If you've been a home builder or remodeler for five or 10
years, chances are you have enough experience to spot a good
price on a residential investment property. You also probably
have the skills to evaluate the property's condition and to
estimate the costs of any needed upgrades. Perhaps you've even
been hired to renovate a building that someone purchased for
As a builder, your skills and experience make you better
prepared to invest in residential real estate than 95 percent
of the population. This article will show you how to get
started at a level and pace you're comfortable with, and will
outline other skills you may need to develop.
Money Is Not the Hurdle
You don't need a lot of money or fancy tools to invest in real
estate. The biggest hurdle most people face is simply getting
started. During my 20 years as an investor, I've talked with
many folks who want to get into this business — but few
who are actually willing to take the plunge. Most people are
determined to wait for the perfect building or are too afraid
to put their money at risk.
And in fact you will need to take some reasonable risks.
However, most investors will tell you that, no matter where you
live, your money will provide an outstanding return — as
long as you invest for the long haul.
Real estate is like the stock market: Despite short-term value
fluctuations, historically there's been no 10-year period when
the value of either hasn't gone up. That's why I seldom buy a
property with the goal of making a quick buck; instead, I look
for one I can improve or add rental units to. I buy and hold,
collecting rent from my tenants and watching the property's
value increase over time.
I made my first modest investment 25 years ago, starting as so
many do with a classic fixer-upper — a single-family home
in central Vermont, which I used as a primary residence. Five
years later, with a partner, I bought my first rental property;
I bought a second property shortly thereafter.
I purchased them as long-term investments — I hoped that
they'd be a source of tuition for my two sons' education
— and financed them using what was then a relatively new
product, an equity line of credit that I took out on my primary
After that small start, I continued to learn and invest, and
today I'm a full-time real estate investor with 18 rental
units, a rental storage business, a six-unit condominium
project, a country store, a new three-unit subdivision, and
building lots for sale in various towns and counties. My
investments provide me with an excellent income and will
finance 80 percent of my planned retirement.
The Potential Rewards
If you want to get into real estate investing, you should start
by deciding what your goals are. You may want to create a nest
egg for retirement, supplement your current income, or generate
work during slow times.
Properties can be purchased either for long-term equity
appreciation or for short-term cash gain. The difference is
defined by how long you hold the property. Several years ago, I
bought a piece of land, turned it into a subdivision, and sold
off the lots the following building season at a substantial
profit. That was a cash investment.
I don't generally recommend cash deals to people who are just
starting out, because they're relatively risky and can have
painful tax costs.
A better first effort is an equity investment. An example of
this is an old barn and farmhouse I bought and renovated into a
nine-unit apartment complex, and which I still own. It
generates a monthly rental income and has appreciated in value
over time. The equity provides collateral for a secure line of
credit that I can use to operate my business (see Figure 1). It
also offers tax benefits I don't get from my own home.
This financial model, based on
one of the author's properties, shows the first-year gain on a
three-unit apartment building. The building was bought in 2005
for $180,000 with an initial down payment of $45,000. With
$5,304 paid in mortgage principal the first year and a 6
percent market appreciation of $10,800, the author gained more
than $16,000 in equity. Add to that $6,400 in rental income
(after expenses), and his total yearly earnings on the property
are $22,504 — a 50 percent return on the original
investment. While market value may fluctuate somewhat, the
amount of principal paid down each year will
Passive income. This is the monthly
income you get from a rental property after paying the mortgage
and other expenses.
The best properties have a strong positive cash flow. I
consider a property a good investment if, at the end of the
year, the revenue it generates exceeds its expenses by at least
However, if you're looking to buy your first investment
property, I recommend that you not worry too much about passive
income. You need to make sure that there's enough of it to
carry the building's expenses, but if you wait for a perfect
property, you may wait forever. The key is to get
Equity appreciation. As you know,
equity is simply the difference between what you owe on a
property and its market value. Last year, in my part of
Vermont, single-family property values increased by 16 percent.
Of course, that's unsustainable, and real estate values can
also drop over the short term — quite a bit more in some
places than in others. But in the long run, value always grows.
And as it does, so will your equity.
Keep in mind, too, that equity grows faster in an investment
property than in a primary residence. That's because most
investment properties are financed with commercial terms,
meaning a 15- or 20-year loan. The payment is higher than with
a 30-year mortgage, but you're aggressively paying down the
loan and thus increasing your wealth. And this increase in
wealth is paid for by your tenants.
