Real Estate 042: Picking an Investment Strategy

Everyone is different. We come from different backgrounds, jobs, financial status, and most importantly, we have different goals. As mentioned previously, part of getting educated in real estate is clearly defining your goals and creating a strategy to achieve those goals. This is a very important step because a ship without a clear direction, is basically sailing towards nowhere. Note: As you continue to read books, network with investors, and listen to podcasts, your strategy, tolerance for risk, and method of execution may evolve, and that is perfectly fine.

There are a couple different strategies that I have seen that are used by investors on BiggerPockets and other successful real estate investors that you may have come across on Youtube or HGTV:

Wholesaling

There are many people who are getting educated on real estate but give lack of money as an excuse for not getting started. Brandon Turner, Co-Host of the BiggerPockets podcast, summed it up perfectly: "To succeed in real estate, you only need to have two of three things: Time, Money, or Knowledge." Wholesaling will require time and knowledge. Wholesaling real estate basically means placing a distressed (needs TLC or major rehab) property under contract and re-selling the property to another investor. You may have seen signs in your neighborhood that say "we buy homes, all cash". These are your wholesalers who typically purchase homes in cash, lines of credit, or other private funds. Wholesalers are not in the business of buying property, but to quickly re-sell them to investors for a profit (aka finders fee).  A good wholesaler will maintain an active buyers list and purchase homes that are in the buyer lists criteria and re-sell them prior to closing on the original contract. 

For example, let's say there is a house in Independence, MO that you put under contract for 30K. If the home has a repair budget of 25K and after repair value (ARV) of 80K, an investor may be willing to purchase the home for 35-40K. In this example, you would quickly sell the contract to the investor for 35-40K and profit 5-10K on this single transaction. Wholesaling is a great way to build your seed money if you are looking to expand into flipping properties or purchase buy and holds for rental income.

Flipping

Flipping real estate properties is a method of purchasing distressed properties (bankruptcy, foreclosure, REO), adding value through rehabs, and selling them for a retail profit. You may have been exposed to flipping on hit HGTV shows such as flip or flop, masters of flip, or brother vs brother. Normally, these investors purchase the properties from wholesalers, courthouse steps (foreclosures), or from banks for cash and "force appreciation" of the home through value add rehabs such as new kitchen, bath, backyard, rooms, paint, HVAC, etc. 

Using the example above, the flipper may purchase the distressed property for 35K and put in rehabs of 15K for an "all-in" cash of 50K into the project, and sell it for 80-90K (market value) for a 30-40K profit. This method is riskier than wholesaling and buy and hold due to the high usage of capital and the risk of properties not selling quickly in a downturn market.  Further, there is also a large risk of miscalculating the rehab costs that can quickly exceed the ARV, in which case the project is no longer profitable.

For example, the flipper buys the home for 35K with an estimated rehab of 15K. However, during construction, it is identified that the foundation needs work (10K), and HVAC needs to be replaced (5K) on top of the original estimate. Now the flipper has an addition 15K of unforseen costs for an all-in cash of 65K into the project. Their profit on this deal has now been cut in half.

Buy and Hold

This is my current strategy of working with real estate investments and if done correctly, this can be the most passive form to generate income and overall wealth. There are normally 5 different steps for this strategy, but you will notice that you don't have to be actively involved in all 5 steps. Like Tim Ferris emphasized in his book "4 hour workweek" you can outsource these steps, at a price, of course. Take a look below and decide the opportunity cost for yourself:

1. Pre-Approval/Financing: 
This is a key step in the real estate investing process. There are many ways to finance a deal: Savings (from W2, Wholesaling, Flipping), Private Loans, Syndications, Partnerships, FHA, or conventional financing (most common). If you are going the conventional financing route, it is important to be pre-approved with a lender who works with investors AND the market that you are investing in. Just because they are in that market, doesn't mean they have experience with the nuances with working with out-of-state investors, nor does working with investors mean they understand the market that becomes more important during the underwriting/appraisal process.

