Real Estate Investing Basics for newbies-- first post!

My first post…

I am a very small-time landlord looking to get bigger and the info and resources here at REIclub have been incredibly helpful! As a sort of “thank you” to the forum as a whole, I am here posting some of the basic stuff that I wish I had known when I first got started, for the benefit of people who are just starting out without an experienced mentor…

Rule number one for Real Estate investing: you have to look at a lot of properties. There is no way around this. All the screening tools, tips, methods, and rules won’t help you if you don’t have a good “gut sense” for what constitutes a good deal. Looking at 1,000 listings in detail and 100 properties in person in your area will enable you to almost instantly spot which deals are dogs (most of them), which ones are interesting (some of them), and which are right in your wheelhouse. Then you can do all the screening and stuff to compare two or more or just to confirm your “gut sense”, if you want. Warren Buffet decides whether he’s interested in a $100mm business in five minutes or less, without a computer, because he knows what’s out there, and what the golden opportunities look like. And if he has to do complicated calculations and projections to justify it, then it is, by definition, not an awesome deal.

That means, sign up for tons of listings, and go to lots of open-houses. Every realtor in the world wants to email you listings. Take them up on it. Not all listings are created equal, and they are esy to unsubscribe from. You may find that you need two or three sites with full access to get complete listings-- this one has more pictures, that one includes disclosures, this other one has more detailed property data, etc. Sign up to have them email you everything in every town you know anything about, whether or not you are interested, in all price ranges. First step is to get a feel for the market, to know what’s out there. Your “price range” and “preferred zip codes” might change quite a bit once you see what’s really out there. Equally important, you need to check those listing emails every day, or preferably as soon as they show up in your inbox. The very best deals are often put under agreement in a matter of hours from listing, and if you wait until Sunday afternoon to look at listings, a lot of the plums will have disappeared. Even if you can’t do a deal in hours yourself, those ones that get snapped right up are the ones you want to have on your radar (there will be more of them), because those are the ones that you want to use to build your own strategies around.

Basic terms and concepts:

- Investing in a strict sense means buying a stream of income. You buy an apartment building for $300,000, and you collect $30,000 in rent per year (or whatever). You’re buying that stream of income, the building and land are incidental. If you do this, you should stick to properties that are likely to return significantly better than the stock market would return compared to your initial cash outlay, since stocks offer a lot less downside risk (more on this later).

- Speculation means buying something with the expectation that somebody will buy it at a higher price in the future. There is nothing wrong with speculating, so long as you are doing it with your eyes open, and not confusing it with “investing”. For example, Florida tends to display a pronounced boom/bust cycle with property values. Right now it’s pretty busted and there are a lot of nice towns where you can easily buy a house for $30~40k that is likely to increase significantly in value when/if baby boomers in the Northeast are finally able to sell their homes for more than they owe. That might take five or ten years or more, but it probably will happen, eventually. What you are “speculating” on is whether the upkeep, taxes, etc will devour all of that profit in the meantime, and whether you could earn equal or better cash returns by “investing” in something that’s putting money in your pocket every month. If you speculate, you should only do so if you reasonably expect to earn better returns than you would by investing, since investment returns are immediate and can be immediately reinvested.

- Arbitrage means buying something at a lower price than it can be re-sold for right now. In real estate, this tends to take the form of either “straight flipping”, (E.g., you buy a house for $50k and instantly put it back on the market and re-sell it for $100k), wholesaling (e.g., you set up some arrangement whereby you find great deals, put them under contract, and then pass the contract to buy onto another buyer while collecting a middleman differential without ever actually owning the property yourself), or rehabbing (where you purchase and fix up a property that can be immediately re-sold for more than the purchase+repair cost). Any of these strategies can work, and real-estate that is available for sale at arbitrage (i.e. below-market) prices absolutely do exist (more on this below). Obviously, arbitraging is an easy way to make money if you can spot the deals and lock them up before anyone else does. The hard part is both honing your skill at evaluating such opportunities to snap them up quick enough, and also the back-end work required to set up access to capital, buyers, and contractors that enables you to move them.

Financing concepts:

- “Regular” FHA-type Mortgage This is the sort of low-interest loan that most people use to purchase a primary residence. Far and away the best way to go if you can get it, since it is the cheapest, safest, and surest way to borrow, and since the bank-approval process includes a number of built-in safeguards to protect the novice (the bank is looking out for their own money, after all). Also typical requires very low down-payments if you are planning to live in the place. Downsides for the investor are that they tend to be slow and uncertain, which means a cash buyer or privately-financed buyer might steal the deal from under you simply by offering more certainty and a quicker closing (most common on the very best deals), and perhaps even more importantly, those very protections may exclude some of the best deals from qualifying: for example, a home that is not currently habitable (in some places, this might simply mean that it has peeling paint, or is missing a sink) typically won’t qualify for a conventional mortgage, although it might qualify for a rehab loan. Additionally you typically need to pass credit and income criteria that might exclude you from some really good deals.

