Real Estate Investing: Strategies and Asset Classes

There are an unlimited number of ways to invest in real estate. I’ve noted some of the more common strategies and asset classes below, however this is not a comprehensive list. Even within the list below there are several ways to structure deals. While it’s important to never force a deal, don’t discard it just because it doesn’t look good on the surface. Look at all the levers you can pull until the deal works, or it doesn’t and then discard it.

Buy and hold

·        LT Rental (long-term)– Single-family or residential multi-family (2-4 units) properties rented typically for periods of 6 months or more. You can either manage yourself or outsource to a 3rd party management company. The attractiveness to these properties is that the barrier to entry is low and can even be purchased with no money out of pocket. They do carry more risk than larger apartment buildings as a higher % of a property’s profit will be tied to a single resident.

·        ST Rental (short-term) – Single-family or residential multi-family properties that you rent for shorter periods, typically less than 6 months. These can produce higher returns than long-term rentals, but the cash flow might be more sporadic, and these carry higher expenses and risk. I recommend underwriting these as long-term rentals, then you hedge against the risk that local ordinances or HOA covenants might disallow the short-term residency.

·        Land – Purchasing land as an investment is typically speculative and should be looked at as a long-term play. Land doesn’t throw off any cash-flow so you should expect to foot the carrying costs (taxes, insurance, debt payments). Investing in land is often viewed similarly to gambling and is more suitable for those with experience in land development.

·        Self-storage – Storage units are a very attractive asset class to someone looking for high cash flow. One huge benefit is the maintenance aspect; you won’t be getting a 2 am phone call about a leaking toilet. These are really location and traffic count dependent. Acquiring storage units near college dorms, mobile home parks or apartment complexes is highly desirable. Residents of those asset classes are typically limited on storage space.

·        Retail – Retail storefronts can often provide higher cash flow than residential or commercial multi-family. I believe this asset class carries more long-term risk. While you can structure leases to leave the owner with essentially no expense liability (triple net lease), the success of a particular property is more susceptible to the ebbs and flows of the economy. Also, we are seeing more and more online shopping for consumer good and food delivery creating increased competition for this asset class. As with residential and commercial multi-family, picking quality tenants is key.

·        Office Space – Similar to retail property, though the influx of online competition isn’t as prevalent.

·        Mobile Home Parks – Don’t discount these based on their “trailer park” reputation. This asset class throws off a lot of cash and has been hot among investors lately. Mobile home parks are unique; they offer residents an opportunity at home ownership who might otherwise not have that opportunity. I really like them for the low maintenance aspect (assuming mobile homes are resident owned) and if you manage right, these residents often take more pride in the property than apartment residents since they have ownership interest.

·        Multi-Family – Apartment buildings of 5 units or more. These properties offer economies of scale. You’ll have more residents to carry the costs of the property, but each resident’s rent will also make up a lower % of rental income, reducing vacancy risk. It’s been shown that this asset class is more recession resistant than most (if not all) others, assuming they are purchased for cash flow and not appreciation.

·        Industrial – Typically warehouses or manufacturing facilities. Businesses that lease these buildings will often have longer tenancy, but they will usually sit vacant for longer periods of time between tenants. Depending on where the market is at in the cycle, you may find it difficult to lease up during a down economy.

Flipping – Buying a distressed asset and fixing it up. I don’t view flipping as real estate investing and most who have flipped several properties will tell you the same. It’s essentially another job as it requires a lot of hands on involvement in the day to day. At the end of the day when a flip house is sold, even for a large profit you have a pile of cash and no asset. This is what we call “big hat, no cattle”. There are no more cattle to throw off additional cash, you must work to go find another flip. Flipping is attractive because of what we see on HGTV, offering large profits over a short period. What people don’t see are the large taxes that flippers pay. Not only do you pay the short-term capital gains tax (your ordinary income tax rate), but you may also pay self-employment tax as the IRS views the activity as active income. Long-term capital gains are usually between 0-15% but capped at 20%. Many investors either start off in flipping and move to buy and hold investing or flip to generate capital to invest in rental properties.

Wholesaling – This is where you put a property under contract and assign the contract to a 3rd party for a spread. Say Suzie’s house is worth $90k and she carries a $50k mortgage. She just lost her job. Unable to make her mortgage payments, she is now facing foreclosure. I offer to pay Suzie $60k for her house and I assign the contract to an investor for $75k. Suzie avoids foreclosure, I make $15k and the investor gets a deal on an investment property. Suzie couldn’t have sold the house to the investor because she needed to sell fast and doesn’t have the network of cash buyers like I do. This makes it a win-win-win situation. The problem with wholesaling is that it’s a lot of work to market for distressed properties and at the end of the day you don’t own any assets. This is another “big hat, no cattle” situation. Also, the tax benefits of real estate aren’t offered to wholesalers.

Note investing – This is where you act as the lender and hold a lien against a property. You collect the monthly interest payments and the property is collateral for the investment. You don’t get the tax advantages with note investing as you do with buy and hold investing.

Syndication – This is where investors pool their money to buy larger properties that they might not have been able to purchase otherwise. Everyone in the deal owns a % of the LLC that owns the property. These are very popular because they offer a ton of benefits. You can invest actively as a general partner (GP) if you value to the team (money raise, bringing the deal, asset management, underwriting, etc) or you can be a passive investor where you invest capital and don’t have involvement in the day to day. Investing passively in syndicated deals is the purest form of passive real estate investment I have come across. It allows you to focus on your day job, mission or volunteer work or sip Coronas on the beach while cash is flowing in. The GP’s will send out monthly or quarterly performance reports and cash distributions and may also hold quarterly or annual conference calls. One major benefit of syndication is the partnership aspect. I’m a firm believer that 2 bright minds are better than 1, so a sophisticated and experienced team provides a hedge against risk. All investors, passive or active, also get to take advantage of the tax benefits of real estate ownership.

REIT – Real estate investment trusts. Investing in these is basically like investing in the stock market, but instead of purchasing shares of Apple, you purchase shares of a company that invests in real estate. On the surface this looks very similar to syndication, but you do not have ownership interest in the individual properties. For this reason, tax benefits of real estate are not available to this investment vehicle. They’ll often provide a steadier stream of income than stocks but offer limited growth potential.

Tax Liens – Often sold at auction, you pay agree to a certain purchase price for the lien on a property in which the owner is in tax default. In addition to the purchase price of the lien, you must bring the property current on its taxes. The current owner at the time of the tax lien sale will usually have a set time period to pay you back plus interest or you can foreclose on the property. This is a great way to increase the return on your capital or get a property at a discount, but these carry a lot of risk if proper due diligence is not performed.

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