Pre approval is critical because as a buyer, you want to know your exact buying power, so that when you make an offer, the seller knows it is solid. You might wonder why the lender is asking for many documents such as tax returns, bank statements, etc. simply for a "pre-approval". However, this will eventually save you time in the back-end as these same docs will not have to be re-submitted.

2. Acquisition:  
You have many options when it comes to purchasing a property. You can find a realtor to represent you in the market you are analyzing (they have access to the MLS, and good realtors have built a network to obtain "off-market" deals, often at a discount), you can work with a "turn-key" company (more information below), or work directly with the owner/seller's agent to negotiate on sites such as Zillow, Redfin, Trulia, etc. I would highly recommend working with a buyer's agent as their commissions are paid by the seller and they can give you objective third party advice at no additional cost - more protection for you (note: some buyer's agent may have a broker's commision -  a fixed fee paid by the buyer, and other fees that will be disclosed to you prior to working together).

There are many subcategories to acquisitions: Neighborhood Class, Cash Flow, CapEx/Rehab, Cap Rate/Cash on Cash, Type of Property, Choosing a Market. I will discuss all of these in a separate post.

3. Rehab: 
Rehabbing might be fun for some, but a bag of worries for another investor. In my experience overseeing the rehab of my parent's primary residence, rehabs always tend to take longer than expected, and cost more than expected. If you are the type of person to loss sleep when you uncover unexpected costs or delays during a rehab, I would recommend you outsource this step to another party (i.e. TurnKey). However, if you want to build "sweat equity" and realize savings through your own rehabs or by using a licensed contractor, make sure you do your research and create an accurate budget with room (10-15%) for contingencies. Network with other investors in the local market from BiggerPockets, Real Estate Investor Association (REIA), or Facebook Groups and obtain recommendation for contractors with a solid track record and interview them thoroughly. I have heard too many horror stories on contractors running away with investor money, or providing pictures of rehabs of different houses, only to have the investor make a surprise visit and see that not everything was done as promised. I want to re-emphasize the importance of getting yourself educated so that you know how to ask the right questions and make judgments for yourself instead of relying solely on other people's advice. Remember, no one has your interests in mind like YOU.

4. Management/Maintenance: 
You will often hear that "investors live and die by their property manager". I think this is no doubt 100% true. The sales/acquisition/rehab/financing is only 5-10% of the overall picture. 90-95% of the time you will be working with the property manager to make sure that your investment is being properly tenanted and maintenances being performed.

You can manage your own properties if you are local, however, if you are investing out-of-state, this will be near impossible. Typically a property manager will request 8-12% of the monthly rental income. A couple key benefits for outsourcing property management is: 1) Not needing to respond to maintenance inquiries at all hours of the night/weekends 2) Not having to perform marketing for leases/screen tenants 3) Not having to perform timely bookkeeping/accounting records for tax purposes. I believe the 8-12% is well worth the above services. There are a ton of bad property managers, but there are good ones as well. Make sure you fully vet the property managers just as you would vet the realtor, turn-key company, or contractor. 

Final Thoughts

I will leave you with this final note. One of my favorite speakers/authors Tony Robbins said this: "The defining factor is not the lack of resources, it's your lack of resourcefulness that stops you from taking action" – Tony Robbins.

Whether you decide to wholesale, flip, or buy and hold, make sure that these strategies are aligned with your goals (building capital, or monthly cash flow). Please make sure you do your due diligence and talk to your CPA/Attorney/Financial Advisor before making any investment decision. 

Good Luck!

Real Estate 041: How do I get started?

Now that we have just discussed why I like real estate as an investment class, let's talk about how you can get started. First and foremost, I strongly believe its very important for you to get educated in the area you are investing in. I am not saying you need to be an expert in the field, however you should know the basics on real estate: finding a market, finding a team/networking (realtor, turn-key, property manager, wholesalers), defining your criteria/goals, analyzing a property, obtaining financing, just to name a few.

In this day and age, there are tons of resources where you can obtain this information. However, with the wealth of information, comes what is called "analysis paralysis". Investors have so much information at their fingertips, they second guess themselves at every turn, looking for the "perfect" deal, or go looking for gurus who can become their savior. There is no such thing as a perfect deal, and too many gurus who don't have your best interest at heart. The best way to learn is to read/listen to blogs, podcasts, and forums (just like you're doing now), connect with other investors and realtors who are active in the field, and then take action at the appropriate time.

