A common question on the BiggerPockets forums goes something like this, “I have $50,000 and looking to invest in real estate. How should I start?”
In normal times, my advice would nine times out of 10 be house hacking for a first-time investor, especially given the markedly better rates and terms homeowners can get as compared to investors. However, in the past year, that delta in loan terms has compressed substantially, and so while house hacking is still an option, it’s not head and shoulders above everything else as it once was. Although, house hacking has certainly held up better than many other strategies.
Indeed, if there ever was a challenging real estate market—particularly for new investors or those with $50,000 or so burning a hole in their pocket—this would be the one. This 2022 meme succinctly explains that challenge as much as any essay could (updated for 2023 audiences):
But sitting on the sidelines has its costs too. Suzanne Woolley at Bloomberg sums up the dilemma facing investors of all stripes, but most notably real estate investors in this current market,
“In the short term, it may make more sense to focus on preserving capital than finding growth. But in the long run, inflation eats away at cash and leaves savers with less purchasing power.”
So, given this predicament, what are the best options to pursue?
The BRRRR Strategy: Mostly No
Don’t get me wrong, if you find a great deal that you can buy for 75% of its market value and it cash flows with current rates, then go for it. Unfortunately, for the most part, the BRRRR strategy is dead (or hibernating, to be precise). This is tough for me to say as the BRRRR strategy—specifically, in our case, buying with a private loan, rehabbing, renting, and then refinancing with a bank—was our absolute favorite strategy.
The main problem is that virtually every lender is going to expect a property to have a 1.2 debt service coverage ratio (DSCR) or better. Namely, your net operating income (gross income minus expenses) will need to be 1.2 times the mortgage payments. Even in high cash flow markets, it’s very hard to get even a 75% loan with interest rates in the 6s and 7s and prices where they’re at.
Furthermore, real estate prices have started to fall. Sure, they haven’t fallen much (see meme above), but after skyrocketing, they are beginning to cool off. A crash is very unlikely, but so is substantial appreciation in the near future. As Bill McBride has shown, the time between one peak for CPI-adjusted real estate prices to again equal that same price after a decline has been between 6.5 and 15 years for the last three cycles.
McBride predicts that, in total, prices will fall 10% nominally and 25% in real terms (adjusted for inflation) from their mid-2022 peak. Opinions on this, of course, vary widely. But the general consensus is that real estate prices will likely fall, are very unlikely to go up more than a marginal amount, and even if they do go up, they will almost certainly trail inflation.
McBride, for his part, believes real estate prices will be “in purgatory” for seven years. I tend to agree.
Therefore, you will probably need to leave a lot of money in a property and are unlikely to see a lot of appreciation in the next few years. If you have a good amount of capital or partners with cash willing to go in with you, that’s one thing. And yes, if you find a great deal, pull the trigger.
But for the most part, the BRRRR strategy is not ideal in the current market.
House Hacking: Maybe
I bought my personal residence in mid-2021 and got a 3% mortgage fixed for 30 years. I’ve heard of many people getting mortgages in the 2s. (I think Mark Zuckerberg set the record in this regard with a 1.05% mortgage). Unfortunately, such rates are a thing of the past.
Today, mortgage rates are in the mid-6s. Although that’s better than the low 7s they were at during the beginning of the year. At least we can all be thankful for small mercies.
While rates are higher than normal, it’s still a good thing to get your foot in the real estate investing door. And with FHA loans, you can do so with only 3.5% down, which $50,000 will cover in almost any market. Furthermore, you can buy up to a fourplex with an FHA loan, live in one unit and rent out the other three, getting a place to live and becoming an investor at the same time.
Even many banks will offer traditional financing up to 95% of the purchase price for homeowners.
However, for the first time in my investing career, I can’t unequivocally endorse house hacking for new investors or those looking to place $50,000 or so. But it’s still definitely an option to consider.
Before moving on, I should note that inflation has been cooling, so there is reason to believe that interest rates will come down later this year or early next. So, while I’m normally a big fan of fixed-rate mortgages, this would be a time to think about adjustable-rate mortgages. (Although you should stress test your financial capacity in case rates do go up, you can just never know with such things.)
