Top 10 real estate investing tips from 37th Parallel Properties.
When it comes to long-term investing, real estate regularly ranks as the number one option for adults in the United States.
In fact, 34 percent of Americans consider real estate to be the best long-term investment. Research show’s they’re right. If you’re interested in delving into the real estate investment space but aren’t sure where to begin, keep reading.
Listed below are ten important real estate investing tips that will help you invest like a pro.
1. Understand Your Market Before You Start Investing
There is no way to overstate the fact that markets matter. In fact, in retrospective analysis, poor market selection ranks as one of the top reasons why people fail in this industry. So if you’re only going to take one of these ten real estate investing tips, never forget the importance of market selection.
Far too many people reflexively invest locally for convenience, instead of relying on market fundamentals to guide their decisions.
While there are a multitude of things to consider, some of the more important things are:
- Population Growth
- Job Growth
- Diversity of Job Centers
- Landlord-Tenant Laws
Populations follow jobs, so markets with declining job opportunities typically result in declining populations as well; the two go hand-in-hand. In those markets demand for housing declines, making rent increases and renter retention programs a failing proposition.
Declining jobs and population are not the only risks you should look to mitigate. For example, markets with growing populations can still be risky if they do not have a diversity of job centers.
Think about those markets where a preponderance of their economy is derived from a single industry; like the military. Many of those communities were decimated when base realignment and closure (BRAC) orders were enacted.
Another important consideration is landlord-tenant laws. Investing in states and municipalities with landlord friendly laws can make your business plan easier to implement than in those that are hostile to landlords.
2. Don’t Forget That Submarkets Are Important Too
Once you’ve chosen a market, you should drill down on submarkets within that market. Keep in mind that renters want to live in clean, safe neighborhoods with good schools for their children. As such, owners should pay attention to crime stats and school scores in their market.
Be sure to note the entertainment and retail quality within close proximity of the property. Will your renters have easy access to grocery stores, nice restaurants, and specialty shopping outlets? Or is the submarket inundated with pawnshops, rent to own businesses, and same day check cashing services?
Money can be made in either scenario, but a misalignment between submarket, apartment grade, tenant profile, and business plan is a recipe for disaster.
Pay close attention to markets and submarkets; there’s a reason why both are in the top 10 of real estate investing tips.
3. Look to Add Value
Hopefully by now, you’ve resolved to never buy a property in a bad market. Next, you want to be sure to never buy a bad deal. If you find yourself debating which is worse, buying a good deal in a bad market or a bad deal in a good market then certainly you’re losing money. And nobody wants that.
Hitting a home run by buying a deeply discounted property that you can turn around and sell at a steep markup is exhilarating – but also uncommon. Disciplined financial analysis and due diligence is less about finding unicorns and more about following a dogged, systematic process that leaves no stone unturned.
You need to be able to identify the “hidden value” when it exists as well as avoid the landmines that can sink the ship.
Ask yourself if you’ll be able to inject capital in a way that each dollar invested will come back in droves? Will your project generate consistent tax-advantaged passive income and portfolio diversification? Whether it’s your investors, your property, your residents, or your employees, you are living these real estate investing tips if you are always looking to add value.
4. Get Your Financial House in Order
What real estate investing tips list would be complete without mentioning the importance of finances?
Whether you’re investing in small residential real estate or large apartment projects, like we buy, chances are you’re going to borrow money. Because of this, it’s important to check your credit report before you start investing. If you find blemishes it’s important to clean it up as soon as possible.
If you opt for residential real estate then you’ll likely be personally guaranteeing your loans. To qualify for those full recourse loans, your credit score and your debt-to-income ratio need to be favorable.
Rather than encumber your credit with full recourse debt, why not reduce your liability with nonrecourse debt?
The safer, nonrecourse debt is more commonly associated with larger commercial multifamily investments. In these projects, the property secures the loan and not the investor(s). That means that your assets are not available as a remedy to the bank, should an unfavorable outcome occur.
Whenever possible, utilize nonrecourse debt instead of full recourse.
5. Employ a Filter When Evaluating Potential Acquisitions
Unfortunately, most properties in a given market are less than stellar candidates for acquisition. That’s why professional investors can look at hundreds of deals a year only to acquire a small handful.
A thorough financial analysis of any given property can be tedious and time consuming. Given the volume of properties out there, an individual can waste a lot of time evaluating mostly marginal properties. To avoid this, it’s necessary to develop a filter to quickly screen out properties that don’t match your investment criteria.
I’d suggest you filter in this order:
Once you’ve developed a reputation as a serious buyer that closes on deals, brokers will be sending you new deal flow regularly. Your time is valuable; so avoid the temptation to look at them all. Delete those properties that are not within your target market. As I said earlier, investing in the wrong markets can kill your success.
Submarket & Asset Level Screening
Of those properties that are in your target market, screen them based on submarket. Look at crime stats, school scores, and median income stats to see if they match your investment approach. If they don’t, then take those properties out of consideration.
For those properties in the right markets and submarkets, you should next screen based on the asset itself. Does it match the age, grade, unit count, and physical specifications that fit your business plan and acquisition requirements?
If you specialize in B-grade garden style, suburban apartment buildings, then don’t waste your time looking at newly built urban core high rises.
