So you want to invest in real estate. Well, who can blame you? Real estate is a time-tested, proven path to wealth for new investors. So what’s stopping you? For many, it’s the question of how to invest in real estate. They simply don’t know where to start.
If you don’t know how to invest in real estate in the first place, then it can be awfully hard to get started.
Getting Started with Real Estate Investments
The starting point has nothing to do with foundations, roofs, or structural components. Instead of inspecting the insides of properties, you really need to start by looking inside yourself.
And the first question you should ask yourself is, “Are you best suited to invest actively or passively?”
Active investors take on the asset manager role. They create the business plan, oversee the capital improvements, and look for a profitable exit strategy. They also work with the property manager to make sure their operations are optimal.
It’s not uncommon for an active investor to also take on the duties of the property manager. This means that they are involved in the day-to-day operations. Property managers get their hand’s dirty managing tenants, toilets, and 2:00 a.m. phone calls.
Passive real estate investing is different.
Passive investors look to place their capital in the real estate market without getting entangled in management. They leverage the time and expertise of real estate professionals to grow their wealth without having to get involved.
Active investing is best suited for those who have experience and expertise in real estate and treat it as their full-time job. Passive investing is ideal for those without the time, energy, inclination, experience, or expertise to successfully manage properties.
Opportunities for Investing in Real Estate
Once you figure out if you’re better suited for active or passive investing, you have multiple options for investing in real estate.
You can invest in commercial properties which include things like retail, office, industrial, and office buildings. You can also invest in resident-occupied real estate. Resident-occupied real estate is typically classified as residential or multifamily.
Residential Rental Properties (Single or Multi-Family Housing)
Residential real estate has small unit counts that encompass single-family homes, duplexes, triplexes, and quads.
Without the economies of scale that come with larger properties, residential properties tend to have small profits and higher volatility. If the property is financed, one vacancy typically leads to negative cash flow.
Multifamily properties are defined as five units and more. However, when I discuss them in this article, I’m talking about big properties (100 units and up). These properties have economies of scale that warrant onsite professional property management. The high stability and predictable revenue that comes with large multifamily properties qualify them for non-recourse lending.
Over the last twenty years, direct real estate has had some of the highest returns, lowest volatility (standard deviation), and best risk-adjusted returns (Sharpe’s ratio) compared to many other asset classes. Multifamily has beaten the S&P 500, bonds, and the various commercial real estate asset classes.
Crowdfunded Real Estate
The “how” of how to invest in real estate used to be a real problem for many investors. Plenty of private real estate investment companies existed in the market, but they weren’t so easy to find. That’s because they all operated under the same SEC restriction.
And that restriction was a ban on advertising. Real estate syndicators couldn’t purchase T.V., radio, or print ads to announce their offerings and services. Instead, they had to build their investor pools methodically through word of mouth.
Excellent operations, solid customer relations, and consistently healthy returns brought back repeat investors who told their friends and family.
Conversely, questionable decision-making, poor communication, and lackluster results also spread by word of mouth.
Over time, quality companies thrived. Those syndicators who produced less than stellar results quickly lost their ability to raise capital.
In many ways, the moratorium on advertising acted as a filter that protected real estate investors. In some ways, it was like natural selection in which only the strong syndicators survived. As good as that was for investors in the know, it wasn’t so easy for other investors to find these quality syndicators.
The JOBS Act of 2012 and The Rise of Crowdfunding
And then along came the Jobs Act of 2012.
This act deregulated our industry by lifting the ban on advertising. Suddenly, anyone could hang a shingle, call themselves a syndicator, and hire professional marketers to raise capital for them. Unfortunately, having experience and expertise was no longer a prerequisite for operating in our industry.
Lifting the moratorium on advertising allowed crowdfunding to take off. Crowdfunders are marketers. They act as a middleman between the investor and the syndicator. For a fee, they will raise money for syndicators who are unwilling or unable to raise money themselves.
Unfortunately, crowdfunding has introduced more risk for investors. It has given a platform for inexperienced and failed syndicators to raise capital for their projects.
For that reason, it has become critically important for passive investors to do their due diligence prior to investing. During that due diligence process, it’s important to remember that the vast majority of high-quality syndicators with a long track record of success do not utilize crowdfunding.
Real Estate Investment Trusts (REITs)
REITs or Real Estate Investment Trusts are companies that own income-producing real estate. And like other publicly traded companies, you invest in them by buying their stock.
With REIT investments, you don’t own brick-and-mortar properties. Instead, you own paper stock. These investments are a sector play within the stock market. That doesn’t mean that REITs are good or bad. For some people, REITs can be a useful addition to their portfolios.
But, it’s important to understand that REITs tend to be correlated to the market. And just like the broader market, REITs are also very volatile. That’s just the nature of stock.
If you’re looking for true diversification from the stock market, solid returns, and tax benefits within a low volatility/highly stable asset class, then you need to own physical apartments and not paper.