-Rehab loan (203k). This is basically a conventional mortgage that also includes the cost of rehabbing (fixing) the property. E.g., you find a house for $50k that needs $50k in improvements, so you take out a mortgage for $100k to cover both the purchase and fix-up. This can be a fantastic way to go for a novice investor who could qualify for a conventional mortgage, since it allows you to compete with cash buyers for deep-discount properties. Moreover, it offers very broad latitude to rehab the place you want it to be, provided that the total cost won’t exceed the projected resale value. There are a lot of rules, and the bank isn’t simply going to hand you the extra dough on your say-so, but there are bankers who specialize in this and who can make the process very smooth and turnkey, so the first step is to get in touch with one of them (ask a realtor for a referral to a lender who specializes in 203k loans).

- Commercial Mortgage is what the bank will typically offer you if it’s a non-residential property, or if it’s more than 4 units. Typically requires a high down payment (20% or more) and/or an EXTREMELY high loan-to-value ratio, and commonly involves “balloon” or “bullet” notes, which means, for example, a five- or ten-year mortgage amortized at 20 or 30 years. IOW, for the first five years, you make small payments as though it were a 20-year mortgage, and then at the end of five years you have to pay the entire balance of the mortgage, or else re-finance it. Hard to get and not advised for newbies unless you have very sound financial backing.

“Creative” financing: this website offers a ton of nitty-gritty resources for how to do unconventional financing, and the first step is to sign up and watch all the videos and read all the articles. Broadly speaking, unconventional financing tends to fall into three categories:

  1. “Hard Money” lenders, who are not quite “banks”, but rather companies that specialize in lending to real-estate investors outside the parameters of conventional mortgages. Typically they offer high interest rates (often credit-card-like), and require high loan-to-value ratios (IOW, the loan is for no more than 60~70% of the immediate resale value of the property). These are best suited for short-term “bridge” loans while you re-hab, flip, or otherwise arbitrage a property. The advantage for the investor is that these lenders don’t usually care about your credit or funding, they look at the deal from the perspective of a real-estate investment, and are willing to provide quick cash and/or proof of funds as long as the deal is good enough.

  2. Private Lenders. These are just people with money who are willing to lend it to you. If your parents are rich, this is an easy concept. But it is surprisingly possible to get complete strangers to lend money if the deal is right. Investors are interested in returns. If you can present them with a collateralized deal that shows a high margin of safety and better-than-average returns (e.g., a piece of real estate purchased for 70% of resale value, with 10% interest going to them plus full foreclosure rights), then that’s a much better deal with much better security than a lot of doctors, lawyers, retirees, etc are getting from stocks or bonds. Perhaps surprisingly, older or semi-retired real-estate investors might be the most keenly interested, since they “get” the concept immediately, and are happy to let you do all the work in exchange for taking a piece of the profits. This site has a ton of great resources on how to arrange this even if you don’t have rich parents. It takes some work, but is a fantastic way for beginners with more time than cash to make money.

  3. Seller financing. This is a variant of private lending, where you get the seller, instead of taking a lump-sum payment, to basically become the bank, and issue you a mortgage. This might sound like crazy-talk, but for certain sellers, it’s actually a significant advantage, since they can reap significant tax advantages. In fact, it is often a selling point in big-ticket deals that the buyer is willing to let the seller carry the note (as opposed to using their own cash or financing). To make this work, you have to find a just-so seller who doesn’t necessarily immediately need the money, who isn’t underwater, and who just wants to retire from the business of owning the property. The ideal candidate is a property that is currently under-utilized and that the seller doesn’t want to deal with anymore.

Other rules, concepts, and guidelines

There are a ton of “rules of thumb” when it comes to real estate. Probably the most common is “location, location, location”, followed closely by “all real estate is local”. Both are absolutely true. More investment-specific rules you may hear are things like the “1% rule”, or the notion that, as a baseline, a rental property should generate 1% of purchase price per month in gross rents (this is frequently scorned on landlord forums as a “seller’s rule”, and aggressive investors frequently favor 2% or more). Another you may hear is the “50% rule”, or the notion that you should expect 50% of the gross rents to go to maintenance and vacancies, especially in reference to lower-income rentals. Yet another is the “75% ARV rule”, or the notion that rehabs should be evaluated such that the total cost to purchase and rehab should be less than 75% of the after-repair resale value. And so on and so on. Scour forums like this, and you will find all kinds of conflicting “rules”.

