estate actually is not an investment at all. It's actually more like a job. So forget about the idea that investing in real estate will give you passive income. That is a pipe dream from social media fake gurus who don't know what they're talking about, or they're just being deliberately misleading. Now, it is true that if you are able to invest in single tenant, triple net leased properties, that you will produce passive income. However, in this video, I'm not going to talk about those types of properties because most people watching this will not be able to afford that type of real estate. But just so we are clear, what I mean by single tenant, triple net leased properties are properties like a Chick-fil-A, Walgreens, CVS, or Dollar General. These are single tenant properties on long-term lease agreements to national tenants that have high credit rating. With these types of lease agreements, the owner of the real estate literally pays no expenses at all. So basically it's like owning a bond where you enjoy a risk-free cash flow. But the bottom line is this, the overwhelming majority of people watching this video and on YouTube will not have the funds or the sophistication to invest in this type of real estate. So when I talk about investing in real estate in this video, we're going to stick to owning multifamily residential real estate. That means apartment buildings. I also want to talk you out of doing fix and flip type schemes. This involves buying a rundown property, renovating it as quickly as possible, and then selling it for profit. Again, this is a pipe dream of many social media gurus. There are many issues with this approach. First, there is a lot of competition to find really good deals. Second, by the time you invest the money to renovate the property, then incur the selling expenses to sell the property, combined with short-term capital gains tax, you really aren't going to make that much money at all. You would probably make better money as a freelancer on Upwork and without all the headaches and risk of owning real estate. All the people I have known who have become wealthy from investing in real estate, and I know a lot of these people, is because they adopted a buy and hold strategy. But how do you evaluate a potential real estate investment to decide if it's a good buy or not? Well, the first thing you need to do is to decide how much your mortgage payment will be per year and per month, which is brain dead simple because there are a million mortgage calculators online for you to run the numbers. Next, you need to determine how much the real estate taxes are on a monthly and annual basis, which is also dead simple because the amount of real estate taxes is publicly available information and you just take the annual real estate tax and divide it by 12 to get the monthly tax. Then, you have to determine how much it will cost for your insurance on an annual basis, which is also something that a child could do by simply reaching out to an insurance agent. Those are all the components of your monthly expenses that you need to determine right away, and it is known by the acronym of PITI, which stands for principal interest taxes and insurance. Let's say you add all that together and you get a PITI expense of $50,000 per year. Then, you want to apply what is known as the direct capitalization technique. Right here is an example of the direct capitalization model. This is for a hypothetical five-unit apartment building. The first thing you will have to determine is the potential gross rent that a property can generate. In this case, it's $100,000. This is simply the gross rent that the property can generate. Then, you have to take out an allocation for vacancy and collection loss, and in many markets, a reasonable allocation will be 5%. However, be warned that you will have to do some research in your own particular location to find out what a reasonable estimate of vacancy and collection loss should be. But this is very easy to do by simply getting on the phone and talking to a few real estate agents or real estate appraisers in your market. Next, you have to deduct the annual expenses for the property. This includes everything from real estate taxes all the way down to a reasonable estimate of a management fee. In this example, you can see that in the far right column, the IREM survey is used as a benchmark to determine expenses on a per-unit basis. This survey is put out by a group known as the Institute of Real Estate Management, and you can spend a couple hundred bucks to get their expense data. It is worth it so you know what you're buying and if you can really afford it. So you can see in this example that the property can generate about $60,000 per year in what is called net operating income. What is important to remember is that net operating income is before you deduct your annual mortgage payment. So this is where that dead simple mortgage calculator plays an important role. You need to apply this financial model, determine your net operating income, and then compare that with your annual mortgage payment. If your annual mortgage payment is below the net operating income, then it is validated as an investment for you. But you want to make sure that you're not cutting this too close. History is filled with real estate investors who went into bankruptcy because they played things a little bit too close. But most importantly, realize that when you buy a property such as an apartment building, you are buying a job and not an investment. You will have tenants calling you frequently in order to take care of things. Even if you hire a that management company will not be able to handle everything and you will have to be involved.