Residential investment real estate comes in all kinds of styles, shapes, and sizes. What at first may not seem like a good investment may turn out to be an excellent one.

The more you know about real estate, including its uses, the more likely you are to be a successful investor. Getting started requires basic knowledge about what you are buying: a property that someone is going to call their home.

In this chapter, you’ll read about how to get started in real estate investing, including minimum requirements you should look for in any investment property. Then you’ll learn about the wants and needs of your customers—your tenants.

Congratulations! You’re going to be a real estate investor!

The big question is, where do you start? Now that you have made the decision to invest in real estate, there is overwhelming temptation to start right away. You may want to phone that number on the “For Sale” sign, or look in the real estate section of the Sunday newspaper, read some ads, and start calling.

But is this the best way to start?

Anyone who knows anything about real estate has probably heard the first three rules of real estate—location, location, location. This is good advice for both beginners and seasoned pros.

There’s more simple advice for investors. Perhaps you’ve heard that in the stock market, the key is to buy low and sell high. That’s wise counsel. Many times, implementing such strategies is easier said than done, and difficult to put into practice.

When it comes to getting started with investing in real estate, the first three rules are knowledge, knowledge, knowledge.

You are already on the right track. Reading this book is expanding your knowledge of real estate investing.

Any home must have the basics. A roof and a sound foundation are basics. The mechanical systems—plumbing, electricity, heating/cooling—are also essential basics. All homes need an area to prepare and keep food (the kitchen), and a bathroom with a toilet, tub/shower, and sink. There needs to be some living space, as well as a bedroom.

When considering properties for investments, these basics must be considered. You will need to provide them to your tenants. Generally speaking, these items include …

Almost any property you consider as an investment is likely to need something fixed, replaced, or added. That’s part of the real estate business. Some small items can easily be added or taken care of with minimal effort.

For example, every rental unit should have working smoke detectors. If it does not (or the number of detectors is insufficient), you can easily add one for just a few dollars and a few minutes of your time.

Some things are indeed minor repairs. A loose doorknob or kitchen drawer with a handle missing takes little time to repair. For some reason, people will live with these annoying problems rather than fix them. Realize what is minor and what you can fix with minimal cost or time.

As an active real estate investor, you look at many properties. You only make offers to purchase those that make sense to buy. As you inspect the properties, ask yourself questions about the rooms in the property:

There will be other rooms in some residential units. These could include dining rooms, dens, recreation rooms, and powder rooms, also called half baths.

If you always keep in mind that you are investing in a property for someone to live in, it becomes easier to realize what you need in your units. Much is easy to overlook, but will be important to your tenant.

Some of those items are …

Another important tenant concern is laundry equipment. Can your residents do their laundry at your rental home, or must they go to a laundromat?

You will have to decide what appliances to provide for your customer. There are two schools of thought in regard to providing appliances. One school says to allow the tenants to provide their own appliances. Tenants who provide their own appliances tend to be more stable and the landlord is relieved of the responsibility of maintaining the equipment.

The second school of thought notes damage can be done to the rental unit while moving in and out large bulky items like appliances. Further, an old leaky washing machine or dishwasher can ruin the flooring. Finally, not every customer has their own appliances, so the pool of potential tenants is smaller.

Properly providing the right amenities and removing any defects or hazards will increase the likelihood that someone will want to become your tenant and live in your investment property.

Trying to figure out what looks nice is never an easy task. Potential investment properties that have not been freshened or updated exist in every town throughout the country. Sometimes, old-fashioned hard work and soap is all it takes to bring a shine to dingy housing. A good cleaning can do wonders.

Removal of trash or junk is also a certain way to improve the appearance of any property. Other simple items are improved lighting, professional carpet-cleaning, and clean windows. A well-maintained lawn and attractive landscaping are a must. It doesn’t matter how great your property looks on the inside if your prospective tenant is turned off by what he or she sees on the outside. The outside appearance of a property is often referred to as the property’s curb appeal.

A good first impression in the only impression you want to make. When a potential tenant walks into the property, what will they think? One certain turn-off is offensive odors. Try to prohibit smoking indoors if you can. Sometimes, removing odors from negligent pet owners is a real challenge. If the property you are considering has such a problem, make sure you can remove the odor for your tenant.

Pet odor can penetrate deeply into porous building materials. An animal urine stain can sometimes require removal of carpet, pad, and even portions of a wood subfloor or the drywall. Sometimes hard surfaces like wood and concrete can be sealed to eliminate the odor without removing the affected building materials. The appropriate sealers will be in the paint department of any hardware store.

