Investors who could benefit from diversifying their portfolios to invest in real estate are often put off due to prevailing real estate investment myths. These myths are misunderstandings perpetuated by cultural percepts and hyped by HGTV shows’ popularity featuring home renovators. When many people hear the word real estate investors, they may think of someone they know who owns maybe one or two single-family homes that they rent out. Or, they immediately think about the latest HGTV program about renovating for immediate sale.
These are examples of how to invest in real estate. Still, both are only partial examples. They show a narrow perspective of the much larger and more diverse field of real estate investing. Beyond these limited real estate investing views, there are many real estate investment strategies to build and preserve wealth. These strategies to wealth growth through real estate investments are more broadly accessible than what the prevailing real estate investment myths lead us to believe. Not only are they accessible, but the different real estate investment strategies offer diversity. They provide a range of passive to active involvement, different levels of skill, and experience. Some require more sophistication than others.
The word IDEAL is a commonly used acronym for those who invest in real estate. It stands for Income (cash-flow or interest rather than wages from labor and time), Depreciation, Equity, Appreciation, and Leverage. All of the real estate investment strategies discussed in this article have one or more of these elements. The best wealth-building real estate investment strategies have all five. Pancham Gupta, the Gold Collar Investor host in episode TGCI 13, provides an understandable yet comprehensive explanation of the concepts behind the IDEAL investment. Also, see the blog post 5 Fiscal Reason to Invest in Real Estate.
Let’s get into the real estate investment strategies. After reading about the strategies, you will have a clear understanding of each and will know which of the real estate investment strategies is right for you.
In this article, the real estate investment strategies are clustered into five categories:
- Occupational strategies
- Kick-starter strategies
- Prosperity building strategies
- Personal banking strategies
- Passive investing strategies
Occupational Real Estate Investment Strategies
The three occupational strategies are the most intensively involved or active real estate investment strategies and the most well-known. Even though they are the most prominent, many experienced and knowledgeable real estate investors don’t refer to them as investments but as a job or a real estate business. They are labor-intensive and produce income only as long as the operator is willing and able to put in the labor and the time.
Fix-and-Flip Real Estate Investment Strategies
The fix-and-flip real estate investment strategy is the most widely known due to rehab’s popularity and rehab reality shows on HGTV. For those who already have construction skills or those willing to learn them, this is one way to invest in real estate. Investopedia offers five suggestions for what to watch for when using the fix-and-flip strategy.
Fix-and-flip can be profitable in the right market with the right timing. It works best in growth markets where housing is in high demand, while at the same time, there is an abundance of fixer-uppers ready for the rehabbers. This real estate investment strategy also favors urban areas over rural because of the supply and demand principle.
The other drawback is the aspect of the unknown. With every renovation, there will always be secrets hidden behind the walls and under the floors. Estimating costs is challenging for the newbie, not familiar with construction projects. Underestimating can make what looked like a profitable deal into a very costly mistake.
Purchasing right, estimating correctly, and controlling the rehab costs are significant challenges. Overcoming these challenges can make fix-and-flip financially rewarding, but it will never be passive. Just like with any occupation or business, you have to show up to do the work. Though it a way to invest in real estate, it is not a passive investment.
Real Estate Fix-and-Flip and the IDEAL Investment Strategy
The fix-and-flip strategy lacks three of the five IDEAL components. One of the two components it offers is the hope of equity by buying low and selling higher due to the repositioning through rehab. This is often referred to as sweat equity, as the equity originates through time and labor.
The IDEAL component of leverage is often found in the fix-and-flip strategy. If worked correctly, the fix-and-flipper may have zero cash investment, borrowing 100% of the purchase price and rehab costs.
If you have the interest, time, and are willing to put in the effort of building a real estate business and if you live in or are willing and able to move to an area where the market condition work for fix-and-flip, as a real estate investment strategy it has the potential to be financially rewarding.
Real Estate Wholesaling Investment Strategy
If you enjoy working with people, marketing, looking for under market deals, and negotiating the best price in terms with prospective sellers, the wholesaling real estate investment strategy offers low investment risk opportunities to build wealth through a real estate business.