The first three filters will leave you with properties that nicely match your acquisition criteria. The only thing left to consider is their financials. Instead of diving in deeply, I’d recommend you employ one last filter.
Some people use the one percent rule. This rule states that every month a property should generate at least one percent of it’s sales price. So a $1 million property should generate at least $10,000 a month in income. If that same property is only generating $5,000 a month, then it’s likely overpriced and not worthy of lengthy financial analysis.
Others utilize a cap rate range to screen the financials of a property. They will take the annual net operating income (NOI) and divide it by the sales price to get the cap rate. Should that cap rate fall below the range that works in their model, they know it’s not worth evaluating further.
While filters provide busy real estate investors with useful tools to quickly evaluate the viability of a potential investment, it’s important to remember that filters have limitations. Use them as a rule of thumb and not as an absolute. And never use them to make a purchase decision. Nothing replaces a full and thorough underwriting and due diligence process.
6. Don’t Be a Trendsetter
Research shows that 80% of your renters already live within a five-mile radius of your apartment building. You can gain a tremendous amount of market knowledge by surveying your competition within that five-mile radius. Ultimately, you want to know what kind of fit and finishes as well as amenities packages drives rents.
Armed with that knowledge, you can create a capital improvement plan that will justify higher rents. Your competition has proven it; you simply need to follow their lead.
Of the real estate investing tips, this one is really important. It’s critical not to get emotional about your property and to avoid the temptation of becoming a trendsetter. For example, if nobody in your submarket has granite counter tops, don’t be the first one to do it. While it’s possible you’ll find renters willing to pay rent premiums for those counter tops, it’s equally possible that you won’t. Over improving a property can stick you with unnecessary expenses that don’t drive rent increases or force appreciation.
Being a trendsetter adds unnecessary risk and is something to avoid if you’re going to follow sound real estate investing tips.
7. Create a Team
Real estate investing is a team sport. Those who go it alone almost never do as well as those that hire a team of experts. The key is to find team members that add more value than they cost.
Whether they help you raise rents, acquire new income sources, decrease expenses, or increase renter retention, their value is undeniable.
While every situation is different, some team members to consider are attorneys (real estate, SEC, entity), CPA/tax strategist, property manager, corporate insurance, deal flow/brokerage connections, inspection team, and title/closing group.
8. Utilize Tax Strategies
One of the greatest real estate investing tips I ever got was to pay every dime of tax I owed, but never leave the IRS a tip. After all, the more money you save on taxes, the more money you have freed up for investing.
And fortunately, real estate is one of the most tax-advantaged investments out there. There are lots of ways that you can save on taxes by investing in real estate:
- Accelerated depreciation utilizing a cost-segregation study
- 1031 exchanges
- Equity harvesting from refinances
- Legacy wealth transfer from a step up in basis
Commercial multifamily real estate returns tend to be blended coming in the form of both cash flow (yield) and equity growth (appreciation and amortization).
Depreciation creates a bank of paper losses that offset actual gains, while accelerated depreciation frontloads that benefit. Together, they can create years of tax-deferral for the investor.
1031 exchanges and equity harvesting are ways in which investor equity can be realized without incurring a capital gains tax. These tax-deferral strategies keep more money working for the investor.
The legacy wealth transfer benefit allows the investor’s real estate to be passed to their heirs on a stepped up basis; eliminating capital gains tax and depreciation recapture tax.
9. Be Mindful of Capital
Some real estate investing tips are just common sense. After all, capital will play an important role in the success of your project.
If you’re buying larger properties, then you’re likely partnering with investors. They bring the capital and you bring the expertise to ensure success and make everyone money. In this scenario, it’s important to align your interest with theirs by putting their returns before yours.
Whether it’s a preferred return or a performance hurdle, there are several ways to make sure the investor gets paid first. Successfully making your investors money will result in you making money, securing repeat investors, and obtaining valuable referrals.
Being smart with capital also means being accountable to timelines, budgets, net-operating income targets and capital improvement plans. The most successful and respected people in this industry do what they say they’ll do when they say they’ll do it.
It also means that you hold capital reserves. This is a really important real estate investing tip as these investments are living, breathing businesses. As such, unforeseen things happen That’s why you should hold initial lender required reserves, as well as capital expenditure reserves, and rainy day reserves.
Having a full complement of insurance to protect the capital that you’ve spent is yet another absolutely necessary way to safeguard your investment.
10. Expect Vacancies
Vacancies are part of our industry and you want to plan for them long before you actually purchase a property. Look at historic vacancy rates for your market. Know what the average rate has been over the last 10, 20, and 30 years.
As a safety metric, we won’t consider investing in a property unless it can sustain at least double historic vacancy rates and still turn a profit. It’s important to implement some conservative rules that you won’t deviate from so that you can safeguard your investments to the greatest extent.
Put These Real Estate Investing Tips to Work
Now that you understand a bit more about the ins and outs of real estate investing, it’s time to put this advice to work and start making money! Are you looking for a new way to put these real estate investing tips into practice? If so, check out our current investment opportunities today.
We’re constantly looking for new properties that benefit our investor community.
To learn more about commercial multifamily real estate investing, download your free copy of Evidence Based Investing from 37th Parallel Properties.