Many potential properties you will consider for investment will have serious cosmetic appearance problems. Cosmetics are those things that can easily be changed. For example, a bedroom painted in a drab olive color could be revitalized with a fresh coat of white paint. A kitchen floor might appear worn, but a fresh vinyl floor would bring new life to it.

Some things are not as easily changed. You might have a bathroom from the 1960s where the toilet, sink, and tub are yellow. Now out of style, it would take a major renovation to change all three to white.

While it will cost you money to correct cosmetic items to improve the appearance of the property, do not discard a potential investment because it does not show well or it needs an update.

There is always a fundamental question that you must ask yourself before investing in any property. Because you are buying residential property, the goal is for someone to live in it. As you consider investment properties, always ask yourself, “who would want to live here?” The answer to that question might determine whether or not you even consider the property.

For example, consider a simple two-story, 3 bedroom, 1 bath modest house. It’s about 50 years old, and is a typical find anywhere in the country. Every community has this property. Let’s think about this home in three different locations.

Our first location for this home is on a quiet, tree-lined street. Within three blocks, there is a park. In the opposite direction, there is an elementary school. Public transportation is available only a short distance away. There’s a small shopping area within easy walking distance, which includes a drug store and convenience store. All the properties on the block where this house is located appear well maintained.

Our second location is a predominately industrial area. The air is permeated with a sour odor. Train tracks are located immediately to the rear of the property. When the long freight trains pass, the house seems to rattle and shake. Heavy truck traffic rumbles in front of the property all hours of the day and night. A questionable bar with a history of problems is just down the street.

The third location for our sample property is at a crossroads in the middle of nowhere. The nearest town is about twenty miles away, on a two-lane road. It takes a good 30 minutes to get there. The location is so rural there is no cable for television. The only thing nearby is woods and farmland.

Remember we are talking about the same house, just in three different locations. Who would want to live in the house at each location?

At location one, the rent would be the highest, because most people would want to live there. It would be easier to attract a good tenant and to rent the property. At location two, the rent would need to be less, only because it would be harder to find a tenant. At location three, the rent would be somewhere in the middle, since some people would love to live in the country, while others would hate being miles away from others. What determines the rent for each location is the type of person who would want to live there.

Let us assume the rent for location one is $800, location two is $400, and location three is $600. Some people would prefer location two over the other locations. Why? The rent is less. Some people could not afford $800 a month, or would simply prefer to pay less. This does not necessarily make them bad or suggest that anything is wrong, it is just a matter of reality.

However, be careful of the location-two type properties. There are plenty of good tenants on tight budgets who are seeking affordable housing, but if the location is truly problematic, no respectable tenant on any budget will want to live there.

Some people would prefer location three and pay $600 a month and travel to work—even if their transportation costs and rent would be more each month than a closer location. Some people prefer to live in a rural location. It may not make logical sense to some, while others think this makes perfect sense. There is no right or wrong here, just the way people are different.

The property will determine who your customer might be. As a real estate investor, your tenants are your customers. Each month, your customer will pay rent for the privilege of staying in your property.

As you evaluate properties for purchase as investments, constantly consider your future customers. What the property offers—and does not offer—will determine who your eventual customers will be.

In real estate, the spectrum of your potential customers can be divided by income into three categories: low-income, medium- or middle-income, and high-income. Each customer group has unique characteristics and concerns.

One thing common to each group—regardless of income level—is the desire for cleanliness. It is amazing how often landlords fail to provide this simple and basic requirement. It is nearly impossible to attract good customers with dirty housing.

Low-income tenants can include young people just starting out in their first home to elderly folks on fixed incomes. In between are other customers that for whatever reason just do not earn a lot of money. Your experience as a landlord renting to these customers will depend on the demographic characteristics of your low-income tenants.

For example, low-income elderly tenants tend to be stable customers who pay their rent reliably and rarely move. On the other hand, they can be quite sensitive to rent increases. Younger tenants tend to be transient, subject to moving more frequently. Younger customers are often living hand-to-mouth, without any cushion of savings or health insurance. Therefore, if there is an illness, an inability to work, or a job loss, this customer may immediately become unable to pay the rent.

The median household income in the United States is $44,473 in 2004 dollars according to the U.S. Census Bureau. The Federal Government defines low income in at least some of its housing programs as those households earning 60 percent or less of the median income.

Providing clean, mechanically sound housing will probably be enough to satisfy lower income customers. Accessibility to grocery stores, other service retail outlets, and public transportation is a greater concern for this customer group. Security features may also be important.

