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!
