How To Make Money With Real Estate Options

How to make a living investing in real estate

When it comes to real estate income, there are two ways to generate cash. You can generate passive income by buying and holding, while you can generate an active income by flipping contracts, doing renovations or adding value in another area — such as putting together property development deals. It might seem overwhelming at first, but it won’t be as intimidating once you gain experience. 

When most people think about making money in the real estate sector, they ask the following types of questions: 

How can I invest in real estate with no money? You can utilize a variety of methods that includes any of the following: 

  • Seller financing through lease options
  • Trading fixed assets such as cars, jewelry and more
  • Taking over someone else’s mortgage payments who might be in a distressed situation
  • Bringing in an investment partner with cash
  • Borrowing from a bank or getting a hard money loan 
  • Taking out a home equity line of credit
  • Utilizing a peer-to-peer lending network 

How does a real estate investment work? Real estate investing works on the concept of cash flow, which means that your income has to exceed your outgoing expenses. This is known as a positive cash flow. This can work for both long-term residential and commercial rentals as well as it will work for short-term vacation rentals. 

Is it good to invest in real estate? Absolutely. This is one of the sources (aside from being a business owner) that has generated the most wealth in our history. 

What is a wholesale deal in real estate? Wholesale is akin to flipping properties, except you never take ownership of the home when you flip real estate contracts. You can learn the specific strategies for doing this from REWW and other data aggregators for the wholesale flipping market.

That being said, there are eight primary strategies for generating a real income in real estate. Whether you can earn a passive income or active income depends on the strategy you implement. 

Related: 8 Ways Real Estate Is Your Smartest Investment

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4. Rent APortion Of Your Existing Home

If you aren’t sold on the thought of purchasing a home only to recoup your money little by little, you could first test the waters by renting a portion of your house. You have a couple of options to do this.

First you could rent a spare room in your home or you could rent the basement. If you’re yet to purchase your first home and like this idea you could even buy a duplex and live in one apartment and rent the next.

The advantages to renting a portion of your house is that you get to watch your tenant closely. It’s less likely that a tenant will try to stiff you for the rent payment when you’re in the same household. Renting a portion of your house also gives you the ability to get a feel for what it’s like to be a landlord without making such a huge monetary investment.

Our friend Michelle recently wrote about renting a room to a stranger, which is a great read if you’re considering this option.

3. Option a Property

A third way to make money in Real Estate investing without money or credit is to “Option” a property. 

How It Works

This type of transaction is similar to a Lease Option, but very different as well. Consider it a Lease Option’s cousin, who is much hotter and more fun.

Here is the simple difference between the two:

  • Lease Option: the seller has agreed to take a monthly payment for a specific amount of time, with a set purchase price to come at some point in the future. I do not accept any less than 5 years for these transactions and try to get ten years. 
  • Option to Buy: the seller is not accepting monthly payments. They have simply given you the exclusive right to buy a property at a certain price for a certain period of time.

Why would a seller choose one over the other?

Let’s look at a few circumstances and reasons that may persuade a seller to decide one way or another.

  • With an Option, the seller can continue to live in the house. At the same time, he/she will continue to make the monthly payment and take care of all maintenance and repairs.  The seller may not want to accept monthly payments, with the idea of someone else is living in their house.  While they may be motivated to sell, the thought of someone else eating dinner and walking around naked where they raised their children may be too much for them to handle. 
  • They may not have the time required for a Lease Option. If a seller is ten months behind on their payments with foreclosure knocking on the door, and you (the investor) don’t want to make up those payments and there is still a TON of equity in the house, an Option may be your only choice, short of paying cash.
  • With a straight “Option” the seller has nothing to lose. You have a set amount of time to buy their house, which you will only do if and when you find a buyer at a higher price than you have an Option for.  In this type of transaction, your target audience is not the B/C credit buyer, but rather the individual with cash or the ability to go to a bank and get a loan.

Why You Should (or Shouldn’t) Invest

The positives for you the investor, are as follows: You are not dealing with tenant buyers, repairs left by tenant buyers, angry sellers, evictions, lawsuits, monthly payments with no tenant-buyer… the list goes on and on. 

The negatives are you do not make any money at all unless you successfully find a qualified buyer within the time allotted in your Option to buy. The seller benefits because they pay no Real Estate commission, and they have the privilege of living in the house while you are trying to sell it.

Strategies for successful real estate investing

Whatever form your real estate investment takes, certain strategies will stand you in good stead.

  • Be financially prepared: Real estate is a particularly expensive investment, so you need to have cash on hand for a down payment, partnership share, or to buy a property outright. You’ll also need a reserve to dip into if and when something needs fixing, which should be entirely separate from your everyday emergency fund. Before getting started, establish an emergency fund, pay off consumer debt, and automate your retirement savings.

  • Get to know the local market: There’s an old saying: “The three most important factors in real estate are location, location, location.” Start by getting to know the local market. Talk to real estate agents and locals; find out who lives in the area, who is moving to the area, and why; and analyze the history of property prices. In short: Do your research and “focus on building relationships with people — because that’s what real estate is, it’s a relationship-based business,” Dana Bull says.
  • Keep it simple: A simple strategy can go a long way in real estate investing. If your goal is to generate passive income, don’t be fooled into believing you need to go big to make it happen. It’s best to start small and keep your expenses low, says real estate investor Chad Carson of CoachCarson.com.