You should not fall into the trap of associating lower income customers with being less desirable. When interest rates are low, many rental units suffer vacancy loss because customers are buying homes. However, lower income customers may not be able to afford their own home. If you carefully screen your customers, you should be able to find plenty of good, reliable, low-income tenants.

Middle-income tenants will have the same expectations as low-income tenants, but will also expect more amenities and a larger unit. These customers will often view dishwashers, garages, and private laundry equipment provided by the landlord as standard equipment. If the kitchen cabinets have a worn or outdated finish, you may be able to get away with painting the cabinets with an off-white, durable paint in a low-income unit. However, this idea is not going to work for a middle-income unit. New cabinets may be required. Similarly, this customer may be expecting self-cleaning ranges and an automatic defrost refrigerator.

Middle-income customers come from all occupations. They can include younger families and older empty-nesters. They can be lifelong tenants or candidates for future home ownership.

High-income customers again have all the expectations of their less affluent peers but have still greater expectations, both in size and available amenities. There is no room for any kind of obsolescence in any part of the housing unit. The customer may expect a premium location such as those locations with a golf course or water view. Expectations may include access to a fitness center or swimming pool and even concierge services. The customer may expect two covered garage spaces attached to the dwelling.

Pet policies excluding pets may be accepted by the rest of the tenant population, but high-income customers are more likely to have less patience with such rules and may expect to bring their cats, dogs, and other pets with them.

Usually, only larger apartment communities of 150 units or more can provide amenities such as fitness centers, swimming pools, and concierge services. A recent trend in luxury real estate is to provide various concierge services for tenants. This can include making dinner and ticket reservations, taking in package deliveries, watering plants and tending to pets during an absence, and other services.

High-income customers are looking for housing that is unique, and they are willing to pay for it. Sometimes middle- or even low-income units can be repositioned as high-income units by making the right improvements and upgrades. Such repositioning represents a terrific profit opportunity for the investor.

David bought a dilapidated apartment building for less than half of its tax-assessed value! This building was designated by the Federal Government as low-income housing. However, behind all the dirt and grime, he envisioned a gem. The apartments had unique architectural features such as lofts and enormous bay windows. The property was structurally and mechanically sound. Little more than upgrading carpets, painting, and cleaning repositioned this building as a middle-income offering, with increased rent to reflect its new status.

The location of the property will greatly influence who your customer will be. As you learned earlier, different people will prefer different locations. Some will not be concerned about a location if it offers a less expensive place to live. Others will pay more for what they perceive to be a better location.

Many times, people choose their residences based upon the quality of the public schools. A strong public school system is one of the most important aspects of infrastructure that any community can provide. Infrastructure describes the road, bridges, rail lines, schools, and other public works found in a modern economy. Good tenants may flee or avoid a declining school system. Realize the availability of good schools will often determine who will want to live in your investment property.

There is always a demand for properties near colleges or universities. If your property is near such an institution, your customer could be a student or a teacher. Many times, creative people—artists, writers, musicians—have a desire to live near these types of schools because of the culture and learning opportunities they offer. Be advised that student housing can be one of the more management-intensive landlord opportunities.

While you are searching for investment properties, you may not know who your future customer will be. You should still ask yourself, “why would they want to live here?”

There must be logical reasons why someone would want to reside in the property. Many times, with a little imagination and small amount of money, you can greatly improve a property, making it look nicer and more desirable. Always consider the extras you can do—the easy things—that can add value, quality of life, and improve the appearance of the property.

You can see how your expanding knowledge—from neighborhoods to living space to fix-ups—can help you in real estate investing. The more knowledge you have about all aspects of real estate, the better off you’ll be.

A property that is appealing to as many customers as possible is always best. The more appealing you can make the property, the easier it will be for you to maintain a profitable return on your investment. It has to be a place that someone is going to want to call home sweet home.

When buying properties for real estate investment, the investor must realize the potential for hazards. Over recent years, government policies and regulations have been established that require the elimination or abatement of specific hazardous conditions. As a landlord and under the law, you are held responsible for any hazards on your property.

Before buying a property for investment, you should realize the possible hazards, and understand what you might need to do to eliminate them and make your property safe for your tenants.

Older residential properties could have lead paint in them. Lead was a common ingredient added to paint for several decades prior to 1974. Many homes with this paint still exist.

Because of the danger to your customers—especially children—a property with lead paint is a particular problem. Lead-based paint cannot simply be scraped off and the surface repainted. Strict environmental regulations must be followed.

