How To Build A Real Estate Portfolio (& What A Good Property Is)
There are numerous ways to invest in real estate and varying degrees of necessary upfront capital, as well as time commitment. If you can learn how to build a real estate portfolio that works for your lifestyle, then you can learn how to create long-term wealth and steady returns generated from multiple investment properties.
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What is a Real Estate Portfolio?
A real estate portfolio is a collection of income producing properties that can encompass rental properties, rehab projects, purchased shares of REITs and real estate crowdfunding. Building a real estate portfolio can be done actively or passively. Design your strategy according to your goals, your lifestyle, and your risk tolerance.
How to Build a Real Estate Portfolio from Scratch
Building a real estate portfolio from scratch is similar to building a stock portfolio. Think about your individual properties like company stocks, each have a different amount of money invested, with different projected returns and different factors that add value to your portfolio.
If you are only invested in the stock market, then you should consider building a property portfolio. Looking at real estate vs stocks, real estate offers less volatility than the stock market, as well as the security of land’s intrinsic value. Having both portfolios within your investments sets you up for steady secure returns and a safety net, if the financial markets have a downturn.
There are different ways of building a real estate portfolio and you do not necessarily need to own properties to do so–again you can design the strategy that best suites your goals, lifestyle and risk tolerance. Maybe you want to be hands on and use the profit from your first real estate investment property to purchase another property of greater scale. Or, maybe you use the returns from your passive real estate investments to purchase additional shares in your crowdfunding investment. Owning properties is an active form of real estate investing, while owning shares in a crowdfunding platform is passive investing–both constitute as real estate portfolios.
Owning properties requires significant financial resources, so for investors just getting started we recommend the passive route. For those more established with larger real estate portfolios, we recommend having both physical properties and passive investments within your portfolio, as diversification means less risk. We are going to cover how to build both types of real estate portfolios.
Building a Real Estate Investment Portfolio (“without” properties)
A passive real estate investment portfolio is a collection of real estate investments that don’t involve autonomous ownership of properties, but instead ownership of real estate fund shares. This type of property investment portfolio doesn’t entail the same financial burden that individually owning properties does and still provides healthy returns.
Most Common Real Estate Investment Types
If you are looking to build a real estate portfolio, but perhaps have limited income, crowdfunding is your best option. We would recommend doing your research and choosing a platform that offers a diversified portfolio of properties, as opposed to allowing you to cherry pick projects. This is because these diversified portfolios offer the greatest security without you having to put in the guess work of what’s going to give you the best returns. Moreover, with a very small minimum and no effort you have your diversified real estate portfolio ready to go!
What is crowdfunding real estate exactly? Real estate crowdfunding is the mutually beneficial method for private companies to raise capital for real estate projects that small investors did not historically have access to invest in due to crazy high minimums–think 5 million dollar minimums. The idea is to have many small investors instead of a few big time investors. Crowdfunding is made possible because of the internet and social media, where private companies can attract a wide array of everyday individuals to invest.
Beyond the fact crowdfunding requires no work (oh the beauty of passive investing), has low fees, and offers high returns, is that some crowdfunding platforms invest in cool projects not previously accessible to small investors–think historic building turned trendy bar, instead of another apartment complex. Imagine making money from the newest trending restaurant in Miami and being an investor in it! School of Whales makes this possible.
REITs or real estate investment trusts are another form a passive real estate investing and offer similar benefits as crowdfunding: the ability to build a diversified real estate portfolio essentially in minutes, the freedom from the financial burden of owning physical properties, and relatively high projected returns. The con of this investment is that REITs are many times associated with high management fees.
What is a REITs exactly? REITs are companies that own, operate and/or finance income producing real estate properties. When you purchase shares in a REIT you are not purchasing ownership stake in the real estate property itself, but instead the company that owns that property. In this respect a REIT is similar to a stock and like stocks can be bought and sold in real time. This makes REITs the only form of liquid real estate investing, which can be both a pro and a con: Yes, you can liquidate your investment in the case you need cash fast, but this also can be too tempting for some wanting to dip into their accumulating invested capital to fund their weekend getaway to a tropical destination.
Building a Property Portfolio the Right Way
Maybe you’re a hands-on kind of investor and you have the capital necessary to be able to own outright a portfolio of properties. In this case, we will walk you through some key factors you should consider while evaluating potential assets to add into your portfolio of properties.