37th Parallel’s New Real Estate Investment Fund
If you’re reading this, then you’re probably already considering investing in apartments. If you’re like most people, you don’t want to become a landlord. You likely want to be in the larger, more stable properties, but you also know that multimillion-dollar properties have multimillion-dollar down payments. So how can you pull this off?
The answer is fractional investing. This allows you to be an owner of actual cash-flowing real estate without getting your hands dirty. Instead, you can pool your money with like-minded investors and ride shotgun with an experienced syndicator that has a successful track record for making their investors money.
In fact, 37th Parallel Properties has a 100% profitable track record over nearly $1 billion in transaction volume. We know how to make our investors money.
Our next investment opportunity is Fund II. It opens in late Q2/early Q3 2022.
If you’re looking to invest in apartments then Fund II and 37th Parallel Properties should be at the top of your list.
What are the Benefits of Investing in Real Estate?
Now that we’ve covered how to get started with investing in real estate, let’s now address why you should consider investing in apartments.
Investing in real estate can provide four economic benefits.
- Cash Flow
- Tax Benefits
Amortization is the gain in equity one realizes as their tenants pay down the loan. As for the other three benefits, along with the diversification benefit, let’s discuss them in the upcoming sections.
Diversifying Your Portfolio
With so many Americans having significant holdings in the stock market, diversification outside the market is critically important.
Both multifamily real estate and government bonds have a long track record of having low correlation coefficients in relation to the stock market. For that reason, both have been used by investors for diversification.
Both are also considered low volatility asset classes which brings stability to a stock-heavy portfolio. Where they diverge is in their returns. Multifamily returns have significantly outpaced the returns from bonds for many years.
It’s important to diversify a portfolio and to add stability to that portfolio. However, you shouldn’t have to sacrifice returns to achieve that. Fortunately, by adding multifamily real estate, you don’t have to.
Creating Passive Income
In addition to the diversification and stability benefits, multifamily real estate also happens to be a great way to generate passive income.
That income comes primarily from the rent tenants pay on a monthly basis. And historically speaking, it tends to surpass the income generated from bonds, dividend stocks, CDs, money market funds, etc.
Note: Yield Comparison Chart as of Q3 2021
It’s important to remember that the yield you generate from properties is just one of four ways you can make money from apartments.
Growing Returns Over Time
You can grow the cash flow and the equity that comes from apartments over time. And sound management practices that grow rents, decrease expenses, and or increase renter retention will grow your returns.
This is the case because multifamily real estate is valued based on its net operating income (NOI). The higher NOI is, the more the property is worth.
Tax Advantages of Investing in Real Estate
As your returns grow, it’s important that your taxes don’t.
Fortunately, multifamily real estate is highly tax-advantaged. Depreciation, accelerated depreciation, and bonus depreciation typically allows investors to defer tax on the income that they generate from their investment.
And 1031 Exchanges allow them to sell a property and purchase another while deferring capital gains taxes.
Things to Consider Before Investing in Real Estate
Due diligence is the process by which one takes reasonable steps to scrutinize an investment prior to investing. A partial list of items that an investor should know includes:
- Market and submarket dynamics
- Type of real estate
- Syndicator’s track record
- Does the business plan align with their investment goals
- What is the holding period
- What is the exit strategy
- Is the syndicator raising the capital or are they using crowdfunding
- What type of lending is being utilized
Now let’s take a deeper look into a few other items you should understand prior to making an investment.
Affording the Down Payment or Investment Fund Buy-In
When you purchase a home, it’s common to put twenty percent down to avoid paying private mortgage insurance. With U.S. median home prices surging over $400,000, that means one would expect to put more than $80,000 down on their new home.
Similarly, large apartment complexes require a down payment. But as I said earlier, multimillion-dollar properties come with multimillion-dollar down payments.
Fortunately, fractional investing allows like-minded accredited investors to pool their money together to purchase these properties. And it’s typical for an investor to gain access to these stable assets with as little as $100,000.
Analysis of a Potential Real Estate Investment
All investments have risk, but they don’t have the same risk. Some investments are riskier than others.
The goal of most investors is to maximize their returns while minimizing risk. Underwriting is the process of doing a risk-reward analysis.
And all professional syndicators have their own in-house underwriters. They tear through the rent roll and financials to determine the appropriate purchase price for a property.
Unfortunately, most investors don’t know the ins and outs of underwriting. They can’t underwrite a property any more than they can underwrite a stock investment.
But that shouldn’t stop them from evaluating risk. To do that, they need to know what financing is being obtained and what is the syndicator’s track record for hitting their projected returns.
Leveraging Mortgage Financing in Your Analysis
Loan-to-value (LTV) range of 55%-75% is pretty typical for large multifamily properties.
This means that the biggest investor in these properties is the lender. If you’d like a primer on this subject, you can check it out at this link.
As the biggest investor, the lender will do their own independent underwriting of the property. They’re not going to put their capital on the line unless it makes sense. You can leverage their underwriting just by asking who will be financing the property.
Different lenders use different underwriting standards. For example, the government-sponsored enterprises (GSE: Freddie Mac & Fannie Mae) along with insurance company lenders have the strictest underwriting standards. To qualify for their loans, a syndicator must comply with their conservative standards.