The wholesaler finds under-valued properties usually in need of restoration to turn around and sell to fix-and-flippers or other real estate investors. The profit comes from the spread between the acquisition price and the selling price.
The wholesaler uses different techniques. They are sometimes working only as a “Birddog,” bringing deals to buyers without the Birddog assuming title but just receiving a fee from getting the sale to the investor buyer. Other times they may tie-up the property with a purchase contract subject to re-assignment of the contract to the final buyer. At times the wholesaler may make the purchase and then immediately resell after closing.
Real Estate Wholesaling and the IDEAL Investment Strategy
The wholesaling real estate investment strategy offers none of the IDEAL wealth-building components. Nevertheless, some have made wholesaling a very lucrative occupation. With the right personality and well-developed marketing skills, wholesaling offers low risk, low entry requirements with high upscale potential.
Real Estate Agent Investment Strategy
Like wholesaling, becoming a real estate agent offers low risk, low investment entry, and relatively low entry educational levels. Every State in the US and every Provence in Canada have their own real estate licensing requirements. In general, a pre-licensing course of approximately five semester credit hours is required, followed by the passing of a licensure exam. Once licensed, the real estate agent can begin marketing to sellers and buyers of real estate.
Successful agents can make substantial sums of money through the commission on the sale of the property. Like with wholesaling, people skills and marketing skills are essential for success. Like with wholesaling, it is an occupation, not an investment.
Real Estate Agent and the IDEAL Investment Strategy
The real estate agent strategy provides none of the five components of the IDEAL real estate investment.
Kick-Starter Real Estate Investment Strategies
The Kick-starter real estate investment strategies are my favorite for the cash-poor beginner with a W-2 income or other means of qualifying for traditional mortgages. With both, there is some aspect of occupation involved as neither is entirely passive. Both provide passive income from a workable rental strategy. Unlike the Occupation Group, neither investment strategy in the kick-starter group has to become a full-time job or business to become a powerful wealth builder.
House Hacking Real Estate Investment Strategy
The house hacking real estate investment strategy is purchasing your personal residence, living in a part of the home, and renting out a portion. Homes that are ideal for this are homes that already have what is often referred to as a ”mother-in-law” suite separate from the main house. If it has its own entrance, so much the better. Duplex, triplexes, and quads are even better. Conventional financing classifies up to four units the same as a single-family home for lending purposes, so the loan qualification is much the same.
If zoning permits and if the home has a conducive floor plan, it may be suitable for dividing into separate apartments with minimal expense.
If circumstances permit, communal living is an option with essentially renting rooms rather than apartments. College and university towns are often suitable markets for this type of arrangement.
Real Estate House Hacking and the IDEAL Investment Strategy
Whatever the configuration of the “hack,” the house hacking strategy offers the real estate investor all five of the IDEAL component benefits. The rental income provides cash flow. The portion of the house occupied by the tenants qualifies for all of the tax write-off benefits of any rental property. The percentage of the home committed to the rental property can be depreciated and cost segregated, and that proportion of the mortgage interest is deductible. Repair and maintenance costs associated with the rental property are deductible, as are advertising, insurance, and utility costs. The house hacker holds 100% of the equity and appreciation. With VA zero down, FHA 3% down, or conventional at 5% to 10% down, there is a significant opportunity for leverage. While investing zero to 10%, the homeowner has 100% of equity and appreciation.
BRRRR Real Estate Investment Strategy
BRRRR is the acronym for Buy – Rehab – Rent – Refinance – Repeat. The house hacker investor can quickly move up from hacking one home to multiple homes using the BRRRR method. Start with your personal residence. Get your personal residence rented and then purchase a second home and do the same. Now you have a system that you can replicate repeatedly, and the built-in rental strategy continues to grow passive income.
The BRRRR has the advantage of moving from the single-family financing arena into the commercial financing area. Commercial lending is a whole new world with its own rules and operating procedures. Commercial loans often require a larger down payment and rarely offer 30-year terms. The advantage of commercial loans is that the loan qualification is based more on the property’s income than the individual borrower’s financial position.
The BRRRR method is flexible in that it can be used with single-family residence or multifamily apartments. The BRRRR real estate investment strategy provides the ability to start small and scale to whatever level the investor chooses. The BRRRR can become a job, but it can also be managed as a reliable side gig. The investor can contract a professional property manager to manage the tenants, toilets, and trash and make the process more of an investment than a job.