We’ve said this before, but we’ll say it again: Location, Location, Location! If you currently invest in real estate you probably already know this, but in case you don’t, location is the most important factor to consider when considering an addition to your property investment portfolio.
Remember when we mentioned the benefit of investing in real estate because of the intrinsic value of land? Well as you very well know–not all land is created equal. A “good” location could be due to the proximity to the happening part of town; it could be due to the proximity to the nearest body of water, or it could be due to the quality of the school district amongst other things. Land is finite, so this is the part of your investment that determines everything.
If you purchase real estate with a prime location–let’s say a waterfront property in downtown Miami–then nothing else matters. The asset is fool proof because, there are only so many waterfront properties in the city, and of course such properties are in high demand. So hypothetically, even if the structure itself is worth nothing, you are protected by the immense value of the land–that according to historic real estate trends, will only continue to appreciate in value.
What is a real estate investment portfolio without rental properties?–this is of course a rhetorical question. If you’re an active real estate investor building a real estate portfolio, rentability is key.
Your best bet in determining if your prospective investment property is rentable is looking at the current number of listings and vacancies in the neighborhood or multi-family complex. High vacancies can force your monthly rent price down and low vacancies allow landlords to raise rents–good ol’ supply and demand.
Many factors come into play as low vacancies could be a sign the neighborhood is in decline or it may be a seasonal cycle. While location is the biggest factor is determining rentability, also take into account the job market in the area and whether there is other ongoing development–this is a good indicator that others are projecting appreciation of value in this neighborhood, as well. That means increased cash flow!
Operating expenses means the total cost of running and maintaining the property. Operating expenses encompass utilities, property taxes, insurance premiums, legal fees, janitorial fees, and general repair costs–although a huge capital expenditure like redoing the roof due to leaks would not be included in this calculation.
The thing to pay close attention to here is property taxes. It is common for property taxes to vary largely by municipality. That being said, high property taxes are not always a bad thing, as long as you are in a good location that attracts quality long-term tenants. But, there are plenty of less than desirable locations where perhaps you are considering a value add property that do still have high taxes! Just do your research. Operating expenses are critical to take into consideration because the only thing more important than cash coming in is the cash going out. Which leads us to our next criteria…
It can be difficult to compare two properties you are considering to add to your real estate portfolio given the factors that determine a property’s value are vast and variable. Cap rate is a metric in which you can measure an investor’s potential return on their investment; thus, a way to compare apples to apples in an industry where you are often comparing apples to oranges.
Cap rate is calculated by taking the property’s net operating income (gross income less operating expenses) and dividing it by the value of the asset (the estimated price the property would sell for if it were listed today). The result is expressed as a percentage, and shows the rate of return that is expected to be generated on the real estate investment.
Due diligence is the critical process of vetting a potential real estate property investment using a set of specific criteria. If you are considering buying any real estate property, this methodical process is critical to ensure you’re purchasing a well-maintained and profitable investment. This is particularly important in commercial real estate, as the owner of the commercial property does not have to legally disclose any material defects that are not observable to the buyer–this is called a “buyer beware” transaction. In the case of residential properties, legally the owner has to disclose such defects; however, its best to preemptively do your research and know exactly what you’re getting into.
Real Estate Cycle
Understanding the real estate cycle will help you find good investment opportunities, as well as have realistic expectations in terms of projecting returns. There are four phases within the real estate cycle, similar to the same cyclical nature of our economy as a whole: 1.) recovery 2.) expansion 3.) hyper-supply 4.) recession.
For example, the best time to buy a house flip is during the recession. That is, as long as you don’t need a loan to do so, and have significant capital to be able to wait it out until the expansion phase when you can sell the property for a huge profit. If you are looking for a rental property to add to your real estate portfolio, purchasing during the recovery and early expansion phase is your best bet.
Building a real estate portfolio: Our Key Takeaways
At the end of the day building a real estate portfolio and the type of real in which you invest is based on your experience level, your available capital, your desired time-commitment and risk tolerance. Our recommendation? To start slow with crowdfunding and REITs and if you’re still itching to get in on the action, then acquire properties gradually over a long period of time. Allow your first property to be a learning opportunity. You can apply these learnings as you continue to scale your real estate portfolio. Oh, and if you have the capital to do so, invest both actively and passively! Diversification means less risk.