Should real estate investors learn how to build a real estate portfolio?
With something for everyone, there are numerous ways to invest in real estate. However, for those looking to accumulate long-term wealth by growing one investment property into several, the first rule is learning how to build a real estate portfolio.
A real estate portfolio is a collection of the different investment assets that are held and managed to achieve a financial goal. It’s a strategic catalog of current and past real estate deals, whether rental properties, rehabs, or REITs (Real Estate Investment Trusts), to earn monetary returns. Although not every real estate portfolio will look the same, the items considered part of your portfolio would generally depend on a combination of factors such as your objective, time horizon, and risk tolerance. When learning how to start a real estate investment portfolio, investors should first consider the expected number of months or years they intend to be investing to achieve their desired goal and the risk versus reward approach they aim to take to obtain it. Risk and reward are inherently intertwined with real estate investment, so the risk tolerance will ultimately be decided by an investor’s willingness to lose some–or all–of their original investment in pursuit of their financial goals.
A real estate investment portfolio is exactly what you’d expect: a compilation of assets. Simply put, however, a real estate portfolio is nothing more than a collection of property investments owned by an individual or group. Appropriately dubbed a real estate investment portfolio, these collections represent an investor’s career-long achievements. Metaphorically speaking, portfolios are like a resume that identifies one’s accomplishments, but if you dig deeper, they’ll tell you a lot more.
For those considering how to start a real estate portfolio, the following highlights components to building a real estate investment portfolio.
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How To Start A Real Estate Portfolio
For real estate investors, understanding how to start a real estate portfolio, as well as why it’s important, is vital to your success. A real estate portfolio will not only serve as your resume of work but your marketing arsenal to finding and acquiring funding for future deals.
“During the course of your daily interaction, you will meet many people who could be potential private lenders for your deals, and that’s why you must have marketing materials that show people the opportunity to potentially earn a high rate of return as a private lender,” says colleague Than Merrill, CEO of FortuneBuilders and CTHomes.
A well-maintained portfolio will essentially showcase your personal investment goals and strategies, the inner workings of deals you’ve completed and currently own, as well as your success/fail rate. When seeking financing, your portfolio can also include your buying philosophy and testimonials from other lenders you’ve worked with — similar to a private money credibility packet. When building a real estate portfolio from scratch, investors need to pay special attention to the following aspects:
Simply put, what do you want to achieve from your investment assets? Because different investments perform differently at any point in time, investors need to understand their end goal before choosing assets. Although an entire portfolio does not decline because of one investment, the combination, including risk factors, will ultimately impact your bottom line. That said, the types of real estate investments you have in your portfolio will play a significant role in achieving your goal, as rental properties and multifamily properties aim to achieve passive income, while assets such as wholesaling and rehabs look to accrue short-term gains.
Building a real estate portfolio hinges on one simple aspect: the numbers. These numbers are the foundation of any real estate investment, as well as the elements of truth. What I mean is, these numbers provide transparency to your deals–revealing whether or not they’re good or bad. Therefore, your real estate investment portfolio should comprise each of your investment assets broken down by various numbers, such as purchase price, transaction/holding cost, profit, repair cost, and sale price.
The next aspect of building a real estate portfolio is financing. How did you find and structure the financing of your deals? How did you find a buyer for the property? Your real estate portfolio will need to answer similar questions when seeking financing through traditional institutes like banks or private money lenders.
Finally, your real estate portfolio will need to include the improvement costs, as well as monthly operating costs. This will provide lenders with a snapshot of the associated costs of each project and how you leverage that money to earn a profit. As an investor, make sure to summarize the repairs and improvements you made to the property, including the After Repair Value for future projects. Your real estate portfolio needs to be accurate, up-to-date and comprised of all financial figures on your real estate investment.
Another critical part of learning how to start a real estate portfolio is asset allocation. For investors, this includes determining the appropriate asset allocation model for your goal. Although a complicated task, real estate investors will need to select a combination of assets that have the highest probability of meeting their goals and doing so at the level of risk they desire.
As mentioned earlier, the appropriate asset allocation for you will take into account your overall strategy, as well as risk tolerance. Looking for greater returns? Investors will need to partake in riskier investments to achieve those results, while others seek safer bets, bypassing bigger gains for consistency. That said, the more risk you’re willing to take on, the more aggressive your real estate portfolio will be, and vice versa.
The last component to consider when learning how to start a real estate portfolio is managed. When holding onto properties, investors will need to decide whether to hire a property management firm to oversee the investment or become the landlord and do it themselves. This is something lenders will not only want answers to but its role for your bottom line. Whether you have a dedicated property manager or not, your real estate portfolio should include how your investments are being cared for, as well as the added cost associated with their management.
