3 Paths to Invest in Real Estate
As a professional real estate investor who owns and manages a $20 million portfolio I often get asked how I suggest people get started in real estate. It’s a wonderful question and I love having the conversation. I am a firm believer there are generally only 3 paths people should invest in real estate, outside of this is where I have often found people get themselves in trouble. Trouble typically means frustrated, loss of money, or in some cases breaking of relationships. My goal is to help people avoid all of those issues and hopefully this helps to provide some clarity on how to do so. As a friendly note, these 3 options are not in any particular order of preference or superiority.
For conversations sake I am going to focus the discussion on long term residential dwellings. Think the typical 12 month lease on a single family home, duplex, or in a big apartment complex. The 3 paths to invest in real estate still apply for the most part to other forms of real estate like self storage, short term rentals, or other types of commercial but given residential dwellings are the most common form of real estate and most accessible for the average investor we will live in this world today.
Option #1 – Stay Small
The Grant Cardone’s of the world are probably ready to pound in the door on me as I write this. Staying small in real estate can be a wonderful strategy for some. I typically suggest this for the people who want to do it themselves, have no desire for employees and are simply looking to supplement in a small or large way their income.
The strategy here is pretty simple. Go buy a few properties, likely 5 or less units total, and work paydown all debt. By owning these properties debt free you maximize the income each month that goes into your bank account to spend on anything else you want in life. The benefit to staying under 5 units is that the workload is small. You will likely only have 1 to 3 tenants move out each year keeping the turnover effort small for you.
With the help of a few friends and family members, a good handyman or other contractors you can also leave for extended periods of time and get the little odds and ends taken care of as they come up. If the average house you own rents for $2,000 per month and you own 5 that’s $10,000 in monthly income. Your expenses are likely going to be $3,000 or so per month(taxes, insurance, maintenance, etc) on this leaving you with $7,000 a month in cashflow and a respectable $84,000 in annual income. Assuming the typical house would likely be $250k the total value of the real estate you would own would be $1.25m and provide annual cashflows of 6.7% of your equity.
Where I see people go wrong is they start buying more properties beyond this and realize it is getting harder to manage the ongoing work and starts to be a time sink on their life. The freedom the real estate was supposed to provide gets taken away pretty quickly beyond 5 units if your self-managing.
Option #2 – Go Passive
The only way to passively invest is to write a check and join as a passive investor with an experienced operator buying larger real estate properties and portfolios.
What about 3rd party management though? Buying a few small properties and handing them over to a 3rd party management company isn’t a great solution in most cases and not a true passive investment as you still had to find the property and now need to manage the manager. Plus the manager eats into your cashflow so much on the small scale it usually leads people to be very disheartened. Our goal is to love the experience so I am going to discourage you from going down I path that I have rarely seen work for people.
Passive investing with an experienced operator is something most don’t know is a viable solution but I would argue is the best for most. The way you do this is through a syndication or partnership. An operator/sponsor will find the real estate deal, put together the financing, legal docs etc., and you are only responsible to write a check and sign a few papers. You should be sure that the structure keeps your personal liability limited to just your investment in the deal. That is a very important component of this strategy!
Moving forward the operator deals with managing the asset and given all goes to plan you should be receiving regular cashflow payments on your investment with the future goal of equity growth.
Typical deals in this structure today result in annual cashflows ranging from 5% to 10% of your investment and long-term average annual returns of 15% to 20% at the sale of the property.
Option #3- GO BIG!
So you don’t want to stay small and you don’t want to passively invest. No problem! Going big is the solution. What does big look like? I would suggest a minimum of 100 units and 120 to 150 is likely the better minimum threshold. The reason for this is once you break 100 units the economics work out such that you can afford to hire a full time property manger and full time maintenance technician. If you don’t want to build a property management company there are some great management companies that are available once you get to the big apartment complexes and portfolios.
Keep in mind that to be successful as an investor at this scale you will need to be working to exit your other career and commit yourself to building this business. Those who successfully balance a larger portfolio and another career/business usually have partners or employees who can handle more aspects of the business.
To get to this point you will likely bring on investors or partners into your real estate deals.
As someone who has built a portfolio like this, I can tell you its extremely rewarding both personally and financially if done right. However, the bigger the properties and portfolio the bigger and more expensive the problems are that you will be dealing with. While I believe anyone can do this, most don’t want to go through the personal growth needed as there are a wide range of skills, knowledge, and personality traits you will need to develop. Every investor I know who has built a portfolio like this puts a lot into working on themselves to succeed in this space so be ready to do that if your going to go big!
As we wrap up, never forget our investments are supposed to serve us in achieving our goals. So as you look to evaluate your financial goals, desires to invest in real estate, and think about how you want real estate to fit into your lifestyle I hope that this guidance helps you be clearer as to which path is right for you and your family. Early on I chose the path to Go Big, I have friends that have Stayed Small, and I work with an amazing group of individuals that have chosen to Go Passive.
If you are trying to find your path and would like to get on a call to talk about your real estate goals I would love to listen and provide what advice I think may be helpful for you!
Founder of JFH Capital