2. Airbnb and Vacation Rentals

For those who want to invest in a property but still retain flexible access to their home, rentals can present a lucrative path to profits and one of the fastest ways to make money in real estate. 

Not only can you make some side hustle income from vacation rentals, but you could potentially make a significant amount of money and build up a substantial passive income stream if you’re in a highly-trafficked tourist locale. 

Places like San Diego and other tourist hotbeds are well known for having a high demand for these short-term rentals.

There are plenty of platforms you can use to promote your short-term rental property. List your home on websites like Airbnb and Vrbo. Be sure to take good photos and go above and beyond in making your guests’ experience a memorable and comfortable one. You can also hire a vacation rental company to help you manage your property and bring business. 

2. Real estate investment trusts (REITs)

If you want to wade into real estate, investing in a real estate investment trust (REIT) will provide exposure to the market without the time and cost commitment of buying your own property. 

REITs are companies that own, operate, or finance properties and real estate ventures. Like mutual funds or exchange-traded funds, they own not just one, but a basket of assets. Investors purchase shares of a REIT and earn a proportionate share of the income produced by those assets.

Equity REITs, the most common type of REIT, allow investors to pool their money to fund the purchase, development, and management of real estate properties. A REIT focuses on a specific type of real estate, such as apartment complexes, hospitals, hotels, or malls. Ninety percent of its annual earnings must be distributed to the investors as dividends.

One big selling point of REITs: Most of them trade on public stock exchanges. So that means REITs combine the opportunity to own, and profit from, real estate with the ease and liquidity of investing in stocks. 

Geared towards generating income, usually from rent and leases, REITs offer regular returns and high dividends. They also appeal to investors because of the unique way that they are taxed: REITs are structured as pass-through entities, meaning they don’t pay corporate tax. This effectively means higher returns for their investors. 

If you want to keep your investment liquid, stick to publicly traded REITs (a few REITs are private ventures). You can buy shares through a brokerage firm, IRA, or 401(k). 

3. Residential Real Estate Income

Residential properties offer a variety of ways to make money. Whether you want to generate monthly income or one-time revenue, different options can suit your needs. The best residential strategy often depends on your preferred level of involvement — though they all require a certain level of research to be successful. Here are just a few different ways to break into residential real estate:

Buy and Hold

Buy and hold” is the most popular investment strategy for residential real estate. As mentioned in the previous sections, you can buy a property and hold it until it appreciates, or you could rent it out to tenants.

You don’t have to own a separate property to buy and hold, either. You can use this investment strategy to make money at your primary residence. You can rent out rooms in your house (a great way to collect extra money for the mortgage payment), or if you own a multi-family home, you can live in one unit and rent out the others.

When you rent out a property to tenants, you’ll become the de-facto landlord of the property. You’ll have several landlord obligations to fulfill, including hiring contractors to do maintenance tasks when needed (you’re the one who’s got to hire the plumber). If you fail to perform those obligations on time, your tenants—in most states—are legally entitled to withhold rent payments.

If you’re only trying to develop a passive income, you might opt to hire a property management company to manage your properties. Most property management companies will charge between 8-10% of your monthly rental income, but they’re a godsend for investors who are too busy to handle landlord duties or screen new tenants.

Fix-and-Flip

House flipping” has become one of the most exciting types of real estate investments—hence the large number of TV shows dedicated to them.

A fix-and-flip investment is when you purchase a run-down or low-valued property. Over a short period, you renovate the property to increase its value, and then you sell it for a profit.

You can generate significant returns with a successful house flip, but they’re challenging and not always suitable for beginning investors. You need to have a good sense of how much renovations will cost (the higher the renovation cost, the lower your profit margin) and how much those renovations will affect the home value.

Vacation Rentals

If you buy a property in a desirable location for travelers, you could rent it out as a “short-term rental,” also known as a vacation rental. Vacation rentals are more popular than ever, thanks to websites like Airbnb. These properties can be tremendously lucrative investments, even when you’ve accounted for cleaning costs and website commissions.

It’s important to know that short-term rentals are being increasingly regulated, primarily due to the escalating housing crisis in the United States—many state and local governments are apprehensive about properties being held as vacation rentals rather than being used for long-term housing.

Keep up with the housing laws in your local market so you’ll know whether or not a vacation rental is permitted.

2. Lease options

Lease options can be a great way to get involved in real estate without having to put up a significant amount of capital or even have great credit at the outset. You’re leasing with an option to buy. This tends to work well when the real estate market is climbing because you’re creating a pre-set price at which you can later purchase the property.

If, for example, the property market climbs substantially, you can buy that property at a discount. You could also potentially turn around and sell your rights for that purchase to someone else. The clear bet here is on the bull market in real estate. As long as this is an option you can exercise and not something set in stone that says you have to purchase at the end of the lease regardless, then you could very well turn a profit.

Whats the Best Way to Make Money in Real Estate?

