What Type of Real Estate Investment is Right for Me?

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February 9, 2018
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February 21, 2018

What Type of Real Estate Investment is Right for Me?

When it comes to real estate investing, there are a variety of options available depending on what your investment goals are. Some real estate investors have plans to become a billionaire real estate tycoon, others just want to supplement their income, while some investors want to use real estate to fund their retirement. As with any investment, you have to weight the risk vs reward to determine what’s right for you.

Fix and Flip

Flipping houses is something that has become extremely popular over the past 15 years or so with reality TV shows featuring savvy investors making tens of thousands, or even hundreds of thousands, of dollars per deal. Unfortunately, there are a ton of people out there who have lost money trying to follow in the footsteps of these TV stars.

The idea behind fixing and flipping is to buy a bargain house that needs repairs, make the necessary improvements to the house, then sell it for more than your total investment (purchase price + holding costs + repairs +closing costs) to make a profit. The investor then uses a portion of the proceeds form the sale to start the process all over again to make a profit over and over again.

The key to being profitable flipping houses is to be disciplined in your process. Investors should be familiar with the local market and an understanding of what factors influence the value of a home. Successful flippers must be patient and only purchase a house when the right opportunity becomes available. Too many aspiring investors get so excited to flip a house they end up making a bad purchase.

When you find the right bargain, you have to do your homework to determine what the house will likely sell for when it’s improved, and what the cost to improve the home will be. You also have to leave yourself enough margin in case unexpected repairs are needed or you don’t get as much as you expected when you sell the home.

Fixing and flipping differs from other types of real estate investments in that it’s a one-time profit. To continue to earn income flipping houses you must be able to find a steady flow of flip opportunities.

Single Family Rentals

Single family rentals are a popular type of real estate investment because of the lower cost of entry. Investors can purchase a fairly inexpensive home and find a tenant to start paying rent without having to put a ton of work into the property. There are also financing options available to make the purchase even easier.

Investors run into trouble with single family rentals when they work full time or have otherwise demanding schedules. When problems arise in the house such as a furnace or water heater going out, plumbing leaks, or any number of other issues, the tenant expects their landlord to be available to get the repairs made as quickly as possible. When repairs don’t get made in a timely manner, tenants sometimes withhold rent payments or use it as an argument to terminate their lease early.

When you invest in single family rentals you should assemble a team of people to take care of any potential issues so you’re not scrambling to find the right person to make a needed repair. Having your list of people readily available when problems come up will make your life as a landlord much easier.

While single family rentals can provide some monthly cashflow, your return on investment often comes in the form of building equity by having rental income to make the mortgage payment on your property. You can also realize additional profit from the appreciation of the home. You can either use this equity to cash out on the property by selling it, or leveraging it to make more investments.

Multifamily

A multifamily property consists of two or more rental units on the same property. Duplexes, triplexes, and quads are what two, three, and four-unit multifamily properties are known as. These are considered small multifamily properties. Mid-size multifamily properties are typically 5-40 units, while large multifamily properties are 40 units or more.

Multifamily properties are often the preferred type of real estate investment once the investor has the needed capital to make the investment. Instead of having to manage multiple properties across town, all units are on one property. The income generated from multifamily properties also often makes it feasible to hire a management company to manage the property for you. By having a professional management company managing your property you can purchase more properties without having them take up all of your time.

When evaluating a potential multifamily investment, you’ll mostly be looking at the current income of the property versus its expenses as well as the potential income of the property. Subtracting the operating expenses from the gross rental income you will know what the net operating income is. Dividing the net operating income by the purchase price will tell you what your return on investment is. Understanding the net operating income will also help you determine if the property’s income will be enough to cover the loan payments while still providing some positive cashflow.

Multifamily investing is more of a cashflow game than with single family rentals. The cashflow from these investments can provide a steady passive income stream known as “mailbox money”. As with single family rentals, you can also gain a return by the growth in equity over time as well as appreciation. With multifamily properties, appreciation is typically due to an increase in the market rent rate.

Commercial Properties

Commercial real estate investments can be office buildings, retail strip centers, shopping malls, stand alone properties, industrial/warehouse, hotels and motels, assisted living facilities, or other special purpose properties. Just like with single family rentals or multifamily properties, investors earn a return from the rent paid by tenants.

While commercial real estate can provide higher returns, it also comes with higher risk. Investors should have a thorough understanding of their local business market as well as the industries of the tenants in the commercial property. When a commercial property has a vacancy, it can often take months, or even years, to fill the space with a new tenant.

Unlike residential landlords, commercial landlords often have to invest money into reconfiguring a space for a new tenant, or provide a tenant improvement allowance. Commercial leases also often have a period of abatement, where the tenant doesn’t pay any rent for the first 1-3 months, or more, of their lease. In exchange for this upfront investment from the landlord, commercial leases are typically for five or more years. Three-year leases are common in commercial spaces that don’t require a significant investment from the landlord to prepare the space.

Commercial properties can make for great long-term investments. Surrounding developments can also greatly increase the value of the property. While commercial investments can provide an excellent return, you must be able to afford to cover the cost of vacancies and large tenant improvement allowances.

 

While there are plenty of real estate investment options available, it’s important to assess your investment goals before choosing your real estate investing strategy. It’s also necessary to determine the amount of risk you are willing to take. Whichever investment strategy you choose, you should do your homework to fully understand the type of property you’re getting into, and develop a detailed plan on how you’re going to manage and grow your investment.

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