My favorite resources to learn about real estate investing have been the following:

Forums/Networking: www.biggerpockets.com (FREE)

Biggerpockets is the largest community of real estate investors on the internet. With that network comes all the other professionals that you need to connect with to succeed. I have talked to over 10 investors from California who are active real estate investors (some have 2 properties, some have 10+), who share their knowledge of investing, common pitfalls, mistakes they have made, success stories, etc. They have truly helped me navigate through the "noise" and the "naysayers" and proceed with owning a rental property. In additional to investors, there are realtors, insurance agents, wholesalers, turnkey providers, property managers, and rehabbers who you can network with and form partnerships for projects down the road. Remember with any relationship, trust is built over time, so don't accept everything you hear/read in totality but use your judgment to make the right decisions for your situation. Remember to sign up for their free webinars every week that has a ton of great information for newbies.

Listening/On-the-go: podcasts (FREE)

Download any podcast app and search real estate investing, turnkey, passive investing, cash flow, rental properties and you will find a ton of shows. I would take a look at the reviews/subscribers just to see if they consistently put out material, are relevant (you don't want to invest in 2020 with information from 2006), and you enjoy listening to. Podcasts are great to soak in information when you are driving, exercising, multitasking on the web, etc.  In no particular order, below are my top rated podcasts:

1) Norada Real Estate - Passive Real Estate Investing

2) Keith Weinhold - Get Rich Education

3) Joe Fairless - Best Real Estate Investing Advice Ever

4) Michael Blank - Apartment Building Investing

5) Brandon Turner - Biggerpockets

6) Scott Trench - Biggerpockets Money

7) Matt Theriault - EPIC real estate investing

8) Rod Khleif - Lifetime Cashflow through Real Estate Investing

9) Matt Nusbaum - Corporate Investor Podcast

10) Dan Lane - Rental Income Podcast

Investor Mind-setting/Action Items: Books ($10-15/book)

I personally own over 30 business/self-help/real estate books and I think they provide a great framework for newbie investors to identify their goals, create a strategy, and devise and action plan to become a real estate investor. Real Estate books such as "ABCs of Real Estate Investing" Ken McElroy or "Millionaire Real Estate Investor" Gary Keller cover all the areas I have mentioned earlier such as finding a market, finding a team/networking, defining your criteria/goals, analyzing a property, and obtaining financing. It is really worth the $10-15 per book. Check out my “books” section of the blog for summaries and personal reviews of business/self-help books I have read over the years.

As always, please make sure you do your due diligence and talk to your CPA/Attorney/Financial Advisor before making any investment decision. 

Good Luck!

Investing 004: Opening a 401K Retirement Account

As you enter the workforce as a young adult, you are faced with many questions such as finding a good career, finding a place to live outside the parent’s nest, paying off student loans, and others. Many of these factors and more also play a key role in how you prepare for retirement. One of the most important decisions you will make is how you plan to fund your retirement. One of the most common themes I often hear from employees in all walks of life is that they simply do not think they have enough money to save or invest. As mentioned in previous blog posts, a key strategy to my retirement plan is to automate my savings and investing. As millions of baby boomers are set to retire in the next decade, they are now more aware than ever of their retirement account balances, or lack thereof. In order to hep facilitate savings, many employers have begun employer sponsored retirement plans such as the 401(k) that help employees automatically set aside funds in tax-advantaged accounts. Tax advantaged accounts can significantly change the amount of money you are left with during retirement if you plan correctly. Many 401(k) plans take small amounts of funds selected by the employee and directs it into the employee’s beneficiary account. Furthermore, many employers offer a matching program on all or a portion of their contribution up to a certain limit to entice their employees. Lets take a deeper look into the anatomy of a 401(k) and how you can get started:

What exactly is a 401(k)?