Benefits Of Building A Real Estate Investment Portfolio
There are various benefits associated with building a real estate portfolio that prove attractive to anyone who wishes to build their wealth, even with varying financial goals. Many types of real estate investments provide a steady cash flow in the form of passive income. By adding a rental property to your portfolio, this passive income can also be utilized to pay down the mortgage debt that was used to purchase the property in the first place. Over time, properties added to your property portfolios can appreciate in value and help hedge against inflation. Expanding your portfolio can help diversify risk while allowing you to have a sense of control while doing so. Finally, building a real estate investment portfolio offers many tax benefits, discussed in the section below.
Tax Benefits Of A Real Estate Investment Portfolio
Many tax benefits come with owning and building a rental property portfolio. Most rental home expenses are tax-deductible, and if you save your receipts or document your transactions, you can discount several charges.
In general, you can claim the deductions for the year in which you paid for these common – but not limited to – rental property expenses:
Cleaning and maintenance
Commissions paid to rental agents
Home owner association (HOA fees)/condo dues
As great as a long-term buy and hold property is, it also takes a great amount of work. You need to constantly keep your property occupied, running smoothly, and free of complications. To do this, you need reserves to handle repairs, maintenance, and seasonal upgrades quickly. You also need to put the time in to find the right tenants at the right price. You can have great tenants for five years, but if the next set stops paying, you could have a problem. There are definitely rental property tenants you will want to completely avoid as well. As great as rental properties are when things run smoothly, an eviction can make you forget all of the good.
If you take a traditional 30-year mortgage out, it will take some time to own the house free and clear. Most investors are unwilling to wait that long or have their money tied up for that period of time. You can do things to accelerate principal reduction and own the property quicker, but even those will only wipe off 5-7 years. The bottom line is that even if you don’t pay off the mortgage, holding a property for the long term is still a good investment. Nobody knows where the market will be in 10 years, but you can assume you will have built some equity over the past 120 months – all the while receiving tax benefits and cash flow.
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Continue To Grow Your Real Estate Portfolio
Now that we have addressed the question of “what is a real estate portfolio,” how to launch one, and its various benefits, you may be wondering how to grow your real estate portfolio effectively in the long run. If you have taken away anything from this discussion, it is that a portfolio cannot be acquired overnight. Rather, it is something that is built up strategically over time.
Leverage Your Real Estate Portfolio
An important aspect of learning how to grow your portfolio is learning how to leverage it to pursue new prospects. In short, leverage means using an asset or a resource to your advantage. For example, your portfolio, a collection of assets, can be leveraged to establish your credibility when trying to close new deals or gain additional funding.
Reduce Risk By Diversifying Your Portfolio
Another motivator for growing your portfolio is risk mitigation through diversification. No matter what type of investing activity you choose, there is always some level of risk present. For example, if you invest in the stock market and the market crashes, you can lose on that investment. Although real estate is seen as one of the more stable investment activities available, no one is immune to risk exposure. By investing in different types of assets, you avoid “putting all of your eggs in one basket” if any external factors influence your portfolio for the worse. Here are a few alternative investments to help bolster your real estate portfolio:
Commercial Real Estate: Commercial properties are often thought of as the “next step” after investors complete a few residential deals. The reason for this is because not only do commercial properties lead to higher profit margins, but they are also a great way to diversify. Commercial properties include office buildings, retail space, and even industrial buildings.
Multifamily Properties: Investing in multifamily properties is a great way to bulk up your real estate portfolio. By exploring different markets and larger residential spaces, investors can protect themselves from market factors that may affect the profitability of single-family homes.
Real Estate Investment Trusts (REITs): REITs are a way for investors to reap the benefits of real estate investing without adding any properties to their portfolios. These trusts refer to companies that purchase income-generating real estate and pay dividends to investors in the company. This is a great opportunity for investors looking to expand their reach while still sticking to real estate.
Raw Land: Undeveloped land is an emerging strategy among today’s best real estate investors. Investors who purchase raw land can divide the plot for resale, lease it to renters, develop new construction, and even hold on to it while it appreciates. Raw land can be used to diversify because it offers investors a chance to switch gears into a new exit strategy (and, in many cases, a new market).
Costly Mistakes To Avoid
Part of effectively growing your real estate portfolio is knowing what mistakes to avoid – mistakes so costly that they can diminish your portfolio. Some of these mistakes include neglecting to diversify your portfolio, ignoring your due diligence, underestimating costs, or failing to recognize when to work with a professional. Get the full discussion here.
Compile Your Assets Using A Real Estate Portfolio
Creating a successful real estate business is often contingent upon an entrepreneur’s ability to design and execute efficient systems to achieve economies of scale. This concept can and should also be applied when growing a real estate portfolio so that once you launch and cultivate it, it starts working for you. In addition, learning how to create the perfect real estate portfolio template can be a great way to showcase your work on your behalf, which can help attract new opportunities, even while you sleep.