These kinds of rules of thumb can be very useful for screening properties, but have to be adjusted based on the particulars of location and strategy. Obviously the best properties are those that offer good metrics as an investment (positive cash flow), speculation (high likelihood of appreciation), and arbitrage (available for less than immediate resale value). Those kinds of deals also get snapped up very quickly, and require a keen eye and the ability and willingness to act fast (possibly including a willingness to buy sight-unseen).

Local factors such as tax rates, desirability, the local rental market, etc can make a massive difference in the application of various “rules of thumb”. For example, an immaculate heirloom home on a tree-lined street bordering an ivy-league university will likely always be easy to rent to stable, high-quality tenants who will pass credit/background checks, who will take care of the place, and who will provide ample notice of their move-out date and accommodate showings and so on. Moreover, such a place is likely to fare well on speculative metrics, not just in terms of property appreciation, but also in terms of rising rents.

On the other hand, a few blocks away there may be a rough-and-tumble neighborhood with a lot of police activity and crime, where potential tenants are apt to have worse credit, be less reliable, take less care of the property, and may have a high rate of drawn-out evictions or periods of non-payment. Moreover, the speculative “crystal ball” might be a lot iffier, and it may be much harder to keep the place occupied (especially if you are selective about tenants), and there may be a lot of downside risk to rents and property values.

In the first case, where you are renting to visiting professors, graduate students, and so on, expecting 50% maintenance and vacancy costs might be patently ridiculous, and following the “1% rule” could make you quite a bit of money over the long haul. In the second case, you might go broke fast following the “1% rule”, but you also might make quite a bit of fast cash by investing more aggressively in riskier properties. Moreover, if you eagerly buy into one neighborhood or the other without realizing that tax rates in one are twice as much, all your “rules” might be completely negated by massive property taxes.

The point is that all of the rules need to be adjusted according to the local particulars. One thing to be careful of is that active members of real-estate forums are probably more heavily-geared towards small-time aggressive cash-flow properties than the bulk of real-estate dollars are. IOW, Donald Trump might be moving and making a lot more in RE than all the posters on this forum combined, but his views are not necessarily represented as heavily as the “50% and $100 per door” crowd. Which doesn’t make any or either right or wrong, it just means to do your own homework, look at tons of properties, and hone your “gut sense” for good deals.

Useful resources

  • note that the “zestimate” values are close to meaningless. The “range” values are slightly better. But the most valuable info is the surrounding “recently sold” properties, along with the detailed public records data. Also be sure to Google “zillow alternatives” for more useful sites.

  • once again, the averages can be a bit iffy, especially where there is wide variation, but seeing the percentile values and the map view of local rentals is huge.

  • especially for rental values. Apartment for rent listings on CL often have pictures and details about whether deposits, credit checks, etc are required or pets are allowed or parking is included, etc. Posted by other local landlords, they can give a much more meaningful “gut sense” of what the local rental market is like than the pure numbers of rentometer. Don’t hesitate to call other landlords and be right up-front that you’re a newb landlord and looking for advice-- 99% of them will offer whatever tips and advice they can, and will see you not as a competitor but as a kindred spirit.

  • NOLO Legal guides for Landlords. If you charge anyone rent, please, PLEASE, if you do nothing else, buy the NOLO package for landlords. It could save you a world of hurt, and you CANNOT take legal advice from forums, since laws vary MASSIVELY by jurisdiction.

  • RSMeans: the standard pricing guide for trades (meaning construction, electrical, HVAC, plumbing, etc). At least buy a used copy of the residential remodeling book. Trying to evaluate real estate is basically impossible without without having some way to guesstimate the costs of new siding, a new roof, driveway paving, new appliances, etc. An RSMeans book can be under $20, or a full contractor’s book+software package can be $1,000+. Either is a bargain.

  • (edit: almost forgot this very important one!) A decent real-estate screening tool. You can google something like “cash flow analysis spreadsheet” or “Real Estate software” to find boatloads of software tools, from free to very expensive, from simple to very complex. Some will include all kinds of standard deviation ranges, alternate models, tons of points of input data, others will basically ask for price, rent, and loan amount, and spit out a monthly cash flow. Personally I favor the simple ones-- the more details, the more assumptions, and so on, the more you run the risk of being precisely wrong instead of approximately right, so to speak. But it will be hard at first to know how much to input for maintenance costs, vacancy rates, etc, so I recommended trying a bunch of them and experimenting with the defaults to get a sense of where the averages are.

