How To Build A Real Estate Portfolio: Strategies For Savvy Investors
Ready to start? Take a look at the following tips and strategies to build your real estate portfolio.
Outline Your Objectives And Goals
Consider your long-term investment goals before you start building a portfolio. Knowing where you’re going can help you determine the best strategies to get there.
Think about how much time and labor you’re willing to put into building a portfolio. If you want to offload active management of a property, you’ll need to hire a property manager. What’s your risk tolerance? To build a portfolio that can handle the ups and downs of the market, you’ll need to invest in a mix of commercial and residential properties around the country.
Choose A Starting Point
Consider starting small. For some investors, this may mean house hacking. With this strategy, you live in a property while renting out the remaining space. Securing financing for a house hack is significantly easier because the home qualifies as a primary residence. And loans with more relaxed down payment and credit requirements, such as Federal Housing Administration (FHA) loans, are only available if you live in the property most of the year.
Consider starting with simpler property types before diving into complex real estate. Residential properties are typically easier to finance and manage than commercial real estate.
Knowing how to buy an investment property can help you avoid costly mistakes and getting in over your head. If you’ve never owned a property with tenants, consider the upfront and long-term costs of managing that type of property – not just how the property’s value may increase over time.
Consider Exponential Rather Than Linear Increases To Your Portfolio
Exponential growth refers to a pattern of data that shows greater increases over time.
Let’s say you grow your portfolio by investing in a new rental property of similar value every 3 years. This approach would likely result in gradual linear growth of your portfolio’s value. However, you can set your portfolio on an exponential growth trajectory when you leverage your rental income and the accumulated equity from your first property after 3 years to finance two new properties. In 3 more years, you may be able to finance four additional properties or move on to more complex and lucrative property types, like commercial property.
Many experts encourage exponential growth because it can help boost profits. Ultimately, you’ll need to craft the investment strategy that works best for your situation. The added complexities and risks with exponential growth aren’t for every investor.
Learn Your Local Market
Knowing your local market gives you a real estate edge. When you’re considering a property that’s far away, you don't always know what's happening with a rental home or much about the neighborhood it’s in.
In an area you know well, you’re likely tapped into a community’s opportunities and liabilities. For example, you may know which neighborhood a new highway will route behind. You’ll likely know where the good schools are in your area or whether a particular neighborhood has started to pick up in popularity.
Keeping tabs on your local market helps you find potentially lucrative deals and can provide insight into the offers you’re contemplating.
Research Your Financing Options
It can be challenging to finance multiple investment properties. But you must know your financing options to successfully carve out your real estate niche. The two most popular financing options are hard money loans and conventional loans.
- Hard money loans: A hard money loan is a short-term loan investors can get from individuals or private companies that accept property or other assets as collateral. You may need a hard money loan if a traditional lender denies your loan or mortgage application.
- Conventional loans: A conventional mortgage conforms to Fannie Mae or Freddie Mac guidelines. Investors with high credit scores who can make large down payments can avoid paying mortgage insurance. A conventional loan is a type of loan the federal government doesn’t back. If you’re using a conventional loan to finance an investment property, you’ll likely need to make a significant down payment and pay a high interest rate. However, the rate on a conventional loan will be lower than a hard money loan rate.
Understand The 1% Rule And Other Financial Benchmarks
You must know your numbers. Track every expense, identify which numbers rise to the top – and know the numbers you need to work on. The 1% rule measures the price of an investment property against the gross income it generates. You can use it to quickly determine how the property should generate cash or decide what you should charge in monthly rent.
Also, make sure you know the financials associated with the following items:
- Economic occupancy: This is the percentage of potential gross income a property can generate during a given period. For example, let's say the total potential rental revenue for a collection of properties in January is $100,000, but you only earn $43,000. In that case, the economic occupancy for January equals 43%.
- Return on investment: Measure all return on investment (ROI) in real estate. Define your investment priorities and goals. Will you invest for cash flow or appreciation? What return on investment will you feel comfortable with? Many investors aim to beat stock market returns, which have hovered around 10% over the last century.
- Improvement costs: What improvements do you need to make on a property? Renovations should increase property value or improve a property’s usefulness for tenants and should follow the 1% rule.
- Monthly operating costs: How much does it cost to maintain the property? Calculate your expenses versus your income. Let's say you collect $1,200 in rent, and your expenses equal $200 each month. You can use your income and expenses to help measure your results against the 1% rule.
Understand The BRRRR Method And Its Pros and Cons
The Buy, Rehab, Rent, Refinance, Repeat (BRRRR) method involves flipping a distressed property, rehabbing it, renting it out and then refinancing it with a cash-out refinance to repeat the process and fund more rental property investments. It’s a steady pattern of turning out more rental properties.
This method can aggressively expand your real estate portfolio – but it’s risky. Flipping a property isn’t always a successful venture. If you overinvested in making the property attractive, you may not make a significant return on investment when you rent the property. If the market goes down and the property’s value decreases, you may not have enough equity for the cash-out refinance.
