Real Estate Investing 101 – Part II

After writing the first article on Real Estate Investing 101 – Part I, it was apparent that a Part II was needed to address some of the things that need to be thought about when investing in real estate either directly or indirectly.  As stated in Part I, everyone should be able to invest in real estate to better their lives, increase their cash flow, grow their net worth, and secure their retirement.  And you do not need to be high net worth ($1 million net worth or higher) or ultra-high net worth ($30 million+ net worth) to access attractive real estate investment opportunities.

Things to Think About to Get Started in Real Estate Investing

While there are a number of things to think about related to real estate investing, some of the most important things to think about are included below with my thoughts on each topic:

How much cash do you have to invest?

Frankly, I hate the saying, “It takes money to make money”.  I do not believe that is always the case, however, there are very few low-risk real estate strategies that do not require some level of cash equity investment.  To get a return on your cash, you have to invest cash.  Lenders want to see the amount invested by a Sponsor.  Even investors who may co-invest with you want to know how much you will invest in the deal that you are Sponsoring.  I started with $10,000 in a mortgage trust deed.  I have invested in single family properties with as little as $15,000, however, investing that little also means that the property is likely smaller and often times, the returns will also be lower. 

What percentage return do you need on your invested cash?

Everyone will have a different answer depending on their particular circumstance, age, and risk tolerance.  I have a range of investments that are generating different cash flow levels.  My worst deal right now is generating about a 5% return.  My best deal has already given me about a 400% return on my original equity over the past 7 years from cash flow and cash out refinances, and I am still getting a 19% cash-on-cash return on the original equity invested.  My personal goal is to get a cash-on-cash return no less than 6% and to generate an internal rate of return (IRR) of at least 15% over a 5-year hold.  Sometimes the IRR will be less and sometimes it will be more, but I know and believe that these return expectations are realistic and achievable with real estate investing.

How much control do you want to have?

There are so many ways to invest in real estate deals.  Most people think that they should or need to invest by themselves, however, investing by yourself is not the only way to invest in real estate and many times it is not even the best way to invest.  The reason it is not always the best is that you can make a lot more money in real estate on larger properties where you can obtain levels of scale.  Having said that, you generally will give up some level of control investing that way because you will likely be a passive investor in that example. 

Direct Real Estate Investments are investments where you invest directly in a piece of property by yourself.  Direct real estate investments are the ultimate in control.  You do not have to answer to anyone else except the lender (if you choose to have a loan).  You get to keep all of the free cash flow.  You have the risks inherent with ownership of the property, but also all the returns generated from the property.  Upon a successful sale or refinance, you get the benefit of the capital gains.

Indirect Real Estate Investments are typically passive or semi-active investments.  Generally, these investments are managed by someone other than yourself.  This Managing Member or General Partner maintains control of the decisions of the property and investment more so than the other investors.  The investor receives a return on their investment, but the investor is generally passive in all other aspects of the deal.  The plusses are twofold – the first is that there is not too much active involvement needed related to the business decisions of the asset and the second is that you receive a return on investment plus a share of the profits.  The negative side is that while you are obtaining a return on your investment, there is also not too much active involvement related to making decisions about the asset or how to improve upon the investment.  The plusses and minuses of indirect real estate investments are two sides of the same coin.  The additional plus of these types of deals is that you have the power to choose which properties to invest, where, and with what Sponsor.  In that way, you have control over where to place your money.  These deals can be structured as Partnerships, Friends and Family, and/or Reg 506 Crowdfunding.

Another form of indirect real estate investing is through a Real Estate Investment Trusts (REIT).  REITs are privately-traded or publicly-traded vehicles where you invest in shares of a company that owns various real estate assets.  The plus side of these investments is that they are generally more liquid than direct or other indirect real estate investments.  REITs also usually have embedded diversification of asset type and geographic locations.  However, where they benefit from diversification and liquidity, you will have almost no say as an investor.  REITs typically are management intensive with more administration and management expenses than most other real estate companies, investors have no say as to which investments the REITs decide to purchase, and there is no involvement related to the amount of debt that the REIT places at the property level or at the corporate level.  Given that the underlying investment is real estate, you really need to look at the Price to Earnings ratio, the Debt to Assets ratio, Funds From Operations, and Net Asset Value.  I would also pay attention to the Dividend Rate.  REITs have to pay out 90% of their net income to unit holders.  In a downturn, this can have negative unintended consequences.  We will look at REIT analysis further in future articles.  The bottom line is that you have to do analysis in all of your real estate investing activities – REITs included. 

My company, Guardrail Finance, acts as a real estate Sponsor where you can co-invest with us in the deals that we Sponsor.  My team and I oversee the acquisition, financing, property management, asset management, investor distributions, and sale of the assets that we acquire.  If you are interested, please sign up on the Guardrail Finance Investor Portal and we will keep you apprised of future deals.

Who will manage the property?

Property Management is vitally important to the success of your property.  If you have a good property management company or a good property management team, you will have an efficiently run property.  If you have a bad property management company or a bad property management team, you will often have ongoing problems that can become systemic to the property.  We have had excellent property managers and awful property managers.  My recommendation is to interview property managers, do not sign long-term contracts without a trial period, and make sure to constantly stay on top of your managers to ensure that they are doing the best job possible for you and your investor team. 

Which lender will you use to finance the property?

Different lenders invest in different property types and different geographic locations.  Some lenders can only focus on a given State while some lenders can only focus on certain property types.  My domain has always been Commercial Real Estate Finance.  If you would like to obtain quotes for a financing or refinancing of a multifamily or commercial real estate loan greater than $3,000,000 then you can reach out to Guardrail Finance

Real estate investing often seems shrouded in mystery.  Real estate investing can often times seems complicated.  It can also feel a bit out of reach since you generally need cash to be able to close a deal.  But the truth of the matter is that real estate investing follows processes that are fairly straight forward.  If you assess your goals honestly and determine what you really want to gain from real estate investing, you can do well and you can increase your cash flow, grow your net worth, and secure your retirement.

Happy investing and let’s continue growing our passive cash flow and net worth together! Robert Newstead

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