If you can stomach hearing no several times a day and maintain a constant follow-up file with all wholesale offers made, you will make more money in Real Estate than most “house flippers” you see on TV.

Money can be made in Real Estate in several different ways. I will never claim a particular technique is not worthy of your time. They all work, some just better than others. 

The smartest and best investors do not focus their time solely on rentals or rehabs, and they never swing a hammer or do rehab work themselves.

The best and most successful Real Estate investors are the ones who focus on being transaction engineers and becoming masters of negotiation, relationships with other investors and accepting the fact that the real money is made in pushing paper, not hammering nails.

As you grow in your Real Estate investing career, you will always want a constant portfolio of different types of transactions going on at the same time. Some investors focus on one particular strategy and make a lot of money. 

However, I would rather have the knowledge to take any deal that came my way and turn it into cash. I constantly have a steady stream of wholesales, lease options, rehabs, new construction, and anything else I can get my hands on. 

As previously stated; all of these strategies (and many more I have not mentioned in this article) have their place and can make money fast. However, for the new investor, dead set to make the millions of dollars promised by the “Gurus,” focus on Options and Wholesale deals.

Example of a Real Estate Option

Here is a comprehensive analysis of risk and reward for a real estate option scenario. Assume a builder has $500,000 and wants to purchase land listed for $2 million. The builder is unsure of a few things:

  1. Can the builder raise $1.5 million through bank loans or other sources?
  2. Can the builder gain necessary permits for residential or commercial development or further subdivision of the property?
  3. Can the builder raise money and obtain permits before another builder buys the land?

In this situation, a real estate option is appropriate. For a defined non-refundable cost (called the real estate option premium) of say $25,000, the builder can enter a real estate option contract with the seller. The real estate option allows the builder to lock down the property sale price at $2 million over a period of six months.

The real estate option contract could include the following conditions:

  • Property details (location, size, and other specifics)
  • Duration of the contract (six months from agreement date)
  • Option premium or consideration amount ($25,000 non-refundable premium paid by the buyer to the seller in a lump sum)
  • Agreed purchase price if the option is exercised during the contract ($2 million)

6. Commercial Property Rentals

Commercial real estate is one of the fastest ways to make money in real estate. This means flipping properties and developing them, adding value to properties in order to increase their net incomes through renovations and upgrades. You’ll also consult on projects that might take more seasoned real estate investors to see to fruition.

Final Thoughts

You can make money from real estate in countless ways. But start with the ideas above as you explore how to make money in real estate investing.

If you don’t know where to begin, try investing $10 in Fundrise or Groundfloor to start building a real estate investment portfolio. Everyone has $10, and just the act of creating an account and investing a few dollars will help you start down the path of making money with real estate.

You can scale up from there as you see fit, but the important part is taking the first step.

Which ways to make money with real estate appeals to you the most? Why?

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1. Increasing Property Value

The most common way to make money in real estate is through appreciation. Appreciation is when a property grows in value.

You might purchase a property for $400,000, and over the course of 10 years, it appreciates to a value of $500,000. Sell the property, and you’ll have profited $100,000.

Most properties tend to appreciate, and that’s why real estate is such a popular industry for investors. There’s an excellent chance that your property will eventually be worth more than what you bought it for.

Let’s talk about land first. “Land” is any property that has few or no existing structures. Land tends to appreciate for two reasons:

  • Development: Land may appreciate if you construct a house or commercial building. Or you could refurbish structures that are already on the land.

  • Natural Resources: If you discover gold or oil on your land, it will almost certainly skyrocket in value. You can also sell land rights to companies that wish to harvest resources off your land—typically, you can earn a percentage of whichever resources are collected.

Residential and commercial properties appreciate for three main reasons:

  • Location: This is the main reason residential properties appreciate. Properties are more likely to grow in value if they’re located by schools, commercial centers, scenic areas, or popular destinations.

  • Development: A property will appreciate if the surrounding neighborhood sees new developments or redevelopment (but a property may also decline in value if the neighborhood decays).

  • Improvements: A property may appreciate if significant building improvements are made. This is the main idea behind fix-and-flip investing.

Inflation in Property Value

Inflation in Property Value

Don’t forget to account for inflation—how prices increase over time. Inflation will cause your property to be a little less profitable than what you’re selling it for.

For example, your property may have appreciated by $200,000, but the average home price may have increased by $70,000 over the same period.

Keep this in mind when you’re trying to calculate your returns on a prospective property.

The Bottom Line

Real estate options offer an alternative method to trade, invest, and profit from real estate investments. They can be considered a type of over-the-counter contract between two individual parties. There is no exchange market for these types of options but there can be creative provisions that could potentially allow a buyer to sell the option while still in an active holding period. In general, the involved parties must ensure that the option contract provisions are appropriately written, fair, and adhered to by those involved.

Real estate option contracts can offer some alternative ways to make money but generally one of their biggest advantages is the diversion of large risks. Real estate developers could benefit from holding multiple real estate option contracts and potentially only exercising a selected few based on evolutions during the holding period. A contract holder may also choose to forego an option if changes occur during the holding period like a new busy highway or an increase in crime.

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