If you hold a building for a few years, you'll probably build
up enough equity to take out a line of credit, which you can
then use as the down payment on another property that has
better cash flow. You can also use the cash for your
Tax benefits. An investment property offers the
tax advantage of letting you depreciate the building and
equipment. Depreciation is the notion that the building will
lose some of its value over time due to age, wear and tear, and
the need for upgrades (such as replacing the heating
Your accountant or tax advisor can help you establish a
depreciation allowance for the property and its equipment.
Depreciation lowers the taxable income on a property, leaving
you more cash to work with.
Getting Ready to Invest
Before you even think about buying investment properties, you
need to have an attorney and a commercial banker. The more
properties you buy, the more you will need their services, so
take the time to choose the right people.
Selecting an attorney. Most attorneys
practice real estate law, so asking other businesspeople for
referrals should give you plenty to choose from.
I suggest interviewing each attorney over the phone, and asking
the following questions:
• How long you been practicing?
• How much experience do you have in investment
• What is your experience with the permitting
• Is there a backup attorney in the office who can help me
if you are in court or on vacation?
• What are your rates and terms?
If you like the answers you hear, the next step is to set up
interviews with at least two attorneys. Focus on their
experience and your comfort level with them as individuals.
Assuming a comparable level of competence, it's better to enter
this relationship with someone you're comfortable with.
Forming a corporate entity. I recommend creating
a separate corporation for each property. If there's a slip and
fall at one property, the dispute is with the entity that owns
the property, not with you. This is not foolproof, but it is a
good business practice.
Lawsuits follow the money, so you don't want to create paths
that let someone follow them from one of your corporations to
another. I prevent this by keeping separate records for each
property, and by having separate insurance policies and
Because I want to insulate my various business accounts from
one another, as well as from my personal assets, I never mingle
funds. That means I never pay an expense for one project using
another project's checkbook. And I don't name my wife as an
officer on any of the corporations, as this would create an
avenue to my personal assets.
Corporations — as you no doubt already know — come
in different flavors. Although you should get the advice of
your attorney and accountant on each project, when I purchase a
property to hold as an equity investment, I usually incorporate
it as a limited liability corporation, or LLC (Figure 2).
Setting Up An LLC
Figure 2. The author creates a separate
LLC for each property he owns. This is inexpensive and simple
to do; in some states it requires only a one-page
An LLC provides the same protection as other corporate forms
but with the tax simplicity of a partnership. Depending on
where you live, creating an LLC costs only $80 to $150 and can
be done with a simple one- to two-page form. It can be formed
with or without partners, requires only one "manager," and has
minimal annual reporting requirements. (Some properties are
better served by an S-corporation, but this business structure
is a bit more complicated and is best handled by your attorney
Working with the bank. Your attorney should be
able to recommend a good commercial loan officer, but you
should also ask other investors for their recommendations. The
policies and practices of commercial loan departments vary by
bank. Some departments are more conservative than others but
offer good terms on existing properties. Others will consider
financing more aggressive or even speculative projects. Yet
others may loan money for multi-unit properties but will shy
away from land deals that don't include a lot of owner
Interview three or four candidates face-to-face and ask lots of
questions. The more you ask, the more you learn and the better
your choice. Ask the candidates how long they've been in
commercial banking, how long they've been working in your
geographical area, how many customers they have that are
similar to you, and if they're planning on leaving the bank in
the near future. They will tell you.
One of the most important questions to ask is who makes
decisions about the types of loans you are requesting and at
what loan amount the decision process changes, if at all. Some
loan officers can lend money to a set limit — typically
$500,000 to $1 million — on their own judgment, but have
to get larger amounts approved by someone higher up the
At other banks, all applications must be approved by a loan
committee. I've learned from painful experience that I would
rather not do business with banks that use committees. I want
to know that I can sit down and talk with the person who is
going to make the decision on my application.
I've also learned that loan rates aren't always what they seem.
I recently had lunch with friend who owned a building that was
up for refinancing. At first, his regular bank — where he
is a major customer — told him that the best rate it
could offer was 8 percent. But after another bank offered him 7
percent, he called his bank back and it matched the lower
The point is that if a bank wants your business and knows
you're shopping around, it can be flexible.
Of course, the bank will also be evaluating you, so you need to
be prepared to show why you are a good risk. For instance, the
commercial officer may ask you questions to determine how well
you understand the housing market, whether you're one of those
people who tend to overextend themselves financially, and how
much cash or equity reserve you have.
The bank will also want to know that your property will be able
to support itself and that you will be able to support it if
the tenants default. Assuming you are self-employed, the
commercial officer will want to see three years of tax returns
— your personal returns as well as returns for each
business entity you own.
