Unlocking The Door To Real Estate: A Guide To Using $40K For Your First Investment Home

If you're looking to use your $40,000 to buy an investment home, there are a few things to consider. Firstly, determine your risk tolerance, investment timeframe, and overall goal. This will help you decide whether to invest in stocks, exchange-traded funds (ETFs), or other assets.

If you're interested in real estate, you can explore platforms like Fundrise, which allow you to invest in real estate projects with a small amount of capital. Alternatively, you could consider buying an investment property directly. In that case, you'll need to factor in the down payment, closing costs, and renovations in addition to the purchase price.

It's also worth noting that there are other alternative investment options, such as investing in art, wine, or farmland. These can provide diversification and potentially higher returns than traditional investments.

Before making any decisions, be sure to speak with a financial advisor to ensure you're making the right choices for your specific situation.

Investment property vs primary home

When it comes to investing in real estate, there are several options to consider. One can choose to buy an investment property or a primary home. Both options have their advantages and disadvantages, and it is essential to weigh these before making a decision.

Investment Property

Investing in a rental property can be a lucrative option, offering the potential for passive income and building equity. It can also provide access to more capital from lenders and investors. However, it is a high-risk investment that requires a substantial upfront cost for the down payment and any necessary renovations. As a landlord, you will be responsible for repairs, maintenance, and other associated costs, which can be costly and stressful, especially for first-time investors.

Primary Home

On the other hand, buying a primary home offers stability and the opportunity to build equity over time. As a homeowner, your housing costs are locked in, and you are protected from rising rent prices. Additionally, you have the freedom to make the space your own without seeking a landlord's approval. However, homeownership comes with its own set of expenses, including property taxes, repairs, and maintenance. It is also a long-term commitment, and selling the property before the mortgage is paid off may result in financial losses.

Weighing the Options

Both investment properties and primary homes have their benefits and drawbacks. Those seeking to build equity and generate passive income may lean towards investing in rental properties. In contrast, those prioritizing stability, customization, and long-term savings may opt to purchase a primary residence. It is crucial to carefully consider your financial situation, risk tolerance, and long-term goals before making a decision.

BRRR method

The BRRRR method is a real estate investment strategy that can help investors build a portfolio of rental properties. It involves buying distressed properties, renovating them, renting them out, and then refinancing to repeat the process and buy another distressed property. Here's a step-by-step guide to implementing the BRRRR method:

Step 1: Buy a Distressed Property

Look for properties that are priced below market value due to the need for extensive renovations. This lower price point can position you for a greater return on investment in the long term. Calculate the after-repair value (ARV) of the property by comparing it to similar homes in the area in terms of size, number of bedrooms and bathrooms, age, building type, and condition. Use the 70% rule and avoid investing more than 70% of the property's ARV.

Step 2: Rehab the Property

Prioritize renovations that bring the property up to code and ensure it's safe and functional. Also, identify improvements that will boost its value, such as updating the kitchen and bathroom, improving curb appeal, and installing energy-efficient features. Create a realistic budget and project timeline before starting the rehab work.

Step 3: Rent Out the Property

Once the property is rehabbed, find tenants to rent it out. Calculate a rental amount that is affordable for renters while also providing a positive cash flow for you. Consider what's affordable for renters in the area and review comparable rental rates. Screen potential tenants by checking their payment history, job stability, credit report, and background.

Step 4: Refinance the Property

Once you have enough rental income and equity, convert the equity into cash through a cash-out refinance. This involves taking out a new, larger mortgage and pocketing the difference as cash. Use the funds from the cash-out refinance to purchase another distressed property and repeat the process.

Step 5: Repeat

Continue to refine and improve your process with each repetition. Learn from past mistakes and build systems to cut down on stress and mistakes. The BRRRR method can be a great way to build a passive income stream and grow your real estate portfolio.

Rental income

When investing in real estate, it's important to do your research. Buying real estate to rent can be lucrative, but it requires a commitment of time and money. Here are some things to consider when using rental income to buy an investment home:

Location

When choosing a profitable rental property, look for a location with low property taxes, a good school district, and walkable amenities such as restaurants, coffee shops, and parks. A neighbourhood with a low crime rate, easy access to public transportation, and a growing job market signals a larger pool of potential renters. An area with a growing population or a revitalisation plan underway can also be a good investment opportunity.

