Formulating a Millionaire Real Estate Investment Strategy
A step-by-step guide to create a real estate investment strategy that makes you money!
Below are the 5 steps to creating a winning real estate investment strategy.
1. Decide your time investment before monetary investment
2. Decide the type of investment property
3. Decide where to finance, loan duration, and amount of funds that you will borrow
4. Determine HOW you will value property
5. Year-by-year planning
Many people say that real estate investing is a game of luck. The lucky become millionaires, while the unlucky drown in debt and never-ending mortgage payments. For some, the possibility of “unlucky odds” is “too scary” to ever take the jump and start investing in real estate. This, to me, is one of the biggest mistakes anyone could make.
I’m not denying that some aspects of real estate investing are luck, but the vast majority of it is sound investment strategy, analysis, and decision-making. It’s one of the best investment vehicles for long-term wealth because simply building an investment strategy drastically increases the odds of success. Combined with due diligence and smart valuation, real estate (at least to me) is one of the safest vehicles to become a multi-millionaire long-term. I’ve already written an article about a complete guide of how my uncle became a millionaire in 10 years through real estate.
Here, though, I’ll be focusing on how to build in an investment strategy, which you need to do before investing in your first investment property.
1. Decide your time investment before monetary investment
Most of us think about how much money we have stocked up to invest, but rarely do we think about over what time we want to invest that money over. So, the first part of formulating a millionaire real estate investment strategy is the time that you want to hold the investment property over.
You could hold it short-term by “flipping” the house. The most value you will get from the investment will be what value is added during the “flipping” process and how advantageous the buy is (foreclosures, lower-than-market selling price, etc.). Although this time period has greater risk, it does also bring greater rewards in the short term.
You could also hold it long-term (7+ years) by managing the property and earning cash through annual cash flows. Because the property is held over the long term, much of the value added will be from annual cash flows and appreciation (which will increase equity). You will also have lower capital gains tax than holding the property short-term.
2. Decide the type of investment property
The property types normally used for real estate investing include residential (single-family, multi-family homes) or commercial properties. There are certainly pros and cons to both.
Here is a very brief summary of just a few points to consider.
Commercial real estate investment pros include longer lease terms, less hands-on management needed, and incremental value-added items have higher returns (you can easily charge extra for services/features like covered parking, vending machines, break spaces, etc.).
The cons to commercial real estate investing include greater demands (you’ll be dealing with business owners, after all), typically lower appreciation rates, greater property damage risks, and larger initial investments.
Residential real estate investment pros include that in the right areas, demand is usually higher (everyone needs a place to live and there are many more general people than business owners). They are normally more remission-prone and have greater appreciation rates. Less initial investment is required and banks are normally friendlier to first-time residential real estate investors.
The cons to residential real estate investing include shorter lease terms, greater hands-on management, local regulations may restrict rental rates, and fewer value-added items can be taken advantage of.
3. Decide where to finance, loan duration, and amount of funds that you will borrow
Where to finance:
As I mentioned in a previous article, the FHA loan is a great option for beginning investors.
There are other options to consider, including local vs. national banks, lending programs, conventional bank loans, and other types of loans.
In my opinion, creating a stable relationship with a local bank goes a LONG way. Also, loan officers will be able to educate you on different options (make sure to ask!!). It sometimes is easiest and wisest to just stick with utilizing a conventional loan, but doing so through a local bank can help you get better rates. In my experience, using local banks and developing a very cordial relationship has always gotten me lower fees and rates than any national bank. These local banks benefit the community, which you are ALSO doing by investing in real estate in the area. Make sure to make it known to the loan officer that both your goals are aligned.
Loan duration:
Determining your time investment is going to be imperative to determining your loan duration. If you are holding long-term, consider a fixed-rate loan so you are not forced to refinance sooner. If the current interest rates are also good, you can lock in on these rates. The disadvantage, though, is that longer-term loans have higher rates.
If you are planning to hold a shorter-term loan, consider a loan with a shorter duration. These usually have better terms because lenders of the interest rate effect: interest rates have a greater effect long-term because they are more likely to change significantly in the long-term than the short-term.
Amount of funds:
The amount of funds that you will borrow is also fundamental to your real estate investment strategy. Some properties fare better with higher leverage (and vice versa).
Here is a simple example to show you this:
Let’s say you have one fourplex selling for $650,000.
Option 1: You could put 30% down ($195,000), which leaves $455,000. You get $1,000 / month in CF from this deal.
Option 2: You could also put 10% ($65,000), which leaves $585,000. Let’s say that in this case, you break even every month ($0 cash flow for the year).
Both appreciate at 5%.