You will also have to fill out a comprehensive statement of
your current financial situation (Figure 3). I keep all this
information on my computer and update it regularly, using an
Excel spreadsheet provided by my bank. This, along with tax
returns, is all the information the commercial officer will
need to process a loan request.
Personal Financial Statement
Figure 3. Most banks will ask you the same
questions every time you apply for a commercial mortgage. The
author recommends keeping your financial information updated in
an electronic file; use a personal financial profile form,
which is available from most banks and from various other
sources, including the U.S. Small Business Administration
(www.sba.gov/sbaforms/sba413.pdf ). The
numbers on the form shown here are for a fictitious
Taking the Plunge
Once you have made all your legal and financial preparations,
you need to learn everything you can about your market. What
areas are growing or declining? Is there a glut of rental
housing, or a stable need? Are rental spaces priced per square
foot or per bedroom?
You can find this information in a number of places. Read the
property listings in local newspapers and real estate
magazines. Think like a buyer. Know what you're looking for,
what you can afford, and how far you're willing to
When you find what seems like a suitable property,
realistically evaluate it to see if it meets your needs as well
as those of the bank. I have created several Excel spreadsheets
that I use as templates to quickly run the numbers on a given
property (Figure 4).
Figure 4. The author uses an Excel
spreadsheet to quickly determine whether a given property will
meet the bank's requirements and satisfy his investment goals.
These numbers come from two contiguous buildings he
A good first investment is a three- to five-unit project, as it
will usually yield a positive cash flow after expenses. In some
markets, the demand for housing is so strong (or real estate
prices so cheap) that a one- or two-unit project will work
financially. However, more units are almost always better: If
you stop receiving revenue from one unit, the others will
likely carry expenses.
You're also better off with a property that has units of varied
sizes and with different numbers of bedrooms, so it will appeal
to a wider variety of tenants.
If you intend to be a landlord, you have to approach the task
as a business rather than as something you're dabbling in. You
need to carefully screen your tenants and be willing to wait
for a good one. And you need to have a lease that clearly
spells out the terms and conditions.
If a tenant calls with a problem, you need to take care of it.
This is extremely important, and I have seen many investors get
into trouble by not heeding this advice. In almost every case
where I've heard someone complain about a lousy experience with
tenants, it was because that someone was a lousy
The critical point to remember is that tenants are customers
— just like the homeowners you build for. They're paying
for service, and giving it to them will benefit both of
You can start by upgrading the building so that it requires
little maintenance. For instance, I bought two older buildings
a few years ago, then totally renovated them before renting the
units. Now the place is like new, and I've had no maintenance
calls. The next year I did the same to another building, and
I've had no maintenance calls on that one, either.
This is a key area where your experience and connections as a
contractor will pay off.
Money Is a Tool
As a kid, my parents never talked with me about their money (or
lack thereof); nor did they talk with their friends about it.
Doing so was considered rude — an attitude that
unfortunately is still very common.
Financial intelligence isn't part of our current educational
system, either; most colleges have classes in economics, but
they don't teach students how money works or how to leverage
If you want to get ahead in business or real estate, you need
to acquire some financial intelligence. You can start by
reading books and articles based on real experiences or
research — there are any number of books out there about
money. Rich Dad, Poor Dad and The Millionaire Next Door are two
that helped me think about how money works and how people who
have it got it and maintain it.
Do your reading with a number of questions in mind. How is
money lent and repaid? What is net worth? What is the impact of
personal debt vs. business debt? How do the terms of a loan
You should also learn how to evaluate risk. Are the risks
you're taking well-thought-out? Do you have a backup plan? Do
you know the difference between an appreciating asset and a
depreciating expense, and can you accurately spot each in
It's also a good idea to develop a relationship with peers who
are willing to talk about money and how they are using it. I am
very fortunate to have several investor friends with whom I can
discuss money and wealth. We don't do this egotistically, but
with the goal of sharing information. We share what kind of
year we're having, what our tax strategies are, which banks we
are using, what their terms are, and what properties each of us
is buying and why.
I strongly encourage you to nurture these types of
relationships. They can become one of your most valuable
You should also sit down with your accountant and your
financial planner at least once every six months to review
where you are with your business, cash, taxes, and investments.
I like to talk with them both at the same time, seeing one
face-to-face and putting the other on speaker phone. The
perspective I get always helps me realize new ways to maximize
my cash and build equity.
Jim Cameron has been investing in real
estate for 20 years and has been a general contractor for 15
years. His business is based in South Burlington,