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How To Build a Real Estate Portfolio for Lasting Wealth

How To Build a Real Estate Portfolio for Lasting Wealth

Andrew Carnegie once said that “90% of millionaires become so through real estate” and that “more money has been made in real estate than in all industrial investments combined”. As a self-made billionaire, Carnegie surely knew what he was talking about.

At RealWealth we’ve also seen first hand that real estate is the key to creating the money and the freedom to live life on your own terms – what we’ve defined as real wealth. So if you’re looking to create true financial freedom, part of your investing strategy should include building a real estate portfolio.

What makes real estate so special? Much of it boils down to cash flow. Let’s say you buy 5 properties for $200,000 each and they make you a total of $2,500 per month in cash flow (if financed, after P&I, taxes, insurance, property management fees, etc.). If you save most of that money, you’ll have enough for a down payment on your 6th property within a year and half, your 7th property just over a year after that, your 8th property less than a year after, and your 9th and 10th properties within another two years combined. Within 5 years you’ll be making $60,000 per year, without doing any work (assuming you’ve hired a good property management company).

At the same time, if you’ve invested in the right markets, your property values have been appreciating – maybe as much as 30% per year in markets like Charlotte, NC. You then have the opportunity to do cash-out refinances and use that income to buy even more investment property or you can sell a property or two and 1031 exchange them into properties in under-appreciated markets primed for growth.

(Side Note: once you own more than 10 properties, you’ll have maxed out your conventional loan options, BUT there are ways to get around this and continue growing your portfolio. Check out this recent webinar for more info).

As you can see from the example above, building a real estate portfolio can be incredibly lucrative. But how do you go about it?

How to build a million dollar real estate portfolio

1. Make a solid business plan​

With home prices rising by 20%-40% or more in many markets over the last year, real estate is at its highest level in history. But what does that mean for real estate investors? You might have to compete for properties in the right market, which makes knowing how to find inventory especially important.

If you’re just looking to get started with building a real estate portfolio, the first thing you need to do is create a comprehensive real estate business plan that covers strategies, goals and financing.

You will also need a business plan if you plan on seeking conventional or hard money financing.

Looking for single and multi family investment property with property management in place? We can help! Become a member of RealWealth to connect with Property Teams from around the country.

2. Choose your primary real estate portfolio strategy

It is recommended that you have six months’ worth of mortgage payments saved up when buying for investment purposes. If you opt for conventional financing, lenders will require this. Additionally, having an emergency fund protects you from vacancies, especially when you are just starting out as a landlord.

Regardless of the strategy you choose, you must be able to evaluate deals. What makes a good deal? In general, you should consider population growth, the local job market, occupancy rate, rent growth, location, cash flow, appreciation rate, expenses, property taxes, and the number of available homes.

You will also need to decide whether to hire a property manager or handle property management yourself. There are pros and cons to each approach. Property managers add to your costs, but they also alleviate the stresses of property management.

3. Use leverage to build equity

Remember we said buying property requires a significant cash outlay? The good thing about real estate is that you can always use leverage. Rather than paying the entire purchase price yourself, borrow funds from a lender or people in your network to finance the deal.

Let’s say you put 20% down instead of 100% to buy a house using a conventional mortgage. For one, if you have a cash-flowing property, you can build equity easily. In the event that your rental income keeps paying down your mortgage, you will be able to start building equity since you have already paid off the interest. At the same time, you keep earning profit from the difference left after paying your mortgage.

Leveraged investments are evaluated based on cash on cash return. Cash-on-cash return represents your return on investment after accounting for all expenses and loan payments.

4. Diversify your portfolio for both cash flow and appreciation

Historically, corrections and recessions happen in cycles, so if we are not in one now, we will be in one in the future. And after a correction, there will be a recovery. Since markets are hard to predict, diversification is necessary to maintain a healthy portfolio and reduce volatility.

Many people understand diversification in terms of reducing risk by having different asset classes e.g. stocks, bonds, real estate, cryptocurrency, gold. But you can also diversify your real estate portfolio by spreading risk across different real estate property types and investment strategies.
For example, while you employ buy and hold for a multifamily property, you could use the BRRRR (Buy, Rehab, Rent, Refinance, Repeat) strategy for a single family property. This allows you to profit from both cash flow and appreciation as you grow your real estate portfolio.

5. Organize your team

Eventually when building your real estate portfolio, the workload will get so big that you won’t be able to manage it yourself. At this point, it makes no sense to try to do everything on your own. Delegate to a team of trustworthy people.

Aside from hiring a property management company, you also need a virtual assistant, an accountant, and a lawyer. If you do not have a real estate license, it would be a smart idea to add a Realtor to your team.

The property management company takes care of the day-to-day running of your investments. You can include some of the costs of property management in your rent so that you don’t hurt your cash flow.

Your virtual assistant takes care of small tasks like cold pitching and website management. Your accountant manages your numbers – taxes and finances, and a lawyer handles contracts. Real estate agents can assist in finding properties and listing them on the MLS.

6. Know your numbers

These metrics are critical to evaluating a property:

  1. Price to Income Ratio: Ratio of median home prices to median household income for a given area.
  2. Price to Rent Ratio: Median home prices divided by median rent gives you the price to rent ratio for a given area.
  3. Gross Rental Yield: In order to determine an individual property’s gross rental yield, divide the annual rent collected by the total property cost and multiply that number by 100. When summing up the property cost, make sure to include closing and rehab costs.
  4. Capitalization Rate: Capitalization rate or net rental yield is more valuable than the gross rental yield because it includes operating expenses on the property.
    • Generally, Cap rate = net operating income/current fair market value of the property.
    • Your net operating income is the gross rental income (total rent revenue * 12) minus operating expenses. For most investment properties, a good CAP rate would be between 4%-10%.
  5. Cash Flow: In order to generate positive cash flow, make sure the rent covers the mortgage, taxes, and insurance. The amount of cash flow a property generates is the difference between its income and expenses.