Diversify your real estate portfolio with several different types of investments. It is common for the market to fluctuate, which can be dangerous if you invest in only one type of real estate. With a diverse real estate investment portfolio, you can rely on more than one of your high-investment properties if the market drops. You can invest in different locations, different asset classes, or REITs.
Utilize Real Estate Analytics
Real estate analytics refers to calculations that analyze the performance of different investment opportunities. Analytics is an important component of any real estate portfolio because they are a measurable tool that can monitor the success of various investments. A few common analytics include cap rate, cash flow, rate of return, after repair value, and even loan repayment schedules. Many investors rely on a real estate calculator to quickly determine these numbers when evaluating an investment property. However, it is essential to take these calculations further by recording them alongside your real estate portfolio.
Real estate analytics are helpful for a variety of reasons. Not only will prospective lenders request these numbers from time to time, but they can also be used to quickly evaluate whether a new property is worth pursuing. A good system is to create a spreadsheet you can easily review and write these numbers in as you analyze different properties. You can even include specific metrics for investments you didn’t land, as these might help when analyzing comparable properties. The key is to find a system that is easy for you to navigate. Tracking real estate analytics is one of the best ways to monitor and improve your portfolio.
Build A Team
As you build your real estate portfolio, there may come a time when the workload is too much to manage alone. This is a great opportunity to start building a real estate team you can trust. Many investors are hesitant to bring new people into the business, but it can help you in the long run. Take your time finding individuals who align with your mission and goals, and start slowly when delegating responsibilities.
Many investors choose to start by hiring a virtual assistant. This is an excellent opportunity to outsource small tasks that take up time, such as website management or tracking the results of a marketing campaign. Another opportunity to build your team is by hiring an accountant. They will be able to manage your taxes and finances as your business grows. This can help immensely with keeping your books in order and making sure nothing falls through the cracks when tax season comes around. Consider the tasks you struggle with the most in your real estate investing business, and start there when it comes to building a real estate team.
BRRRR Method Vs. Conventional
The BRRRR method stands for: buy, rehab, rent, refinance, repeat. Essentially you buy an undervalued property, renovate it and then get an appraisal. With the new, higher property value you have just increased your equity in the home and can secure a cash-out refinance. During this process, you are also renting out the newly renovated property and earning rental income. You can then use the cash-out refinance to buy the next property, and the monthly rental income to cover any remaining costs. The purpose of the BRRRR method is to build up your portfolio and consistently increase your equity.
A conventional mortgage refers to the traditional real estate transaction process. You apply for a mortgage from a lender, agree to the terms of the loan, and then purchase the property. At that point you can rent it out for monthly income. With conventional financing, you would then need to identify another source of funding for your next deal to keep building your portfolio. Overall, there are benefits to both in terms of building a solid real estate portfolio.
Measuring The Success Of A Real Estate Portfolio
There are two main ways to measure the success of a real estate portfolio: with an asset manager or through your own calculations. After compiling your portfolio you can approach an investment management group to begin working with a financial advisor. A professional financial advisor will be able to audit your current investments, make recommendations for future opportunities, and manage your holdings over time. However, these services do come at a price.
Many investors will instead opt to manage their own portfolios. The key to this approach is adding the right performance metrics and comparing numbers over time. Remember to regularly update your calculations so you are constantly away of whats working, and whats not. Here are a few key indicators to help you get started:
Net Cash Flow: Net cash flow is a metric that every real estate investor should be familiar with. It is essentially the annual income of a property minus the annual operating expenses.
Cash-on-Cash Returns: Take your net cash flow and divide it by your initial investment. The result will tell you your cash-on-cash returns, which will help you compare your investments across the board.
Economic Vacancy Rate: The economic vacancy rate can be determined by multiplying the number of vacant units by 100, and then dividing that by the number of total units. This will help you measure your vacancy rate against similar properties in the area, and can even signal when its time to raise the rent.
Property Appreciation: Keep an eye on the property value of each of your investments and track the appreciation rates over time. This is a good indicator of the long-term holding benefits of the property.
Understanding the importance of a real estate portfolio is necessary to not only manage and grow long-term wealth, including your personal budget but obtain financing for other future projects. Ultimately, how to start a real estate portfolio comes down to an investor’s overall end goal, as the types of assets they obtain will dictate their path to achieving it.
You won’t hear about long-term investing in reality TV shows, but it is still a great way to generate wealth. Think about where you want to be financially 10 years from now. What you may find is that investing in real estate may be the perfect way to get there. And building a rental property portfolio is a great way to start.
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