The drawback to the BRRRR real estate investment strategy is its reliance on extensive leverage. With this method, the rehabbed and rented property is refinanced to the maximum allowable to provide cash to repeat the BRRRR process with the next property purchase. When real estate markets are on the rise and rentals are in high demand, highly leveraged rental properties can operate okay. When the economy takes a downturn, highly leveraged properties that do not have a reserve are susceptible to foreclosure. The BRRRR is an excellent wealth builder, but the BRRRR investor is advised not to move forward too aggressively because economies will always take a downturn.
BRRRR Real Estate Investing and the IDEAL Investment Strategy
The BRRRR, like house hacking, offers all five of the IDEAL investment advantages. Being a high leverage strategy, income will be limited in the early stages of your investment career. With each passing year, though, equity grows through mortgage pay-down and appreciation. BRRRR is a robust wealth-building strategy base on what is a good ROI on rental property. Beyond the IDEAL, the hidden power is in the repetition of a system that the BRRRR investor knows and understands.
Prosperity Building Real Estate Investment Strategies
The prosperity building real estate investment strategies can be applied in conjunction with the house hacking and the BRRRR strategies. They can be used in combination with any of the real estate investment strategies to bring prosperity to real estate investors.
Buy and Hold Short to Mid-term Real Estate Investment Strategy
The buy and hold short to mid-term real estate investment strategy is viewed as a “value-add” proposition. The goal of the purchase is to force appreciation in a short to mid-term time frame. This strategy is most useful with commercial real estate such as multifamily, mobile home parks, self-storage, retail, and industrial. Generally, the property is income-producing. The goal is to increase the net income by improving operational efficiencies, reducing costs, and/or increasing rental income.
The project may require renovation to allow for rent increases. Or, it may just need new management to bring down vacancy rates. It may be as simple as raising under market rents to current market rents.
Once the property is stabilized and rental property income produces a higher return on investment (ROI), it can be held for continued passive income or sold for a profit. This strategy is a mixed strategy because once the property is stabilized and producing a reliable cash-flow, there is no rush to sell. The prudent investor can hold the property and watch the market to sell at the most advantageous time for the best overall ROI.
Buy and Hold Short to Mid-Term Real Estate Investing and the IDEAL Investment Strategy
Buying and hold short to mid-term provides all five of the IDEAL components. When you invest in real estate through this strategy, the investment produces cash-flow through rental income from the day of the asset’s initial purchase; as the property stabilizes, the cash-flow increases. Cost segregation is applied to maximize depreciation. With the improved performance, the property appreciates and produces more equity. The property is purchased with institutional financing to make the best use of leverage.
Buy and Hold for the long-term Real Estate Investment Strategy
The long-term buy-and-hold strategy is a time-tested and proven strategy for building wealth for a prosperous legacy. The power of the buy and hold real estate investment strategy is real estate appreciation. Over the long haul, property value keeps pace with inflation and, in some markets, outpaces the inflation rate. For this reason, the buy and hold real estate investment strategy provides a lower risk investment than the stock market.
Stocks can lose 100% of their value, but when you invest in real estate, your investment will rarely go to zero value, even in the worst of economic downturns. Not only is the buy and hold strategy comparatively low risk, but it is also non-correlated. When you invest in real estate, your investment does not correlate with the fluctuations of Wall Street. Thus, the buy and hold strategy provides for attractive diversification of an investment portfolio.
The buy and hold investor is not looking for immediate or outstanding ROI but is planning to build wealth over the long-term. The buy and hold strategy combined with BRRRR and house hacking has the potential to develop a robust and diversified investment portfolio over the long haul.
Buy-and-Hold for the Long-term Real Estate Investing and the IDEAL
The buy-and-hold for the long-term provides the potential to take advantage of all five of the IDEAL investment components. I say potentially because not all buy-and-hold investors are investing in income-producing property. Buy-and-hold investors who invest primarily in the land are not looking for cash-flow or depreciation but are looking for long-term growth. Even without the income and depreciation, buy-and-hold can be relied on to build wealth through the equity that grows through appreciation.