Make sure you realize the problems associated with any property that has the potential of having lead paint. Lead-based paint is a critical issue in housing today. Lead-based paint can be toxic, particularly for children. The Federal Government banned lead as an ingredient in paint in 1974. However, owing to the existing stock of paint that may have already been in existence, the government has determined that any housing built prior to 1978 may contain lead-based paint. If the real estate was built before 1978, the government requires sellers of real estate and landlords to furnish buyers and tenants with a copy of a booklet called “Protect Your Family From Lead In Your Home.” It is available online at www.hud.gov.

Never scrape or sand a painted surface unless you are sure there is no lead in the painted surface you are working on. Paint test kits are available in most hardware stores. If a contractor (or anyone else) is disturbing more than two square feet of painted surface, the pamphlet “Protect Your Family From Lead In Your Home” must be again provided to anyone who might touch the work area.

There are no established standards for acceptable or unacceptable concentrations of mold. Levels of airborne mold fluctuate rapidly, rendering mold testing of little value. Mold is a risk that few insurance companies cover. There are cases where mold contamination has resulted in condemnation of the real estate. Overlooking a potential mold problem could have devastating financial impact. Mold requires water and a food source to grow. Most building materials are suitable for hosting a mold bloom if they get wet. The only practical way of combating mold is to keep water out of where it does not belong. Any building materials that get wet from a sewer backup, roof leak, or other calamity should be removed if possible.

Beware of musty odors or visible signs of mold. Any property that has had roof repairs, basement leaks, or any extensive plumbing problem should be further investigated to make certain there is not a related mold problem. A good home inspector should be able to help you assess any property for the potential presence of mold.

There are a multitude of additional hazards that you might encounter. Many of these perils were hot-button hazards a few years ago. Asbestos is one example. Other lasting hazards include radon gas, termite infestation, and in-ground storage tanks.

Asbestos is a fire-resistant material that has been known to man since nearly the beginning of time. It can be found in floor and ceiling tile and in insulating materials like boiler pipe wrap. It can also be often found sprayed on the ceilings and support structures of underground parking garages.

Asbestos can be carcinogenic, causing lung cancer. Asbestos is most dangerous when it becomes friable. This means when the asbestos product starts to deteriorate it begins to crumble or turn to dust, creating greatest potential for harm.

In its heyday as a hazard, the standard response to asbestos was to remove it using specialized contractors. The flaw to this approach is that the removal process can pose the greater risk of disturbing the asbestos and releasing toxic particles into the air. Today the approach is most often to either encapsulate the asbestos in place or to even to just leave it alone if the asbestos material is in good condition. If you suspect asbestos is in a dwelling you are considering buying, the best approach is to rely on a home inspector to identify whether asbestos is present and if so, what should be done about it. More information about asbestos is available from the Environmental Protection Agency (EPA) at www.epa.gov/asbestos.

Similar to asbestos, radon gas is another carcinogenic associated with lung cancer. Radon is a colorless, odorless, radioactive gas. The only way to be certain of its presence or absence is to test for it. Radon levels vary according to location. Local geology, construction materials, and how the home was built are among the factors that can affect radon levels in homes. Radon comes from the ground underneath a home, well water, or building materials. Newer or more tightly insulated homes may be more prone to higher radon concentrations, because the gas is less likely to escape. The EPA believes radon remains a serious hazard. Other studies and experts contest this position. Test kits are inexpensive and can be purchased at home improvement centers and hardware stores. Remediation is typically inexpensive, averaging about $1,200 nationally per dwelling unit abated. More radon information is available from the EPA at www.epa.gov/radon.

Termite infestations can have a devastating impact on real estate. Since termites will bore into the insides of wood building products, the damage can be invisible. For those areas of the country, primarily in the south and west, where termite infestations are an issue, a termite inspection by an experienced, trained contractor is a must.

Preventative termite measures include keeping any wood products in the dwelling from being in contact with the ground. Make sure that perimeter grading drains water away from the foundation to deprive termites of needed water. No standing water or firewood should be allowed near the foundation. Even cardboard boxes in a garage should be elevated off the floor.

Underground storage tanks (USTs) as a real estate hazard usually relate to heating oil that was stored for use in fueling an oil furnace. These old tanks may have been abandoned years ago when natural gas became available to the dwelling. But the tank may still be in the ground and it may have begun to leak because of its age.

