Real Estate 025: Scaling your Real Estate Portfolio
/After meeting with hundreds of real estate investors through BiggerPockets, Real Estate Meetups and Conferences, I have seldom met an investor who does only one deal. The goal is to find a formula that works for you and your goals, and repeat the process enough times to achieve the target passive income. The big question becomes, how does an investor scale from a handful of properties to tens or hundreds of units? I have highlighted four different ways that an investor can scale their portfolio below:
Spend less and invest the difference
This option may seem like a no brainer, but its sometimes easy to be overlooked. As a buy and hold investor, you are in it for the long haul, meaning that you have to be consistently earning more than you spend (I personally suggest you get to a place where you are able to comfortably stash away 40% of your earnings), invest the savings into cash flowing real estate, and repeat the process. Each time you go through this cycle, you should have additional funds from your new rental property to help enhance the velocity of this cycle. One mistake I see investors make, is they begin to inflate their lifestyle along with their newly built portfolio. For example, they may put $25,000 down to purchase a turnkey duplex property in the Midwest that generates $400/month in passive income after all expenses and debt service. They use this $400/month to pay for a new car lease that they wouldn't have bought otherwise. While rewarding yourself is important, this is a risky move as that $400/month cash flow is never 100% guaranteed. Meaning the tenant could stop paying, leading to an eviction and couple months loss of rent before that $400 starts coming in again. During this time, you are left paying the mortgage and expenses related to upkeep of the rental in addition to the new lease payment. You have effectively dug yourself a bigger hole to climb out of.
My advice is to continue living as if you have not creating the additional stream of income. Think of it almost as a 401K or IRA account that is restricted from use. By placing this phantom restrictions on this newly created income, you will be able to reinvest the earnings into your business again and again and exponentially assist in the growth of your portfolio. Lets say you were able to buy 2 rentals a year through this process. By year 5, you have 10 properties that generate $4000/month in passive income, which means that every 6 months, the cash flow from your portfolio alone is enough to purchase another rental so you can buy 4 properties a year instead of 2. This will shorten the growth from 5 to 2 years, and so forth. This is the snowball effect that myself, and many other investors have realized while building their portfolio. I have personally increased my W-2 income by 28% during the growth of my portfolio, reduced my expenses, and did not use the cash flow from my rentals to offset any of my personal living expenses. That way, I was able to allocate nearly 30-40% of my earnings straight into investing for my future.
Private lenders & BRRRR
Another way of building your rental portfolio is through using private lenders. A private money lender is an investor who makes loans secured by real estate or promissory note, typically charging higher rates than banks but also sometimes making loans that banks would not make (rehab loans), funding more quickly than banks and/or requiring less documentation than banks. Private money lenders exist because many real estate investors need a quick response and quick funding to secure a deal when looking for a real estate loan. Banks and other institutional lenders that offer the lowest interest rates don’t provide the same combination of speed and transparency in their decision making process, along with quick access to capital. By securing private lenders who will fund 80-90% of the purchase price and/or rehab, you have significantly reduced the amount of capital you need to acquire a new deal. As long as you can find a deal that is "all-in" near 70% of the ARV, then you are able to find a discounted property, renovate it, and force the appreciation (read: sweat equity), that will take place of a normal cash downpayment. You can repeat this property to scale your portfolio, otherwise known as the BRRRR (buy rehab rent refinance repeat) strategy.
HELOC
A HELOC, or home equity line of credit, is a 2nd mortgage (home serves as collateral), but a HELOC is a form of revolving debt, like a credit card with simple interest (not amortized). This means that you are able to withdraw money up to an approved limit, using a bank transfer, card or check, repay it and draw it down again within the predefined terms of the loan. As a HELOC is a secured loan, you are able to obtain a lower interest rate than the average credit card (around 22-25%) or personal bank line of credit (typically 8-12%). Savvy investors will use the equity in their primary residence or rental property to withdraw capital at low interest rates (e.g. 5%) and re-invest the funds into another cash flow rental property (e.g. 15% cash on cash) and make money on the spread, or difference of the return (10%). As you are cash flow positive in this scenario, you can effectively continue this cycle until your HELOC is fully utilized. Be sure that you are investing into a deal has significant upside, as a HELOC typically has variable interest that may jump up and eat into your profits. I personally only use my HELOC on the BRRRR strategy as I have a exit strategy (re-finance) and pay off my HELOC balance in less than 6 months, reducing my overall risk to variable interest.
Partnerships
Whether your expertise is in finding good deals, underwriting potential leads, or bringing the capital to fund the deals, each investor that you meet may be a potential partner. If you find someone who has complimentary skills, you may consider bringing them on as an equity partner. I have personally bought 4 units together with an equity partner and there are multiple benefits such as pooling of resources, increased capital, and diversification of risk. Lets say that you are great at marketing, and can find distressed properties from motivated sellers for 20-40 cents on the dollar. This is a huge value add for an investor who has capital but does not have time to conduct direct mail campaigns or call motivated sellers for screening. By teaming up with each other, you are able to take down a property with significant upside and refinance once the rehab is complete to allow each of the partners to recoup their initial investment and/or create equity that would otherwise be unavailable had they chosen to work as separate individuals.
These are the four ways that have allowed me to purchase 12 units in about 1 year, and as you continue gaining experience, you will learn to add more tools to your tool belt such as seller financing, subject to, and other methods that allow you to scale by being a little creative. There is more than one way to invest in real estate, so find a way that works best to meet your goals. As mentioned above, it may feel as if $400/month is not life changing, however, the steps that you took and knowledge gained to increase your passive income IS. These small changes and building blocks will be the foundation that will eventually lead you to create thousands of dollars in passive cash flow a month and achieve financial freedom years.
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!