Most buy-and-hold investors buy rental properties that produce cash flow; thus, the buy-and-hold investor multiplies their wealth through all five IDEAL components, creating prosperity for a very comfortable future.
Trade-up Real Estate Investment Strategy
The trade-up real estate investment strategy helps the investor prosper via the IRS 1031 Exchange tax code. A significant cost to real estate investors is the capital gains tax that comes with selling investment properties. Capital gains taxes can take a sizable portion of profits on the sale of a property.
When the property sells, both the appreciation and depreciation accumulated over the period held, are taxable capital gains.
To help mitigate the capital gain taxation, the IRS allows all of the taxes on that gain to be pushed forward by exchanging one like-kind property for another.
For example, the investor sells property A with a substantial ROI and has a sizeable capital gain. Rather than cashing out the capital gains, the investor applies those gains to the purchase of property B. Using the established IRS 1031 Exchange, the capital gains are preserved in property B, and the taxes are deferred. Upon the sale of property B, the taxes will come due unless the 1031 exchange process is repeated with property C’s purchase and exchange.
The exchange process can go on indefinitely. If property C is never sold, as would be the case in the buy and hold long-term strategy, the capital gains are preserved indefinitely.
The Trade-up Real Estate Investment Strategy and the IDEAL
All five of the IDEAL advantages are at play in the trade-up real estate investment strategy. The 1031 Exchange preserves the value gained through income, depreciation, equity, appreciation, and leverage without decreasing the value via the assessment of capital gains taxes. The trade-up strategy can be combined effectively with all the other strategies thus far mentioned to hasten the wealth builder processes.
Become the Banker
By design, our economic systems are built to make bankers wealthy, and it works very efficiently to do just that. You don’t have to be a bank to take advantage of the banking system. Anyone can become a banker and profitably lend money to make money.
Hard Money Real Estate Investment Strategy
The Hard Money Lender is a well-known commodity in the world of real estate investing. The hard money lender is an individual who or an organization that lends private money to another person or entity. The hard money loan is guaranteed with a promissory note. In the case of real estate, the hard money note is secured with a deed of trust. The deed of trust allows the hard money lender to take possession of the property via foreclosure in the event of delinquency or non-payment. These are the same documents and processes that institutional banks use when lending on mortgages.
Hard money lending can be quite lucrative as it is not unusual for hard money loans to produce 14% or more ROI. With 75% or greater loan to value, hard money lending can be a relatively low-risk investment vehicle with good returns.
Hard money lending is also comparatively passive. Once the loan is made, the hard money lender is making money while sleeping.
The Hard Money Lending Real Estate Investment Strategy and the IDEAL
Hard money lending offers only one of the five IDEAL components of investing: income – cash flow while sleeping. Even with the lack of the other four wealth-building components, hard money lending is attractive to many real estate investors because of the high ROI and the security of the Promissory Note backed by real property.
Hard money lending is a secured high ROI, cash flowing, and non-correlated asset class that diversifies many investors’ portfolios.
Real Estate Discounted Notes Investment Strategy
Real estate discounted notes are selling and trading private promissory notes secured with mortgages or deeds of trusts. The promissory notes are originated by banks, seller financing, or hard money lenders. The idea behind selling a note at a discount is the time value of money. Money is more valuable now than in the future.
For example, I sell a property that I own free and clear. I have $60,000 in the property and sell it for $100,000. I provide seller financing. The buyer puts $10,000 down and gives me a note for $90,000 at 8% interest, a 15-year term, and monthly payments of $860.00.
After 5 years I’d rather have cash now than monthly payments. At this point, I’ve received $32,495 from the interest, $19,110 principal, plus the $10,000 down payment. The remaining principal balance on the note was $70,890. I sold the note for $60,000, giving me a total yield of $121,605 (10,000 down + 19,110 principal +32,495 interest + 60,000 note selling price = 121,605)
The Note Buyer received an asset worth $70,890 for a discounted price of $60,000. This gives the Note Buyer a 12% ROI on their investment. The Note Buyer is happy with their ROI and I’m happy with the profit from the sale plus the money in hand now to invest elsewhere.