GSE and insurance company lenders have extremely low (well under one percent) foreclosure rates. Commercial mortgage-backed securities (CMBS) debt and local bank financing tend to have less conservative underwriting standards. They finance riskier investment properties. For that reason, they have higher foreclosure rates.
Bridge debt and hard money loans finance the riskiest of properties.
Knowing which form of lending will be utilized to finance an investment lets you know the level of scrutiny a property’s underwriting has gone through. Investments financed with GSE and insurance company debt are best suited for conservative investors who want to minimize risk.
Comparing Projected Returns with Actual Returns
The underwriting process that the syndicator uses allows them to calculate projected returns. These projected returns are an estimate of what the syndicator believes an investor will make if they participate in a project.
They will publish these projected returns in the Private Placement Memorandum (PPM) and quote them in marketing discussions with investors.
These projected returns can be helpful, but never forget that they are forwarding looking statements. The syndicator is giving you their best estimate of what they believe the property will return.
What really matters is actual returns.
Of course, there aren’t any actual returns yet on a new investment property. The next best thing you can do is to look at the actual returns of existing investment properties and properties that have gone full cycle. Compare the projected returns quoted on these properties with the actual returns they achieved.
When the actual returns a company achieves consistently meet or beat the projected returns that were quoted in the PPM you can be confident that their underwriting is conservative and realistic.
When companies consistently underperform their projected returns, it indicates that their underwriting standards are overly optimistic and unrealistic. They are overpaying for their assets which leads to anemic returns for their investors. You should think twice about investing with companies that regularly underperform their projected returns.
Calculating Return on Investment (ROI)
Multifamily real estate can pay the investor in multiple ways as we’ve already discussed. As of this writing, the return profile for core-plus and value-add multifamily real estate in high-quality markets ranges between 11%-15%. This is the annual overall return.
Of that, 5%-7% tends to come in the form of ongoing annual cash flow. The rest typically comes from equity growth.
While my preference is to look at the annual overall return, some people prefer to look at the return on investment (ROI). The formula for ROI is as follows:
ROI = (Net Profit / Cost of Investment) x 100
As an example, let’s look at a hypothetical investment. Let’s say you invested $100K in a property five years ago. It sells today and returns $150,000 to you. In addition, you received $5K a year in cash flow during the five-year holding period for a total of $25K.
ROI = (($50K + $25K) / $100K) x 100
ROI = 75%
So your ROI for this investment would be 75%. As you can see, ROI doesn’t reflect the hold period of the investment. When you factor in the five-year hold period of this investment, you get an overall annual return of 15% per year.
Location of the Property
Another very important thing to consider before investing is the location of the property. Make no mistake, market and submarket matters. Investing in markets without solid population and job growth can handicap the performance and property value of that investment.
It’s not that you can’t make money in challenging markets and submarkets, but your margin for error diminishes in these markets. The worse the market, the more important it becomes to marry the right strategy with flawless execution.
It’s definitely better to invest in properties in high-quality markets and submarkets. These areas tend to be more forgiving. Ideal markets have characteristics like:
- Strong and consistent population growth
- A long history of job growth
- Diversity of job centers
- Favorable landlord-tenant laws
Leverage on Your Investment
If a property was owned for all cash, it would be unleveraged. Leverage is the use of debt to finance a property. I wrote more about leverage in this article.
Excessively leveraging a property can introduce unnecessary risk. Conversely, too little leverage can lead to financial underperformance. So just like Goldilocks, there is a sweet spot that is just right.
Leverage is measured by a metric called Loan-to-Value (LTV). The calculation for LTV is below:
LTV = (Amount of loan / Appraised value of asset) x 100
With core plus and value add multifamily located in quality markets with experienced managers, LTVs ranging between 55% – 75% are common.
Choosing the Right Investment Manager for Real Estate
I mention “experienced managers” because just as markets matter, so does the syndicator. These properties won’t manage themselves. And the quality of the syndicator can make the difference between making money and losing money.
When you invest in a physical asset, you’re partnering with a real estate investment company/syndicator. And like all industries, there is a range in the quality of companies and the services they provide.
The top managers know how to consistently maximize investors’ profits. Mediocre companies chronically underperform. Unfortunately, mismanagement can lead to the failure of the investment. So it’s important to know who you’re investing with and what their track record of success is.
37th Parallel Offers Specialized Asset Management Services
Since 2008 and over nearly $1 billion of transaction volume, 37th Parallel Properties has a 100% profitable multifamily track record.
We are a private real estate acquisitions and asset management firm that specializes in multifamily real estate. Apartment investments in quality markets are all we do and we know how to make our investors money.
Contact Us for More Resources to Start Real Estate Investing
If you’d like to learn more about the 37th Parallel advantage and how to get started investing in apartments, I invite you to schedule some time to speak with our team.
You can do that now by clicking on this link.
To learn more about commercial multifamily real estate investing, download your free copy of Evidence Based Investing from 37th Parallel Properties.