Whether a person invests in real estate, paper assets (like stocks and bonds), or business opportunities, investment strategies are unique to each individual. This blog will focus on one particular type of income producing asset–real estate. While there are many ways to build an investment strategy around real estate, for example, buying fixers and selling them for a profit or purchasing bare land and developing buildings for sale or lease-the scope of this article will focus on seven keys to building a strong portfolio of cash-flowing properties.
1. Assess Your Situation
(a) Know What You Need and Want
The first item to consider is whether real estate is right for you. It is not for everyone, but if you find that real estate investment is what you want, then designing a real estate investment plan is the best place to start. From a cash flow perspective, identify what your current monthly expense requirements are and how much income you need every month to maintain your current lifestyle. Once you have this figure, consider where you want to be in five, seven, or ten years, etc. How much monthly cash flow will it take to support this future goal? Then add this to your current monthly expense figure and you will have a starting point for your cash flow goals. This figure will most likely change as you begin working your plan and making periodic adjustments to your goals.
(b) Assess Your Direction and Identify Your Preferred Property Type
Within real estate, there are different property types from which to choose from, for example, single-family rentals, multifamily rentals, office buildings, industrial office buildings, warehouses or public storage, retail properties, etc. Each property type has its own unique considerations and operational requirements.
Researching and learning how to operate that particular property type means having the knowledge to manage the management team from an informed position.
(c) Know What Kind of Financing is Available
While the mortgage market recovers from its recent meltdown, financing requirements will remain tight, but there are still options available to facilitate purchases, such as seller financing and lease options. Learning about the different financing options available is a key factor in planning a real estate investment strategy. Financing can mean the difference between a good and bad deal. Before the mortgage crisis, lenders commonly required a 1.20 DCR or “debt coverage ratio”–meaning, they would require 20 dollars of income for every dollar of debt that the property carries. With this information and a property’s net operating income, you can calculate maximum loan amounts and minimum equity requirements (aka. down payment) for any income producing property. This can also help determine whether a property is overpriced and at what price the property will yield your required rate of return.
(d) Set Your Required Rate of Return
If you want your money to work harder than a savings account or a CD, then determine your required rate of return upfront and use this rate to calculate the investment value of a property based on its net operating income. This maximum amount will be the point where you will draw the line on any particular investment. When a seller is not agreeable to your maximum price, then it is time to walk away and find an investment that will fulfill your investment requirements.
(e) A Word About the Tenant Landlord Law
If you are considering single-family and/or multifamily rentals, then you will need to become familiar, if not well versed, in Tenant Landlord Laws. Having a set system that keeps you in compliance with the law is a wise investment of time and money. Management companies and real estate attorneys can be helpful in this area.
2. Set Minimum Property Requirements and Limits
From a cash flow perspective, the ideal situation is to start receiving rents the following rent period after closing. If you have to gut and rehab a building entirely, there will surely be a period of downtime and you may have to support the property until you are able to lease and begin receiving income. If your goal is immediate cash flow, then a major rehab project may not be the right project type to consider. Instead, a well-maintained property or one that needs a minor amount of cosmetic work with a steady tenant history is the ideal property from a cash flow perspective.
3. Assemble a Stellar Team
Assembling a team of professionals dedicated to your financial success in real estate is a key component in realizing your cash flow goals.
The Real Estate Broker – A buyer’s broker who is also an experienced investor, if you want to avoid dual agency, then find an exclusive buyer’s broker to work with.
The Mortgage Planner – A mortgage planner that specializes in investment and commercial properties
The Financial Planner – A financial planner with a positive perspective towards-and a full understanding of-real estate investments
The Real Estate Attorney – To review all loan and closing documents before signing, as well as any contracts or agreements-this is a CYA (Cover Your Assets)
The Management Company – A professional management company with a solid reputation will free your time so you can live your life and look for more properties to buy
The Property Inspector – This team member should have experience inspecting your chosen property-type.
4. Real Estate Investments Are About the Numbers
Leave Emotions at Home
Buying a real estate investment is about making money with property-not falling in love with property. This is especially bad, if the seller becomes aware of the infatuation. Investment real estate is about what it can do to bring you closer to your income goals, period.
5. Buy Properties Right
List Price Does Not Set Property Value
Regardless of the price, you see on a listing, a property’s investment value will vary between investors because his or her required rate of return will be unique to each situation. Therefore, a list price is just an asking price. Set your required rate of return and make an offer accordingly. If meant to be, the seller will either accept or open up negotiations. If not, then it will be better to walk away than to end up with a property that does not meet your investment goals.
6. Periodically Re-Assess Your Direction and Make Adjustments as Necessary
If you started out with single-family rentals, you may decide to upgrade and own small multifamily buildings. If you own small multifamily buildings, you may decide it is time to buy your first 16 or 20 unit building, etc. The point is to keep your eyes on the horizon for new opportunities to grow your knowledge and portfolio of income properties. With experience comes confidence and with confidence comes new learning opportunities that will continue on a path of limitless growth. When it comes to learning, growing, and evolving we limit ourselves by the barriers we place upon ourselves.
. Cash Flow Strategy: Buy Right and Hold Long-term
The key to building cash flow through real estate investments is to buy properties that satisfy your investment requirements upfront and holding them for the long term–a minimum of five years or ideally ten years. Have an exit strategy in place before the property approaches the end of its holding period. Start learning about 1031 tax-deferred exchanges and speaking to a specialist who can help guide you through the process well in advance. Being familiar with the process will ensure a smooth exchange transaction and preserve your wealth-building strategy when the time comes. Your accountant, tax attorney, or a financial advisor well versed in the area of 1031 exchanges can provide you with more information.
In closing, real estate investing can be a very rewarding experience. It requires planning and knowledge, but the end-result can secure your financial future. Education and motivation are key factors in building wealth and achieving financial independence.