The Best First Investment

Many aspiring real estate investors want to have a plan for how to succeed and build a strong portfolio. They want to build wealth and have heard stories about other investors making lots of money through flips or rentals. But what is the best first step? There can be so many “voices of wisdom” and so much “advice” that it can become paralyzing. New investors want to know how to get started on solid footing and make a strong first purchase. I know I did. So what is the best way to begin on the real estate road to riches? Is there a strategy or formula to follow? How do you start with a winner?

My real estate story started pretty simply, and I think that my approach is the easiest way to begin to build wealth through property. I believe that buying a well-appreciating primary residence is the best first investment. In 2002, when I was buying my first home in Nashville, TN, I took time to understand the real estate market. I learned how to look at every property with an eye toward its potential profit. I was searching for a good deal, for a property that already had some equity in it and one in which I could also increase its value through improvements. The more I looked at properties on the computer and in person, the more I started to grasp the characteristics of the different neighborhoods around town. I learned which neighborhoods were out of my price range, which ones were stagnant or declining, and which ones were improving. I soon narrowed my searching to two zip codes, with my focus being about 80% on the zip code that I thought had the most upside.

I ended up getting a brick cottage in the historic Lockeland Springs neighborhood in East Nashville, which was the bulls-eye of the target location I was aiming for. In hindsight, my wife and I somewhat unknowingly timed the market perfectly, as we bought into the close-to-town neighborhood before the values shot up considerably over the next few years. This first purchase was to live in, but it ended up being a fantastic investment after selling it two years later for a substantial tax-free profit.

my first home in East Nashville

I am not suggesting that each investor should sell their primary home and move every two years. But other than in a few very high priced markets, owning a home is mathematically more sensible than renting one. The owner gets to build equity through mortgage payments, improvements to the property, and neighborhood appreciation. Many homeowners want to put down roots and live in one house for many years. That is fine. Selling the home is not the only option to realize the monetary gains. The equity can be drawn out through a home equity loan, which is often the source of a down payment for the first rental property or flip.

Do average homebuyers approach their purchases as investments? Not really. Some of them discover that they have a great asset that has increased in value along the way, while others bought into a generic subdivision that has barely kept up with the rate of inflation.

Wise buyers that have an investment mentality will choose a home that is a wealth-building tool. Before beginning a housing search, it is important to set a realistic housing budget that doesn’t stretch the limits of the buyer’s income. It is imperative to save money each month and not be “house poor.” After the purchase price limit is set, buyers should see what their money will get them in different parts of town. It is always better financially to buy into the best neighborhood you can afford, even if it means a smaller house or one that needs updates. Quality neighborhoods are typically zoned for the highest achieving schools and have a track record of solid appreciation. I choose to invest near the city center, but there are other established neighborhoods farther from town that appreciate nearly as well, or even better.

Purchasing a primary home is an excellent opportunity to learn about the real estate transaction process. Buyers typically select a real estate agent to work with and become familiar with the standard purchase and sale agreement. They learn how to make an offer and negotiate the final sale price. Then buyers gain knowledge about the home inspection, appraisal, and closing process.

Living in a primary residence is also an opportunity to learn about how a house works. Homeowners get exposure to how the electrical, plumbing, and HVAC systems operate. They have a chance to find out what skills they have or don’t have, from painting to carpentry. For homeowners who are not do-it-yourselfers, they can learn how to hire and interact with a contractor. They can also grasp more knowledge of project budgets and making design choices. The home can be a laboratory for experimentation, gaining greater understanding, valuable experience, and skills that can carry over to future investment projects.

If the homebuyer is comfortable living next to their tenants, buying a duplex or multi-family home can be an incredible first purchase. It is both a primary residence and an income producer at the same time. The tenants often pay nearly enough rent to cover the mortgage payment, and sometimes the rent exceeds the payment. Purchasing this type of property typically requires a larger down payment, but the results may be worth it.

Other income-producing strategies for homebuyers include having roommates that pay rent, or leasing out an upstairs, detached studio, or in-law suite. Another option is making part or all of the house available for vacation rental on Airbnb. Creativity is rewarded in real estate, and there are no limitations other than what the local law and building codes allow.

Some investors overlook their primary residence as part of their investing strategy. My experience has proven that the primary home is too valuable of an opportunity to overlook from an investment perspective. It is the best first step for beginning investors, and should elicit greater consideration from long time homeowners. Owning a home for decades in a consistently appreciating neighborhood makes a huge difference on a balance sheet. Wise investors will examine their own home and see if it is performing. If their appreciation rate is languishing in mediocrity, it might be worth moving to a better appreciating house that will bring greater returns by simply occupying it.