How to be successful in real estate is a question that millions of would-be investors ponder. The U.S. real estate industry is worth trillions of dollars. And many would love to tap into its wealth building potential. But being a real estate investor isn’t as easy as it sounds and figuring out where to get started can be overwhelming. That’s why we’ve put together this guide to help you learn how to be successful in real estate.
The first step in deciding which path is right for you is to examine three decision points. Then we’ll present some options available to you depending on your responses to those three questions.
#1: Evaluate Your Real Estate Expertise – Active or Passive Investing?
How to be successful in real estate question #1: “Am I better suited for active or passive investing?”
Real estate is a brick-and-mortar business. These are not paper assets like stocks and bonds. Instead, they’re physical assets that you can see and touch. As such, it’s easy to lose track of the fact that real estate is also a people business.
The most important person in any real estate investment is the asset manager. This is the person that puts the deal together, analyzes the opportunities inherent in the deal, sets the budget, creates the capital improvement plan, oversees the operations, and decides on the most profitable exit strategy.
Make no mistake, the success or failure of a real estate venture largely depends on the expertise of that asset manager. With that said, are you asset manager material? Ask yourself if you have the experience and expertise necessary to succeed in this industry. If you do, then active investing might be right for you.
If not, then perhaps you’re willing to obtain it. You need to learn this industry and how to become a professional asset manager. It’s a good idea to look to partner with someone who is already successful. They can act as a mentor to help you get to where you need to be.
Passive investors typically don’t have real estate management expertise. They also don’t have the time or interest in learning what it takes to be successful in the industry. Therefore, they hire that expertise by investing passively. In this scenario, they leverage the success of professionals, while avoiding management headaches.
If you’re still not sure whether you’re better suited for active or passive investing, take our quiz to help you determine which is best for you.
#2: Evaluate Your Financial Situation – Accredited or Non-Accredited?
How to be successful in real estate question #2: “Am I considered an accredited investor?”
Regulation D of the Securities Exchange Commission (SEC) governs private placements. This regulation, in most cases, limits these investments to accredited investors. So what is an accredited investor?
You are an accredited investor if you meet any one of the following three definitions:
- Have a gross income individually (not counting spouse’s income) of $200,000 a year for the last two years with a reasonable expectation of the same in the current calendar year.
- Have a gross income combined (your income and your spouse’s income) of $300,000 a year for the last two years with a reasonable expectation of continuing to do the same in the current calendar year.
- Or have a net worth of at least $1 million, not counting the value of your primary residence (home).
You’re accredited if any one of these definitions describes your financial situation.
#3: Evaluate Your Real Estate Investment of Choice – Residential or Commercial?
How to be successful in real estate question #3: “Which classes of real estate best suits me and my portfolio?”
To better understand your investment choices; let’s define your primary options. First, there is resident occupied real estate. This is providing housing for others and can be broken down into two primary categories – residential and commercial multifamily.
Residential real estate is 1-4 units and encompasses single-family home rentals, duplexes, triplexes, and quads. Commercial multifamily real estate is defined as 5-units and larger.
Commercial real estate offers other options. Within this category are office, retail, industrial, hospitality, and storage. Still other investing options include raw land and trailer home parks.
There are lots of ways to make money in real estate and you should choose the one that works best for you. We specialize in commercial multifamily real estate for several reasons. As a risk-averse company, we like the conservative nature of multifamily.
Commercial Multifamily Real Estate Outperfroms The Others
Over any long-term period, commercial multifamily has the best Sharpe ratio (risk-adjusted return) compared to the other commercial real estate asset classes. After all, it’s an investment in the basic need of shelter. Multifamily also acts as an excellent hedge against inflation as well as a diversification tool for those heavily invested in the stock market.
We also like the fact that multifamily is less volatile and less sensitive to economic cycles than many of the other real estate asset classes. Unlike retail, multifamily isn’t threatened by Amazon and other forms of e-commerce. It also doesn’t take the hit that retail, industrial, and hospitality takes when the economy is bad. People will travel less and buy less goods and services in hard times, but they still need a roof over their head.
#4: How To Be Successful In Real Estate Involves Pinpointing Your Options And Educating Yourself
By this point, you should know whether you’re best suited for active or passive investing. You’ve evaluated your financial situation and determined if you’re an accredited investor. You should also have a better sense of your real estate investment options. Now let’s look at some of the opportunities you can look at based on your answers to those first three questions.
Options For Passive, Accredited Investors
As a passive, accredited investor, you have quite a range of options. You can participate in real estate investments from private real estate investment groups. This type of investing is also known as real estate syndication or fractional investing.
There are syndicators that specialize in the various forms of commercial real estate. And prior to 2012, these companies operated under a general ban on solicitation. In other words, they could not advertise their offerings. Because of this ban, they typically started with their own money, family money, and friend money. If they did a good job, then word of mouth would drive demand for their investments. Any misstep could be lethal, leaving only the strong to survive and thrive.
