Real estate is a popular asset class for investors who are comfortable with a little risk. If you’re goal-oriented and careful in evaluating each deal, many investors say that rental property can be the path to financial freedom. But investors who rush into real estate investing may saddle themselves with financial obligations that they aren’t ready to maintain.
Building a diversified real estate portfolio starts with buying your first property. And buying your first property starts with understanding why you want to buy real estate assets in the first place. Once you know what you want to achieve and how much money and management it will require, talk to a real estate professional about taking your first step into the industry.
Planning For Successful Real Estate Investing
Before you purchase your first property, educate yourself about your regional real estate market. What are the trends in your local housing, office and retail markets? Which product types are poised for growth in which neighborhoods?
Additionally, if you’re new to real estate investing, take time to learn about the industry itself, including any certifications you might need or regulations you’ll have to abide by. Working with a trusted real estate professional can help.
Next, ask yourself: What do you want out of real estate investing? How much cash flow do you hope to be generating in five, 10, and 15 years? Will you be managing your portfolio hands-on throughout that time, or do you hope to retire and pass it off to a portfolio manager?
Once you can clearly articulate what you want to achieve, you can organize a financial plan around those goals. Work with a financial advisor to review the current state of your finances and decide whether now is the right time to start building your real estate portfolio. Figure out exactly what you can afford up front and how much debt you can service on a monthly basis — and don’t forget to account for all the expenses that come with owning real estate assets.
With those parameters in place, start exploring your financing options, from hard money lenders to mortgages to seller financing. Again, a real estate professional can help you navigate the lending landscape.
Choosing a Commercial Investment Strategy
A real estate portfolio can include everything from multifamily rental property to office space to single-family homes. Choosing the right assets depends on your investment strategy.
A standard commercial real estate investment is a property with several tenants of the same type, such as an office or retail building. Property owners find tenants and negotiate leases, but once tenants are in place, these investments can be active or passive.
Passive investments are those that require little day-to-day management. The most passive investment is a single tenant triple net lease, which means one tenant fills a rental property and not only pays the lease but also property tax and utilities.
Investors who prefer residential tenants can invest in single-family homes or multi-family properties, and both can be marketed either as short-term or long-term rentals depending on local regulations. Short-term rentals can generate high returns but often require more capital up front, since AirBnB and VRBO users are often seeking luxury; they also require hands-on management. Long-term rentals allow investors to be much more passive.
Some commercial real estate investors start by investing in assets as a group. Real estate partnerships take many forms: Private equity groups, real estate investment trusts, crowdfunding, and more. These groups usually have large, diverse portfolios that can make them less risky, but investors usually need to be accredited, which can be difficult for newcomers to real estate investing.
Wholesaling is best for experienced, hands-on investors who enjoy risk. These investors first contract a home with a seller and then find an interested buyer. The investor will contract the home with the buyer at a higher price than with the seller and profit off the difference.
Investors who have longer time horizons can invest in land or buy and hold properties. In both cases, investors hold on to properties while values increase, then sell them for profit months to years later — but if values don’t increase, they may never see returns.
Choosing Your First Property
If you’re new to commercial real estate investing, start small. Focus on regions you know well, where your understanding of market dynamics is most likely to be sophisticated. Within those regions, work with a professional to do a real estate market analysis and choose what kind of property is best for you.
Successful commercial property investments maximize location, rentability and appreciation potential while minimizing expenses. Remember that this equation is about optimization, not maximum potential profit. For example, a property at a reliable location with a track record of rentability may not have the appreciation potential that a property in a neighborhood poised for redevelopment does, but it’s more likely to generate stable cash flow right away.
Once you acquire your first property, keep meticulous track of your cash flow. Monitor how much you spend up front on capital improvements, marketing, and your down payment; then, keep track monthly of the property’s cash flow. After a few months — and certainly after a year — you’ll have a detailed picture of the property’s cap rate and risk-adjusted returns.
If those indicators are good, it may be time to start searching for your next property.
Growing Your Real Estate Portfolio
Once you’ve gotten comfortable with the process of real estate investing, you can acquire more properties that help you work toward your financial goals.
If you want to pull the equity out of an existing property and invest it in a new one, consider a 1031 exchange, which allows real estate investors to sell an investment property and use the profits to purchase another without paying taxes on those profits. To receive a total deferral of capital gains, the investor must purchase a like-kind asset of equal or greater value and reinvest all of their equity. Talk to a real estate professional about whether a 1031 exchange could help you grow your portfolio.
Some real estate investors swear by the “snowball method.” These investors use the profits from your first investment property to buy their next, and so on. For example, say you purchase a rental property that cash flows $1,000 per month. After saving for three years, you’ll have $36,000 to use toward a down payment on your next property. If that rental property performs as well as your first and you start generating $2,000 each month, you can purchase your next property in half the time.
Other investors adhere to the BRRRR strategy, which stands for “buy, rehab, rent, refinance, repeat.” This method is pretty self-explanatory: purchase a property, invest in improvements, generate rental income, and then pull out all the equity you have in the property when you refinance your loan. You can then invest that equity in your next property — and so on.
Over time, you can begin diversifying your portfolio by investing in a different asset class or exploring a different location. Diversification helps insulate your portfolio against market fluctuations. If the office market softens or if state regulations slow the profitability of multifamily properties, you can focus on growing your revenues in another part of your portfolio.
Investing out of state is particularly difficult for commercial real estate investors; however, so consider starting with different cities or even different neighborhoods within your own city.
Note that as your investment property portfolio grows, managing it will require more time and expertise. If your goal is to retire early and not to actively manage your properties, make sure you budget for real estate portfolio management services. A professional portfolio manager can focus on the day-to-day management of your properties while you manage your broad investment strategy.
WindWater exists to help real estate investors through every part of the investing process. We start with consulting services, learning as much as we can about your long-term real estate goals and creating plans for success. Our brokerage services team can help you find your first property and grow your portfolio. Our marketing team can help you find high-quality tenants quickly or, when the time comes, sell your property and reinvest the profits.
Reach out today to set up a conversation with our consulting or brokerage services teams. We can’t wait to help you start building your real estate investment portfolio.