How To Determine Your Goals and Strategies When Building Your Real Estate Portfolio

Investment goals should be specific, measurable, achievable, realistic, and time-bound (SMART). You may want to build a portfolio of five multifamily properties through syndication by XYZ date. It checks all the boxes.

Goals can be big or small, depending on your previous experience and net worth, but strategies are not as flexible. You can use any of these strategies to build your real estate portfolio:

1. Buy And Hold

This is probably the preferred strategy when building a real estate portfolio for cash flow. In this approach, a real estate investor purchases a rental property, rents it to a tenant, and collects rental income. Apart from the possibility of receiving consistent positive cash flow, the investor can also benefit from appreciation in the right market.

So, using the buy and hold strategy, an investor might start out with one property, manage it for some time, then sell or use cash out refinancing to invest in other properties.

2. Short term rentals

With websites like VRBO and Airbnb, short-term rentals are very popular these days. In fact, the short term rental industry is growing at a faster pace than hotels.

Both tenants and landlords appreciate the flexibility that short-term rentals offer. If you are a landlord, you may decide to use your property for a month as a vacation getaway, while you make money from short-term and flexible leases for the rest of the year. Renters are not locked into 1-year contracts. Typically, they rent a property for no more than 30 days.

In a way, the short-term real estate portfolio strategy is similar to buy and hold in that you can invest your profits into purchasing another property for short-term renting.

3. Fix and flip strategy

If there’s a booming real estate market in your city, then you may be able to get some good deals if you check out houses that need repairs. You’ll usually have to spend money, time and effort to restore these properties to good condition.

Within a few months, you can sell it off and make a profit. Invest your profits in a second run-down house, then fix and flip it for profit. This is called house flipping. It’s one of the fastest ways to make money in real estate.

4. Real estate investment trusts (REITs)

Since REITs are true passive income generators, investors usually include them in their portfolios. REITs offer you the chance to receive dividends in the same way as investing in the stock market. You don’t have to manage properties, buy or sell.

They offer a convenient way to diversify your portfolio if you can’t devote time, money and effort into building a real estate portfolio on your own. And they can be very profitable too. In fact, the FTSE Nareit All Equity REITs index performed strongly in 2021, with a total return of 41.3%. However, you’ll need to do your due diligence when shopping for REITs. The only problem is that dividends you receive from REITs will be taxed at a higher rate.

5. Real estate syndication

A syndication is a type of partnership among investors. Usually, it’s about combining capital to buy multifamily apartment buildings and then having an experienced property manager handle their operations.

As with REITs, you reap the benefits of owning multifamily properties (cash flow, tax breaks, appreciation) without having to deal with daily property management stresses. If you want to know how to scale a real estate portfolio fast, then you should learn more about real estate syndication.
The properties you can buy through syndication are usually larger than what you can afford on your own. Also, you can expand your portfolio to include land, mobile home parks, and self-storage units.

6. Wholesaling

Of all the real estate investing strategies, wholesaling requires the least capital to start. Wholesaling, also known as micro-flipping, involves buying an undervalued property and selling it to an end buyer for a profit as soon as possible.

So, essentially, you’re reselling houses at a higher price than you paid for them, most times using leverage. This means that to succeed at wholesaling you’ll need to have above-average sales and negotiation skills. This makes it a preferred choice for realtors.

How to Build a Real Estate Portfolio: Your Financing Options

  1. Cash Financing: Investors with access to significant capital, either personally or through their network, should take advantage of this.
  2. Hard Money Lenders: You can use a short term loan to purchase properties when you have low credit.
  3. Private Money Lenders: Can any of your connections offer you a loan? Then use this option. Ensure you work out the terms of the loan – interest rate and payback period.
  4. Self-directed IRA Accounts: Self-directed IRA investors may decide to tap into their account for access to capital. A self-directed IRA also offers tax savings
  5. Seller Financing: When the seller owns the property outright, you can avoid the bank altogether through seller financing. The seller finances the sale, while the buyer maintains the agreed-upon payment schedule. Seller financing allows for a faster transaction. However, both buyer and seller might need to hire attorneys to draw up contracts and the promissory note.
  6. Traditional Financing: If you qualify for a conventional loan, you should consider going this route. Even though interest rates on traditional real estate investing loans are usually higher, you might be able to use the equity in your current home to secure a favorable loan.

What is the fastest way to build wealth in real estate?

BRRRR, or Buy-Remodel-Refinance-Repeat, is a great way to build a rental portfolio without running out of cash, but only when executed correctly. When done right, the BRRRR strategy lets you pull out all the money you put into a property when you refinance. Learn more about the BRRRR strategy.

However, you’ll need to keep your risk small at the start. Your portfolio grows as you gain knowledge and experience.

Scaling your real estate portfolio: How do I build a large real estate portfolio?

Scaling a real estate portfolio is not an easy task, regardless of how fast or slow you do it. Hence you need a solid plan to figure things out. Increase your risk taking capacity and be prepared to invest hours of hard work into building your real estate portfolio.

Now that you know how to build a real estate portfolio, here are some success stories from people who built their own real estate portfolios.

If you need help to start building your portfolio or to grow an existing portfolio, we can help. Become a member of RealWealth to enjoy access to exclusive inventory, connect with experienced Investment Counselors who can coach you on your journey, and to utilize our network of prefered resources like CPAs, attorneys, 1031 Exchange Intermediaries, and more.

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