Passage of the Jumpstart Our Business Startups (JOBS) Act changed all that. It repealed the ban on solicitation in 2012. This deregulation of the private placement industry opened the floodgates.
Almost immediately, a deluge of marketing companies began standing up fancy websites with glossy pictures and professional sales copy. Their purpose was to attract investor money for newer real estate investment companies. They acted as a middleman between the investor and the real estate company. For a fee, they’d raise money for their deals. And their avalanche of marketing made it infinitely more difficult for investors to separate the quality syndicators from the questionable ones. The JOBS Act created this new marketing industry known as crowdfunding.
Deregulation Creates Crowdfunding
Unfortunately, for those crowdfunders the top syndicators don’t need their marketing services. The strongest companies have built a robust track record of excellent results that lends itself to high demand, repeat investors, and plenty of referrals. They don’t need a marketing service to raise money for them and it doesn’t make sense to pay the extra layer of fees charged by the crowdfunder.
For that reason, crowdfunding marketers typically represent newer real estate companies and existing companies with less than stellar results. That’s not to say that some of those companies will eventually develop an excellent track record and be able to break free from the crowdfunders. But it takes time and excellence to develop that track record.
The deregulation of our industry and the rise of crowdfunding has introduced extra risk to unsuspecting investors. Professional marketers don’t necessarily know much about real estate. Many have had problems and some have even gone under.
That’s why I’d highly recommend you look at companies that started their business before 2012. Look long and hard at their track record. Deal with the syndicator themselves and not some marketing middleman. If they use a crowdfunder to raise money for them, ask them why they don’t raise money themselves.
Being a passive investor should never mean you’re disinterested or uninformed. You need to do your due diligence upfront to be sure that you’re investing with a company that invests consistent with your own principles. Know their strategy and know their track record.
I’m An Active Investor – Now What?
Active Investors, whether accredited or not, often start in residential real estate. The lower price points can be alluring. However, there are some drawbacks you should be aware of.
Typically residential real estate only qualifies for full recourse lending. That means you’ll need to personally guarantee the loan. Should you default, the bank can come after you and your assets to make themselves whole.
Additionally, the residential space is too small to attract professional property management. Instead, you’ll have to rely on mom-and-pop property management or do the day-to-day management yourself. Managing tenants, toilets, termites, and 2:00 A.M. phone calls may be more than you bargained for.
Lastly, these smaller properties simply don’t have the economies of scale that come with bigger properties. One vacancy in a duplex means you’re only 50% occupied. That’s very different than one vacancy in a 200-unit property. Without the stabilizing effects of larger properties, the returns in residential real estate can be volatile.
The Advantages of Commercial Real Estate Over Residential
For those active investors who understand the advantages of going big, commercial real estate might be right for you. You can qualify for non-recourse debt, take advantage of professional property management, and benefit from economies of scale.
Typically these investors have a large net worth or access to capital. They may be part of a trust, family office, or partnership. Ultimately, they need to be able to raise significant amounts of capital.
Their obligation to their investors is to bring the experience and expertise required to successfully own real estate and make them money. If you don’t have that expertise, but think this would work best for you, then I’d highly recommend you look into our affiliated program Multifamily Partner and download the free report – The Essential Step-By-Step Guide To Apartment Investing.
Options For Passive, Non-Accredited Investors
Passive, non-accredited investors have limited options. Nevertheless, you may be able to invest with a private real estate company that focuses on Regulation D, Rule 506(b) offerings. These can be hard to find. Non-accredited investors can participate if they’re considered “sophisticated.” Sophisticated investors have sufficient knowledge and experience to evaluate these investments and understand their risks and benefits.
Another option is publicly traded REITs. Unfortunately REITs are not actually physical real estate. Instead, they’re stocks that focus on the real estate sector.
As stock, they have a higher correlation to the market, making them more volatile and less beneficial from the perspective of diversification. REITs are also subject to higher taxes. They don’t enjoy the favorable tax benefits given to physical real estate.
Nevertheless, REITs may have a place in your portfolio. If you’re considering investing in REITs, you might benefit from speaking with a qualified fee-based financial advisor.
The investible universe for real estate is deep and wide. With so many options, knowing where to start can be paralyzing. But, if you want to know how to be successful in real estate, the best place to begin is to ask yourself those three questions. Do you prefer active or passive investing? Are you an accredited investor? Do you prefer residential or commercial real estate (or both). From that point, you can make better decisions for yourself.
For more information, read “How to Build Wealth Through Real Estate Investment.” If you’d like to learn more about investing with 37th Parallel Properties, read “Apartment Investing – How to Get Started With 37th Parallel Properties.”
If you have any questions or if we can help you learn more about getting started investing in real estate, send us an email at [email protected]
To learn more about commercial multifamily real estate investing, download your free copy of Evidence Based Investing from 37th Parallel Properties.