Hope some of that helps someone half as much as this forum has helped me!


I did not have time to read your whole post but your meaning for Arbitrage is incorrect.

An Arbitrage in basic terms is where I look to borrow say $10m at prime rate due in 10 years and I take that money and I spend $9m and I buy government bonds that pay prime and mature in 10 years, then I pocket the remaining 1 million dollars.

  1. The nearly simultaneous purchase and sale of securities or foreign exchange in different markets in order to profit from price discrepancies.

  2. The purchase of the stock of a takeover target especially with a view to selling it profitably to the raider.

That is Arbitrage in it’s purest form!!!


Nice post, Commander Q!

Thanks for taking the time to spell out the basics. Welcome to this forum and I hope to read more of your posts.



If buying and then immediately selling at a higher price is arbitrage, then why doesn’t this also apply to the property flipping scenario? I see this as equity arbitrage.

#2 is really speculation. There is no arbitrage opportunity because the resale price today for the asset you are purchasing today is the same as your purchase price. You are purchasing and HOPE to resell for a profit – that is speculation.

In the lending industry, the term “conventional loan” or “conventional mortgage” has a very specific meaning. A conventional loan is ANY loan that is not insured by the federal government. In other words, a conventional loan is any loan that is not an FHA loan or a VA loan. The loan you get from any funding source other than the FHA or VA is a conventional loan. This would include your bank, credit union, hard money lender, or private lender.

VA and FHA loans are generally only available to owner occupant buyers and have a down payment requirement from 0% to 3.5%. Conventional loans, on the other hand, could have down payment requirements as high as 30% for the non-owner occupant investor.

Investors (non-owner occupant buyers) can get conventional loans for residential property without having to resort to the commercial lending market. Conventional mortgage lenders that sell their loans to Fannie Mae or Freddie Mac will also have restrictions on the number of financed properties that the borrower can own before obtaining a new loan or even refinancing an existing loan.

[b]-Rehab loan (203k). [/b] This is basically a conventional mortgage that also includes the cost of rehabbing (fixing) the property. E.g., you find a house for $50k that needs $50k in improvements, so you take out a mortgage for $100k to cover both the purchase and fix-up. This can be a fantastic way to go for a novice investor who could qualify for a conventional mortgage, since it allows you to compete with cash buyers for deep-discount properties. Moreover, it offers very broad latitude to rehab the place you want it to be, provided that the total cost won't exceed the projected resale value.

The 203k rehab loan is a government insured loan that is only available to owner occupants (investors need not apply). Therefore, by definition, this is not a conventional loan. It has been a few years since I explored 203k loans, but at the time, the loan amount could not exceed 85% of the after-appraised value (not necessarily resale value), and the rehab cost had to be at least $5000. All repairs had to be performed by professional and properly licensed workmen (do it yourself work not allowed) and the finished work had to be approved by a HUD approved inspector. As I recall, there was also a six month rehab timeline involved.

[b]- Commercial Mortgage[/b] is what the bank will typically offer you if you are either not planning to live in the property, or if it's a non-residential property, or if it's more than 4 units. Typically requires a high down payment (20% or more) and/or an EXTREMELY high loan-to-value ratio, and commonly involves "balloon" or "bullet" notes…

While commercial loans can be used to purchase any real estate, even the residential property you plan to live in, they are not required for the investor purchasing a one-to-four unit residential rental dwelling. Conventional mortgage lenders will also give loans to rental property investors who do not plan to live in the property.

[b]Other rules, concepts, and guidelines[/b]

More investment-specific rules you may hear are things like the “1% rule”, or the notion that, as a baseline, a rental property should generate 1% of purchase price per month in gross rents (this is frequently scorned on landlord forums as a “seller’s rule”, and aggressive investors frequently favor 2% or more). Another you may hear is the “50% rule”, or the notion that you should expect 50% of the gross rents to go to maintenance and vacancies, especially in reference to lower-income rentals.

The 1% rule was espoused by Carleton Sheets back in the late 80s and early 90s as a rule of thumb screening tool. The premise of the the 1% rule is if the monthly market rent for a particular property was at least 1% of the purchase price, the property should generate a positive cash flow for the rental property investor. Of course, it was OK if the cash flow was just $25 per month; the investor was told to buy 100 properties and “retire” on the cash flow they generated. The 1% rule was a valid quick and dirty screening tool 30 years ago, but as property prices increased faster than rents, the 1% rule has fallen out of favor with the 2% rule now used instead.

