Real Estate Strategies
There are many strategies to make money in real estate – from sales to financing to investing in real estate securities. The fundamental method, however, is buying and either holding and/or selling commercial and/or residential property. You can also invest in real estate securities. Regardless of the method, all successful real estate strategies require proper planning, research, and analysis. Before you make a decision on which strategy (or strategies) you will employ, you should set financial goals, study your available options in-depth, develop a plan, and obtain feedback. One strategy for successful planning involves developing a network of real estate entrepreneurs and industry professionals that you can rely on for advice. Many cities and online venues have social clubs for entrepreneurs, which can be a good source of insights and feedback. Networking with brokers, and other industry professionals is key to execute other real estate strategies, so start building a list of contacts in the planning stage.
However, if you choose to develop your real estate business plan, make sure that you have written goals and understand both your target real estate market(s) and all of the strategies you have available to you. In this article, we will cover 1) residential property strategies, 2) investing in commercial property, 3) investing in real estate securities, and 4) lessons from successful real estate entrepreneurs.
RESIDENTIAL PROPERTY STRATEGIES
One of the keys to make money in any endeavor is buying low and selling high. But how do you find real estate that can be purchased and sold at a premium? One way is to purchase properties at a discount. You can purchase distressed properties – those in need of extensive repair and/or with significant liens levied against it, at public auctions or foreclosure sales. Another is to develop a network of professionals who can help you identify inexpensive properties. Such a network would obviously include some brokers, but might also include other real estate professionals, such as appraisers, home inspectors, contractors, and marketing specialists; divorce and estate lawyers, who can inform you when divorce proceedings or deaths are likely to result in a home sale; and moving men and trash haulers, who can inform you if their jobs are at properties for sale. Bankers can also inform you of foreclosures and/or short sales. A third strategy is looking for properties in markets undergoing falling housing prices. This might be due to a weak job market, rising crime, changing demographics and/or a surfeit of available housing. You should buy in these markets if you anticipate that either the market will soon undergo an upswing or that you can otherwise find interested parties willing to buy from you at a premium. Lastly, you can become a residential real estate developer, and work with a construction firm to build residential housing prices inexpensively to be sold at a premium. There are often tax credits and financial incentives when building properties in local real estate markets suffering from slow or negative economic growth.
Strategies for Residential Real Estate Investment
One of the key decisions to make when investing in residential real estate is how involved you will be. Will you be a passive or an active investor? An passive investor is one who owns, operates, and/or sells the property, making any necessary repairs and assuming relevant liability. They may purchase the property using leverage from traditional lenders, and leave the daily management of the property to a paid property manager or a property management firm. Or they purchase properties jointly with others as a part of a limited partnership, leaving the management of the property to the general partner. The typical return for passive investors is usually between 3% and 10% appreciation and 2.5% to 8% income. By contrast, an active investor is one who uses unconventional financing methods and employs tactics involving more effort and resources, such as renovation, and more risk. Their return is typically 5-25% appreciation, and 8% yield.
Another key decision to make is whether to invest for the short-term or the long-term. In general, this is heavily dependent on your financial goals and your risk tolerance. If you want to get hands on, will not stay up all night worrying about your investment’s performance, and make a significant return on your investment in the short-term, then flipping – buying and trading houses within a 30 to 60 day period, may be the strategy for you to pursue. You will want to look for houses in need of minimal repair and make the needed repairs as quickly as possible. Further, to maximize your return, wait for a period when the rate of inflation is forecast to exceed current interest rates, other real estate investors, interested in residential real estate speculation may enter the market, willing to purchase your properties with leverage and, once inflation increases, pay off the mortgages with less valuable dollars. This is a strategy that you, in fact, can take advantage of, albeit a risky one.
If, by contrast, you are looking to be minimally involved, and are willing to sacrifice a potentially higher rate of return for minimal volatility, then investing in a portfolio of residential properties and paying for the services of a property management firm, may be the route to take.
When assessing a property, one of the most important considerations should be cash flow. With residential property, this usually means rental income, which should be evaluated against going expenses, such as utilities, and both current and long-term related liabilities. If you calculate a negative cash flow, you may want to stay away from the property. The property should also be evaluated in terms of long-term potential for capital appreciation, but this means little if you cannot pay the associated bills in the interim. You should also have/save funds to be held in reserve in case unforeseen circumstances increase expenses.
Beyond flipping and buying-and-holding and renovating, other strategies include purchasing property jointly with other investors, and/or property development. These are entry strategies. You should always enter a real estate investment with one or several exit strategies in mind. Plan for what you will do if housing prices suddenly drop or you have difficulty finding a viable tenant. With real estate investments, ongoing expenses are guaranteed, while income/capital appreciation is not.
Advantages and Challenges of Being an Entrepreneur in Residential Real Estate
One of the many advantages of being an entrepreneur in residential real estate is that because there is a fixed supply of land, and existing residential houses, there will always be a demand for residential real estate. The level of demand in each local real estate market may fluctuate in accordance with local and national economic trends; however, there will always be demand for places for individuals and families to live.
Compared to investing in commercial real estate, it is generally cheaper to begin investing in residential real estate; there is also less risk in the latter than the former. Residential real estate is, generally speaking, less complex and requires less due diligence. Residential real estate investments are also typically less risky than stock market investments and can serve as hedges against both inflation and deflation.
There are many challenges to invest in residential real estate as well. Properly forecasting what housing prices will look like in a particular market can be challenging, as there are many variables. Further, landlording, if you should choose to do it, can present its own challenges. Identifying a good property management firm, critical if you choose to be a passive investor, can also present difficulties.