Real Estate Discounted Notes Investment Strategy and the IDEAL
Discounted notes, like hard money lending, offers only the income of the IDEAL investment. Nevertheless, it appeals to many investors because of the attractive ROI on a secured asset, the cash flow while sleeping, and a non-correlated asset class for portfolio diversification.
Passive Real Estate Investing
REITs Real Estate Investment Strategies
Investopedia defines a Real Estate Investment Trust (REIT) is a company that owns, operates, or finances income-generating real estate. Modeled after mutual funds, REITs pool the capital of numerous investors. The pooling of funds makes it possible for individual investors to earn dividends from real estate investments without buying, managing, or finance any properties themselves.
REITs are the most passive of passive real estate investments. Publicly traded REITs are highly liquid as they can be bought and sold on the major securities exchanges just like any other stock. They provide a steady passive income through dividends. The purchase of one publicly traded REIT provides instant real estate diversification as the REIT is invested in a broad range of real estate classes, including residential, retail, and industrial.
REITs can also be traded privately. Private REITs are less diversified and less liquid but may have a higher ROI. They provide an attractive way to invest in real estate for the investor looking for truly passive income.
REITs Investment Strategy and the IDEAL
REITs offer only the one component of the IDEAL, that being income. Being the most passive of all the real estate investment strategies, REITs also provide the least ROI. The appeal of the REITs is diversification across a range of investment properties that produces a steady income. The diversification offers the investor some security, and even though exchanged on the major stock exchanges, as a real estate asset class, it provides for non-correlation.
Real Estate Syndication Investment Strategy
Investing in real estate syndications is one of my favorite passive real estate investment strategies. Investing in real estate syndications is not quite as passive as investing in REITs, but the likelihood of a significantly improved ROI makes the additional effort more than worth the added effort.
For an explanation of what real estate syndications are and how they work, see my article Is Real Estate Syndication Suitable for a Passive Investor.
When investing in syndication, the investor is investing in the equity of the real estate. Passive investors are often in a preferred class, meaning they receive distributions before other classes of investors. The overall returns are expected in the range of 8% to 25%. It depends on whether the underlying investment strategy is a buy- and-long-term hold or a buy-and-hold-for-short-term value add.
The syndicator manages the entire operation. The passive syndicator investor needs only to review quarterly reports and collect the distributions.
Investing in real estate syndication is non-liquid. It is difficult, if not impossible, to get the investment money out until the real estate property’s refinancing or sale. Depending on whether to underlying strategy is short or long term hold, an investor’s money could be tied up for anywhere from a year to ten or more years.
Many investment advisers see this as a downside, but having money tied up in an ROI producing asset class may actually be a good thing that prevents one from being swayed by every shinning object that comes along.
Real Estate Syndication Investment Strategy and the IDEAL
Investing in a real estate syndication offers the investor the benefits of all five IDEAL components. Even though the investor is an entirely passive partner, the investor holds an equity share of the real estate property. As an owner of the property, the investor’s share of the property qualifies for all the tax benefits of depreciation.
The investment is generally leveraged with institutional debt at a loan to value around 75% to 80%.
If the investment is a value-add project, the appreciation can be significant. The growth in equity from the appreciation often provides a desirable internal rate of return.
The cash flow originates from rental income and flows into the investors’ coffers while they sleep.
These are the primary real estate investment wealth-building strategies. Rarely are any of them applied singularly. Most investors combine the wealth-building strategies in different configurations at different times with different investment properties.
As you’ve read through the strategies, you most likely have a feel for what may work best for you.
I hope the article has been informative. I’d like to hear from you. What real estate investment wealth-building strategies feel right for you? Have you tried any of the strategies? If you have, now did they work for you? Please let me know in the comments below.
With so many investment options, confusion as to where to invest leads to inaction. Schedule a FREE call or email me at allen@SteedTalker.com. I’ll help you sort it all out, and you’ll soon be on your way to prosperous investing to live more abundantly in all areas of life.
About the Author — Dr. Allen Lomax
With careers in academia, podcasting, and real estate investing, Dr. Allen Lomax inspires us to break open our minds’ secrets to discover individual and universal well-being. Through passive real estate investments, he helps engaged professionals create time freedom to live abundantly in all life’s areas.