Financing

The process of obtaining a rental property loan is similar to that of a primary residence mortgage, but there are key differences. Lenders typically charge higher interest rates on rental properties due to a higher rate of default. Underwriting standards are also stricter for rental property applicants, with a focus on credit score, down payment, and debt-to-income ratio. Most lenders require a minimum credit score of 620, with better rates for scores of 740 and higher. For a down payment, borrowers typically need to put down 15% to 25% for an investment property.

Operating Expenses

Operating expenses on a rental property can be significant, ranging from 35% to 80% of your gross operating income. These expenses include maintenance and upkeep costs, homeowners insurance, property taxes, and monthly expenses such as pest control, landscaping, and routine maintenance. It's important to set aside a portion of your rental income to cover these costs and plan for potential emergencies, such as roof damage.

Property Management

As a landlord, you will need to manage the property, find and screen tenants, handle rent payments, and arrange for maintenance and repairs. This can be time-consuming, especially if you have multiple properties. Alternatively, you can hire a property manager, who typically charges between 8% and 12% of collected rents. While this is an additional expense, a property manager can provide valuable services and help free up your time.

Legal and Tax Considerations

It's important to familiarise yourself with the landlord-tenant laws in your state and locale. Both tenants and landlords have rights and obligations regarding security deposits, lease requirements, eviction rules, and fair housing laws. Additionally, consider purchasing landlord insurance, which covers property damage, lost rental income, and liability protection in case of an injury on the property.

Alternative investments

There are several alternative ways to invest your $40k in property, depending on your risk appetite, investment goals, and the amount of time you want to spend managing your investment.

One option is to invest in Real Estate Investment Trusts (REITs). These are companies that own and operate income-generating real estate, such as rental properties or commercial spaces. By investing in REITs, you can gain exposure to the real estate market without the hassle of being a landlord. REITs are traded on public stock exchanges, making them highly liquid, and they can be held in retirement accounts such as 401(k)s and IRAs. You can invest in a broad range of REITs through Vanguard's Real Estate Index Fund, which offers a steady dividend.

Another option is crowdfunding real estate investments. This involves pooling your money with other investors to fund a specific property project. Typically, a deal sponsor will find and manage the deal, and you will own a percentage of the investment as a limited equity partner. Crowdfunding platforms such as Crowdstreet, Fundrise, Equity Multiple, Diversyfund, and Groundfloor offer a variety of real estate investment opportunities.

If you're looking for a more hands-on approach, you could consider buying and renting out a physical property. This option gives you more control over your investment but also requires more time and effort in managing the property. To get started, you'll need to research the market and analyse potential properties to ensure they meet your investment criteria. There are several rules of thumb to consider, such as the 1% rule, which states that a property will generally be cash-flow positive if the monthly rent is at least 1% of the purchase price.

Finally, you could also look into alternative assets outside of the stock market and real estate, such as investing in fine art through platforms like Masterworks, which allow you to purchase shares of ownership in artworks by renowned artists.

High-yield savings

• UFB Direct High Yield Savings: Best for APY at all balance tiers, with a 5.25% APY, no monthly fee, and no minimum balance requirements.
• Laurel Road High Yield Savings® account: Offers a competitive 5.15% APY with no monthly account fees or balance requirements.
• Varo Savings Account: Offers an APY of 3.00%, or 5.00% if you have a Varo Bank Account and receive direct deposits of at least $1,000 per month.
• LendingClub Bank High-Yield Savings: Provides a strong 5.00% APY on your entire balance, with no monthly fees and a $100 minimum deposit requirement.
• Bask Bank Interest Savings Account: Earn 5.10% APY with no monthly account fees, minimum deposit, or balance requirements.
• TAB Bank High Yield Savings: Offers the highest rate on our list at 5.27% APY, with no monthly service fee and no minimum deposit requirement.
• Salem Five Direct eOne Savings: Earn 5.01% APY on balances up to $1 million with a $10 minimum opening deposit, no monthly fee, and no minimum balance requirements.
• Popular Direct High-yield Savings Account: Offers a 5.15% APY and requires a $100 minimum opening deposit, with no monthly service fee.
• First Foundation Online Savings Account: Provides a 4.90% APY with a $1,000 minimum deposit requirement and nationwide ATM fee reimbursement.
• Synchrony Bank High Yield Savings: Features a slightly lower APY of 4.75% but has no monthly maintenance fees, minimum balances, or deposit requirements.

When choosing a high-yield savings account, consider factors such as the interest rate, initial deposit and minimum balance requirements, fees, compounding interest, and whether you prefer an online or traditional bank. These accounts are a great way to boost your savings and get closer to your goal of buying an investment home.

Frequently asked questions