I don’t know if Mike Rossi is the creator of the 2% rule, but he is certainly a strong proponent in these forums (Mike’s username is propertymanager). Mike’s concept is that you should not pay more than 50 times the monthly rent for a property if you expect a positive cash flow. The amount you pay for the property is the total amount of cash needed to purchase and rehab the property. Restated, if the market rent for a particular property is at least 2% of the total cost of purchasing and rehabbing a property, the property will probably generate a positive cash flow, even with 100% financing.

Note that the 1% rule and the 2% rule are not intended to determine rents, but rather use market rents to establish a maximum purchase price for the subject property.

Somewhere in between the 1% rule and the 2% rule, there is a large contingent of real estate investors who use the 50% rule to estimate a property’s cash flow potential. The 50% rule says that, as a general rule, if 50% of the market rent for a particular property will pay 100% of the operating costs, then the property will probably generate a positive cash flow. Operating costs include everything you would pay for ownership and operation of a rental property that you own free and clear. Property taxes, hazard insurance, maintenance, repairs, advertising, leasing costs, legal fees, management fees, utilities, pest control, cleaning, rental licenses, HOA dues, vacancy and rent loss allowances, as well as some contribution to a replacement reserve fund for major systems replacements are all included in operating costs as well as anything not mentioned that the landlord pays for. This leaves 50% of your market rent to cover your debt service and also leave enough left over for your cash flow. The 50% proponents generally want a minimum cash flow of $100 per unit.

Hope this helps.

Thanks very much to Dave_T for the clarification on conventional mortgages. I edited the top post to reflect it. It’s very possible that there are other things that could use some clarification/correction!

@ Gold River, thanks for the alternate view of “arbitrage.” My intention with the three approaches (investment/speculation/arbitrage) was to illustrate the three basic principles and then connect them with real-estate-specific opportunities/strategies. In particular to help a novice understand the differences, as a lot of people tend to lump all those approaches under “investment”: e.g., “investing” in gold is really pure speculation (or possibly arbitrage, if you’re buying it at a lower price than the pawn shop up the street is paying in melt-down value, for example).

To clarify what we are talking about for the benefit of beginners, the basic principle of arbitrage is taking instant advantage of market inefficiencies, specifically buying something that can be immediately re-sold at a higher price (e.g. you buy discount jewelry and then re-sell it at a higher price for the melt-down value of the gold).

More nuanced forms of arbitrage might include finding securities such as bonds or derivatives that are returning better yields/selling at a lower price than some other effectively identical security, or buying, for example, a struggling chain of retail jewelry stores if the purchase price of the business is less than the melt-down value of their precious-metals stock. Professional arbitrageurs might actually end up with some rather complicated exchanges in order to collect very small percentages (e.g. buying Yen with dollars, then buying oil futures in Yen, then selling the oil futures in British pounds, then converting the pounds back into dollars to take advantage of tiny, nearly-instantaneous price discrepancies between the Japanese and British markets in oil futures or whatever).

But in either case, the “arbitrage” is the difference between immediate market value, and what you can buy it for. IOW, you’re not waiting for it to appreciate (speculation), nor are you counting on it to provide income (investment) in order to make money.

In RE, the simplest example of “pure” arbitrage is straight re-selling, and I think my examples in the first post are fairly valid in terms of relating the principle of arbitrage to real estate opportunities for beginners, so I’ll leave it as is. But having more perspectives certainly doesn’t hurt!

Pure arbitrage is the simultaneous buying and selling of an asset, profiting on the spread. Not sure that you can really simultaneously sell real estate any more, but there are still arbrtrage plays available.

Buying a property with conventional financing then re-selling it at the same price with seller financing at a rate 2 points higher than the underlying mortgage is interest rate arbitrage. Buying property at a discount then flipping for a higher price is equity arbitrage.


 I have always equated Arbitrage as a meaning refering to the financial and securities industry!

An Arbitrage is meant as the previous poster stated to be the spread on paper, not physical things like property and I have never heard the word Arbitrage ever spoken till now in regards to real estate.

Now I guess if you were buying a Trust Deed and selling it for the spread the same day we might think of it in terms of Arbitrage, but were really thinking then of the Trust Deed as a securities.

It’s just like refering to a moose as a mousse, one is an animal and one is a desert, and neither one has business being refered to with the other!

I disagree with Dave as I would not consider a transaction that may take months to achieve an Arbitrage as the security is physical property and not a security. Now I do agree that a loan taken at one rate (Prime) and resold at another more profitable rate (Prime Plus) is arbitrage however I don’t believe Arbitrage applies to real estate.

Buying paper at a low price and reselling paper for a higher price is Arbitrage!