Until the mid-1980s, most USTs were made of bare steel prone to corrosion and leaking. Soil and groundwater contamination can result and remediation costs can be punitive. The key is to determine whether a UST may be present and to then act prudently if one is discovered.

Abandoned USTs may leave telltale signs. The old oil furnace may be long gone, but the fill pipe for the UST may still be in the yard. Be on the lookout for fuel lines coming through the basement walls near the basement floor. All that may be left of the fuel line is the portion still stuck in the wall. The rest will probably have been long ago cut away.

Seller condition reports that are a part of most real estate offers usually require the seller to make a representation about whether the seller has knowledge about any UST. However, do not rely on the seller’s representations alone. A good home inspector can again be of help.

If you find an UST, having an appropriate contractor remove the tank is the only remedy. The seller should undertake this project, never you as the buyer. The reason

One universal remedy to concerns over USTs, petroleum spills, or other environmental contamination is to hire a consultant to perform what is called a Phase One Environmental Study. The parameters of this study do not include taking any soil borings. Instead, the approach is to study the history of how the site was used to determine whether it would be likely that petroleum or other contaminates may have been disposed of on the site. The surrounding area is also studied to assess whether an adjacent contaminated site may have impacted the site. The review typically includes the study of building permits, aerial photographs, historical municipal directories, governmental environmental databases, and a physical inspection of the site. A Phase One study is not cheap and may cost $1,000 or more. However, this expense pales in comparison to the cost of an unanticipated environmental cleanup.

While the preceding discussion should leave you well equipped to handle most property hazards experienced in real estate investing, this list is by no means comprehensive. Until you gain greater experience, you should rely upon a qualified home inspector to uncover every potential problem that might exist in any property you are considering buying.

You will wonder what are the best properties to buy, hold, and rent. Any property has the potential of producing rental income. Even bare land could be rented to a farmer for crop production.

Commercial properties—which are covered further in Chapter 23—are legitimate investment opportunities, but for our discussion here, we are looking at either single-family or multi-family properties.

Single-family properties come in all sizes, shapes, and styles. They are saltboxes, colonials, bungalows, in one, two, or three stories, designed to accommodate a single family living on the property.

Single-family properties are the most common availability in most areas of the country. The best for rental income are …

You do not need to have expensive and potentially fragile features in your rental home. In fact, such features can be a detriment. For example, a property with an expensive carpet throughout may not generate more income than one with less expensive carpet. Yet if the carpet is damaged by a tenant, the loss is less when the carpet is not as expensive.

Consider properties that offer rental income more than ¹⁄100 of the acquisition price. For example, a property that costs $100,000 should generate a $1000 a month in rental income. If the property would only generate $750 per month in income, the property may not be desirable from a real estate investor’s viewpoint.

A property that generates more than the ¹⁄100 formula is an appealing property for the real estate investor. For example, a property that produces $1000 a month in rent but only costs $75,000 to acquire would be a lucrative investment for an investor.

Properties designed for more than one family to live in are called multifamily. These properties are commonly called apartment houses, and the units where people live are referred to as apartments. Even duplexes and triplexes could be accurately referred to as multifamily properties.

Multifamily homes are appealing to real estate investors because they usually generate greater rental income at a lower cost per unit. Often, multifamily units are good real estate investments. It is easier to generate positive cash flow in a multifamily property than with single-family homes.

Properties that you purchase to resell require one thing: a below fair market value price. The only way to make money is to buy below fair market value, or to buy below potential fair market value. These discounted properties may be available because, for whatever reasons, the owner wants rid of the property quickly—perhaps because the property has not been maintained or because of a personal calamity. The better the discount from the market value, the more money you will make when you resell the property.

Properties that are distressed can occasionally be purchased for less than the fair market value. Sometimes owners of properties do not maintain them, and allow them to become run-down. Sometimes, the repairs that need to be made are cosmetic in nature, while others could be extensive and expensive.

Distressed and ugly homes are just that: these are the properties that no one wants—in the condition they are in at the moment. They may need paint, landscaping, cleanup, and more.

Real estate investors may purchase these properties for the sole purpose of flipping them. Sometimes it is after repairs are made. Other times, it is without any work being completed. This occurs most often when these properties are sold to another real estate investor. You will learn more about property flipping in Chapter 10.

Another way to buy properties below fair market value is to acquire them from motivated sellers. These are owners who want to sell the property immediately, and are willing to take less to get rid of the responsibility of owning the property. These owners are often under financial pressure, perhaps from an illness, death, job loss, or divorce. For more information about buying properties from motivated sellers, see Chapter 12.

The Least You Need to Know