Real Estate Investment Strategies
INVESTING IN COMMERCIAL PROPERTY
Many of the aforementioned strategies for finding residential properties can be applied to commercial properties. Developing a network of real estate professionals, who can tip you off to potentially lucrative sales, is key in both instances. Analyzing depressed markets can yield some attractive buys. Building commercial real estate is an option if you have the capital and resources to do so. And proper attention to local business development, especially to failing businesses, can alert you to potential distressed commercial properties that may soon be on the market.
Strategies for Commercial Real Estate Investment
Commercial real estate is divided into several different categories: office, industrial, retail, multifamily (four or more units), hotels, land, and mixed use. The fundamentals of making money with this kind of property is largely the same: building or financing a purchase either through traditional or creative (for higher returns) methods, and then either buying and holding for appreciation and rental income, or reselling for a higher price. The most common strategy is buying and operating, though many owners use professional property managers for this endeavor. The time horizon for commercial property management is typically much longer than residential real estate investment, usually five years or more. When building or looking for office properties, it is important to understand the key businesses in your local market and their requirements. It is also advantageous to form partnerships with other investors, to pool financial resources for costly acquisitions. Another key strategy is to make money by establishing/installing income-generating assets on the property. For example, a commercial office building with ground floor and basement parking, may open the parking up to the public at a premium.
Advantages and Challenges of Investing in Commercial Real Estate
One advantage of investing in commercial real estate is that leases tend to be long-term, which, assuming the tenant(s) follow(s) the lease terms, can make it a stable investment. Further, the returns of commercial real estate investments in absolute dollars are typically higher than the returns of residential real estate investments. Commercial tenants typically make money off of their leased property and so have a vested interest in maintaining it. There’s less subjectivity in pricing compared to the residential real estate market. Further, most leases are structured as a variation of triple net leases – which require the leaseholder to pay all expenses directly besides the mortgage.
However, commercial real estate typically costs more than residential real estate. Further, managing commercial real estate and commercial tenants is quite time-consuming and not for the DIYer. It can also be riskier than residential property, given that it will be visited/used by more people.
Strategies to get Started in Commercial real estate
INVESTING IN REAL ESTATE SECURITIES
Of course, direct ownership of residential and/or commercial real estate property is not the only way to make money in real estate. One can invest in real estate securities – certificates (paper or electronic) that entitle the holder to the rights of ownership of a particular asset or bundle of assets. While certain types of municipal bonds and equities in real estate-related industries can provide avenues for investing in real estate, when one talks about investing in real estate securities, typically they are referring to Real Estate Investment Trusts (REITs). These are firms which own and manage income-generating residential and/or commercial real estate, usually of a single type (i.e. office REITs, retail REITs, etc.), or real estate related assets. There are three types: equity REITs, which typically operate rather than flip the properties they acquire; mortgage REITs, whose value is based on mortgages they provide or mortgage-backed securities they acquire; and hybrid REITs, which invest in both properties and mortgages/mortgage-backed securities. You can invest in publicly traded REITs (those that trade on an exchange) or non-exchange traded REITs, or real estate mutual funds whose holdings are primarily or heavily weighted in REITs.
You can take advantage of fluctuations in the market for real estate securities buying and selling REITs for profit on exchanges. To do so requires careful and consistent analysis of the markets for the securities you hold, as well as broader economic indicators.
You can increase your trading profits of exchange-traded securities through the use of margin trading. Margin trading involves borrowing funds from a broker to purchase securities, usually more securities than the investor would have otherwise been able to purchase. This strategy is usually used for short-term trades. Of course, while trading successfully using margin will amplify your losses, unsuccessful margin trades will result in increased losses.
Buy and Hold
REITs, by law, must distribute a minimum of 90 percent of their taxable income to shareholders as dividends. For investors looking to add an income generating asset in their securities portfolio, REITs can be a solid choice.
By investing in real estate securities, you can invest in many different real estate markets at once. Unfortunately, since local factors can often have a disproportionate impact on real estate performance, it may be hard to forecast the performance of the assets the REIT owns, and the proper market value of the security, accurately, if you are not intimately familiar with the real estate market in which the REIT operates. This becomes more challenging if you choose to invest in mutual and/or hedge funds that themselves invest in REITs.
Another challenge is the underlying leverage that REITs may have used to purchase their real estate assets. If interest rates go up, and/or the REIT has cash flow problems, it could soon drop precipitously in price.
LESSONS FROM SUCCESSFUL REAL ESTATE ENTREPRENEURS
One of the best ways to understand strategies is to study the moves of successful real estate entrepreneurs. While it competing local entrepreneurs may be reticent to share their methods with you, there is enough publicly available information about some of the most successful real estate entrepreneurs online. Such entrepreneurs include Donald Bren, who pooled assets with two other investors to purchase 10,000 acres and develop the city of Mission Viejo, California in 1963. Today, his portfolio includes 50,000 apartments, 40 million square feet of office space and 8 million square feet of office space, and his net worth is approximately $14 billion.
The entrepreneurial activities of Jorge M. Perez can also provide inspiration and insight. A real estate developer, Mr. Perez built multifamily apartments in Miami, after working for the city’s economic development department, a role that gave him the kinds of insights into the local real estate market that fueled his success. For example, in the mid-1990s, he figured it would be profitable to develop high-end condominiums in Miami, much to the disdain of his network. His initial venture, which would result in more than 5,000 condominiums owned and operated by his firm The Related Companies, sparked a development boom in downtown Miami, with 22,000 such condominiums built between 2003 and 2009. Further, when the subprime mortgage occurred, Mr. Perez began making substantial acquisitions of distressed properties, which, with development and time, have helped him rebound from $1 billion in related losses.
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