Many would be inclined to believe that option 1 is a better real estate investment. You get to earn cash flow on the property, while in option 2 you don’t. Most wouldn’t think breaking even is “good.”
But here’s what the math says after Year 1:
Option 1:
Total ROI: (Total CF Year 1 + Increase in Equity) / Total Investment = 12,000 + 0.05 * 650,000 / 195,000 = 22.8%
Option 2:
Total ROI: (Total CF Year 1 + Increase in Equity) / Total Investment = 0 + 0.05 * 650,000 / 65,000 = 50.0%
Even without cash flow, option 2 will technically earn more than investor 1.
This is a pretty inflated example, but the premise is the same: increasing the amount borrowed and decreasing the down payment earns you a higher rate of return on invested cash.
There are certain scenarios where investing cash might be a better option, but generally, increased leverage = higher returns. However higher leverage also means greater downfall when things go BAD.
4. Determine HOW you will value property
Determining how you will value your property will be imperative to your real estate investment strategy.
Some people value property “as-is”, while others value property for “future potential.”
If you are “flipping a house,” then you might value the property based on what improvements you plan to make and how much value added elements will increase the future selling price. You might also find a single-family home that is zoned as a multi-family residence and value the property based on how much value you could gain from converting the home to a multi-family unit. You might also take into account future developments 5-years down the line, population trends, etc.
If you are planning on keeping the property “as-is” and utilizing it as a long-term investment vehicle, then you might try to estimate the current value of the property.
Either way, here are 6 quick ratios to consider when valuing a real estate property:
1. Cap rate
Cap rate = Net Operating Income / Property Fair Market Value
A cap rate between 6–12% is good.
2. Internal rate of return
Use projected cash flows for each year you plan to hold the building. Use Excel’s IRR to calculate the IRR.
Anywhere from 12%-25% is good.
3. Total ROI
Total ROI = (Total CF Year 1 + Increase in Equity) / Total Investment
Greater than a 15% return is good.
4. Gross to Rent Multiplier
Gross to Rent Multiplier = Property Fair Market Value / Gross Rental Income
A GRM greater than 5 is considered good.
5. Cash-on-cash return
Cash-on-cash return = Net cash flow after debt service / total cash in deal invested.
A cash-on-cash return greater than 10%.
6. Loan to Value Ratio
Loan to Value Ratio = current loan balance / appraised value
Most banks don’t go higher than 70% for this ratio.
5. Year-by-year planning
It’s important to formulate a year by year strategy to meet your long-terms goals in real estate investing. Your long-term plan should take into account (1) increases in equity (from appreciation) and (2) increases in cash and cash flow.
You should also decide the volume of your investments. Do you want to buy a unit every year? Buy four units in two years? All of this will make up your long-term investment strategy,
One real estate investor aimed for an average of one unit a year. The purchase price was always between $95,000- $112,000 and he put anywhere from 20–25% down. He re-invested all of his cash flows, so by year 4 he used solely his cash flows to fund new investments. In years 1–4 when cash flow wasn’t enough for the down payment, he aimed to save $15,000 every year which covered the initial investment.
At the time, it was only possible to have 4 loans at a time. This meant once he had four, he would sell the oldest one to buy another. After 10 years, he had more than $850K in equity. After selling out in year 12, he walked away with enough to buy an entire apartment complex, which cash flows him over $400K a year… not too bad for a side hustle!
This articled was originally posted on my blog www.dailyscientia.com.
For related investing articles visit:
Subscribe here
FAQs
What are the 4 major real estate investment strategies?
Four real estate investment strategies include:
- Buying and holding
- Flipping
- Real estate investment trust (REIT)
- Real estate investment group (REIG)
What is best investment strategy?
In my opinion, buying and holding is the best investment strategy. Although it is a long-term strategy, it is also a passive strategy. You will be able to have a stable portfolio regardless of what happens in the “short-term,” which is overall less risky.
What is a real estate investment plan?
A real estate investment plan is lays out how you intend to invest in real estate over time. It allows you to have a year-by-year plan to reach your investing goals. This document should also detail your investment strategy, which is detailed in this article. Check out this 10-year real estate investment plan here.
What are the 5 major real estate investment objectives?
- Increase equity
- Increase total cash on hand
- Meet financial goals
- Lower taxes
- Increase ROI
How do beginners make money in real estate?
You can greatly increase your odds of making money in real estate by formulating a winning investment strategy, which includes (1) deciding your time investment before monetary investment (2) deciding the type of investment property (3) deciding where to finance, loan duration, and amount of funds that you will borrow (4) determining HOW you will value property (5) creating a Year-by-year plan
Subscribe to DDIntel Here.
Join our network here: https://datadriveninvestor.com/collaborate