A 401(k) retirement plan was established through section 401(k) of the Internal Revenue Code (IRS) that gave employees the ability to defer taxes on their contributions towards their retirement up to the annual limit, or in the case of a Roth 401(k), allowed them to pay taxes when they contribute, but draw funds tax free at retirement. Furthermore, it allowed employers to contribute company funds towards their employee’s retirement through an employee match, providing additional perks and incentives to retain key employees for longer periods of time. In general, Companies typically partner up with mutual funds (e.g. Vanguard, T.Rowe Price, Fidelity, Charles Schwab, to name a few) to pick a handful of investments that employees can use to allocate their funds in the portfolio. An advantage is that most of these large mutual fund companies provide lower fee structures for institutional (Companies) clients, but a drawback is that there are limited options if an employee wanted a “specific” vendor or fund to invest in. The biggest takeaway in setting up a 401(k) early on in your career is the ability to lower your taxable income in the amount equal to your contributions. As such, if you made a $100K/year, but contributed $15K towards your 401(k) retirement, ignoring tax credits and deductions, you will have reduced your taxable income by $15K, which at a typical 25-30% tax bracket for single workers in California, equates to about $3,750-4,500 in cash savings per year.

How to open a 401(k)

Now that we have looked into what a 401(k) is, lets find out how to get one started. Assuming that your Company offers this plan (not all Companies do this as there are cost/benefits in maintaining this service), you can first talk to the hiring manager or human resources to find out if you are eligible, as some companies require a minimum time of service prior to enrollment. Next, you will need to identify how much you want to invest per pay period, whether it is a fixed dollar amount or percentage of your paycheck. Once that is determined, you will need to select the allocation percentage from different fund options selected by your employer. For example, lets say you decide to contribute a fixed amount of $500/month towards your 401(k) retirement, or $6,000/year. Out of 12 mutual fund options, you decide to choose 3: SP500, international stock fund, and bond fund. You can decide to allocate 50% to the SP500, and remaining 25% to each of the funds, or you can split equally in 33.33%. Please note you can “rebalance” your portfolio as they balances move up and down throughout the year, and also re-allocate funds from one to another if you feel like doing so.

Managing your 401(k)

An importance piece to owning a 401(k) plan is that this offering is typically reserved for “employees” only. Meaning that if you ever decide to move to another company or simply quit/retire, you will generally have three options: 1) Move the 401(k) funds into the new employer’s 401(k) through a trustee to trustee transfer 2) Move the 401(k) funds into an IRA (Individual Retirement Account) 3) Withdraw funds. Its very important to note that when you are going with option #1 and #2, you cannot request the funds through check/wire into your bank account and send it to the next institution. Even though you send the exact same amount that may have come in, it may trigger a taxable event identified as a withdrawal, that will add penalties if you are not of retirement age. As such, please consult your CPA and retirement plan administrator prior to making changes and to understand the implications of the transfer.

As mentioned previously, a huge benefit in 401(k) plans is the possibility of an employee match. For example, if your employer is providing a 50% match on the first 6% of contributions, your contributions can look as follows: Employee makes $100K /year and decides to contribute the maximum employer match of 6%, which is $6,000/year. In this scenario, the employer will contribute $3,000/year total towards the employee’s account. That is a guaranteed 50% return on investment on the employees contribution, even if the mutual fund does not go up or down a single penny throughout the year. Please note that some employers do not allow employees to front load or back load their contributions, meaning contributing $6,000K in January and pausing month 2-12, or vice-versa. Employers may only provide matching when employees are consistently contributing to their account with each paycheck, so please check with your plan administrator.

In conclusion, saving and investing for your retirement is going to be an important decision. Making good choices early on will allow you to take advantage of compounding interest and time. Whether you invest in real estate, or individual stocks, a 401(k) may be a great way to diversify, automate your savings, and also take advantage of company matching (aka free money). My personal investing strategy consists of 70% real estate and 30% stocks (IRA/401(k)), but I sometimes use 401(k) funds to purchase rental real estate through a 401(k) loan or use as reserves for the Fannie Mae underwriting requirements. I will post more blog posts about creative financing with 401(k) loans in a new blog.

As always, please make sure you do your due diligence and talk to your CPA/Attorney/Financial Adviser before making any investment decision.

Good luck!