Creative Financing: Yes
In this regard, I am mostly talking about subject-to deals. With such deals, the property is bought “subject-to” the existing mortgage. So, the deed is transferred to you, but the seller stays on the mortgage.
There is a big opportunity here in this market as most homeowners have great loans, and yet the market has slowed, so it’s harder and can take longer to sell (although prices have only dropped a bit because very few people are motivated to sell). And as I put in a previous article, “The advantages to the buyer, in this case, are obvious. If you can ‘assume’ a loan at 2.85% on a property, how much does the purchase price even matter?”
There are some disadvantages to subject-to. For example, the bank has the right to call the loan due, although they rarely do such a thing. Another is that the buyer cannot borrow any of the money for rehab. And if there is a big discrepancy between the sales prices and the loan, there’s no way to bridge that gap without getting a second mortgage.
But for an investor with about $50,000 to spend, that will very often do the trick and fill that gap.
It should also be pointed out that seller financing is another option that buyers should consider in this market. It presents similar challenges and similar opportunities, except for the obvious fact that virtually no homeowner is going to lend to you at 3% interest to buy their house from them.
Syndications: Mostly No
Real estate syndications are usually done on larger deals where a principal party finds, negotiates, and arranges a deal and brings in investors to cover the down payment and repairs. Usually, the principal will keep about 15-35% of the equity, and the passive investors get the rest.
During the past few years, investors in syndications have made a killing as real estate prices have skyrocketed. But now, returns are lower because interest rates are higher, and (at least as of now) prices have not come down much to soothe that reduced cash flow. And as noted above, there is no reason to think real estate prices will go up much, if at all, in the near future. And they will almost certainly not keep pace with inflation. So, most of the advantages that real estate syndications offer are no longer there, particularly for passive investors.
Of course, as with BRRRR, there are still good deals around. And if the market does get messier, there may be more motivated sellers and, thereby, more opportunities for really good deals, which will be worth it regardless of interest rate or potential appreciation. But that has not yet come to pass.
Private Lending: Maybe
Private lenders often lend at 8-12% interest. Hard money lenders (typically businesses set up to lend private money to flippers) usually lend at 12-15% with three to five points.
$50,000 is generally not enough to lend to someone buying a house to flip or hold, but if you have closer to $100,000 or more, there should be opportunities out there.
And indeed, with interest rates in the mid-6s, a 10% private loan doesn’t sound nearly as bad to an investor as it did a year ago. If that kind of return meets your goals, private lending is something to consider.
The Sidelines: Maybe
Another first for me is even considering the possibility of recommending those with $50,000 who want to start in real estate to instead sit on the sidelines for the time being. Time in the market beats timing the market—or at least it usually does.
This market is one of the few times I would say that it isn’t that bad of a thing to sit on the sidelines for a while. For our part, we are focused on finishing our rehabs, increasing our occupancy, and optimizing our systems. We’re not looking to purchase much this year. Although, that is in part because we had a big year in 2022 and are playing a bit of catch-up.
As of this writing, the one-month U.S. treasury bond has a 4% yield, and the six-month provides a 5% return. These were in the ones last year. So, sitting on the sideline isn’t the de facto equivalent of stuffing money under your mattress as it was not long ago.
While those returns are still below inflation and rather paltry compared to what real estate investors tend to aim for, they are much better than buying a mediocre deal with a high interest rate loan in a volatile and likely declining market.
Ultimately, my recommendation would not be to sit on the sidelines. But I would be much more comfortable holding on for a really good deal and waiting a lot longer than I would have been last year and more so still than, say, five years ago.
In this economy, in particular, you do not want to force anything.
This is the most confusing and challenging real estate market I have seen in my lifetime. I certainly don’t envy someone looking to start now. It’s important to approach the market cautiously and not try to force a deal to happen. There will be time for that, and the economy will, sooner or later, become more advantageous for real estate investors.
Even still, there are opportunities in real estate out there for someone with $50,000 or so, even in this market. You just need to be a bit more careful and a lot more patient.
Creative financing techniques to do more deals, more often
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Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.