Real Estate Investing: 9 Considerations for Success
by Bobby Daniels, CFP®, CIMA® | January 17, 2024
Real estate investing has pros and cons, but it can be rewarding if done correctly through strategic planning because it has the potential to offer cash flow, appreciation and portfolio diversification from your other assets.
Investing in real estate, just like any other investment, involves risk. It is crucial to understand the risks involved, do your due diligence, and deploy strategies to help mitigate these risks as much as possible.
Regardless of skill or education level about real estate investing, here are some things to consider if you are looking to dive into this market.
Property location is a significant factor when it comes to real estate whether it is a primary residence or a real estate investment property. A property's location can significantly impact its value, potential for appreciation and rental income. Location will also impact the costs associated when buying a property. If the property is in a great location, it is likely that an investor will pay more to own that property, and rents tend to be higher. If the property is not in a great location, the investor is likely to pay less for the property and rents tend to be lower. Location can also impact the type of tenant who will rent the property.
Some things to consider when determining a location are schools, safety, amenities, walk score, public transportation and overall growth/or potential growth of an area. Areas to consider might be downtown metro areas, college towns, tourist areas and smaller communities. If you want to invest in smaller communities, one consideration would be to make sure there is enough stability with the population, i.e. making sure there are larger businesses or jobs to support a continued rental vs. having a large vacancy rate.
2. Market Trends and Economic Indicators
Doing your research on market trends and economic indicators is key when making investment decisions on when to buy and when to sell real estate. It is a good idea to continually analyze local and national real estate trends, interest rates, economic forecasts and rental rates. If your desire is to own real estate in smaller market areas or communities, keeping an eye on employment rates will be more crucial. In my experience, the easiest way to stay on top of the real estate market trends is to work with an experienced real estate agent you know and trust. Find an agent who focuses on real estate full time and works with other investors, because it will likely require too much time to try and do it all on your own.
3. Property Type
Choosing the right type of property to invest in is going to be one of the most important decisions because it will guide many of the other categories outlined in this article. Whether it's residential, commercial, land, or a mix of all three, each property type comes with its own set of risks and potential returns. It will also come with its own set of management requirements, which we will talk more about in the property management section. Once you have narrowed down the type of property you want to invest in, you can begin your research to find ones that meet your criteria.
Residential – there are many ways to invest in residential real estate, whether it’s buying a condo/townhouse, single-family home or multi-family home.
Condo/Townhouse – There is normally an association involved that may have limitations to how many units can be rented and how long tenants can rent for. This could affect you as an investor if you are looking at Airbnb-ing a property or having short term rentals vs. having long-term tenants. The other downside is association dues. However, these dues generally ensure the association is taking care of everything outside of the unit, and the landlord typically handles anything inside the unit.
Single-family or multi-family property – The owner has more control over whether they want to Airbnb the unit, have short term tenants or long-term tenants. However, the flip side is the landlord covers all interior AND exterior upkeep. So, things like siding and the roof are added expenses the landlord will have to plan for down the road.
Commercial – Investing in commercial real estate is yet another investment tool to complement a financial portfolio. Investment in commercial real estate requires a keen knowledge of your specific market, understanding the investment risk and the significant capital required to finance, purchase, maintain, your property. Commercial real estate is classified in five major asset types:
Office properties – Office properties can be single tenant or multi -tenant and carry three classifications: Class A properties, are generally newer properties, have an excellent location, are well maintained and command the market’s highest rents. Class B properties are older properties, may need building upgrades, more amenities and upgraded tenant finishes. Class C properties are outdated properties that need significant upgrades and are generally on the lower rent scale.
Industrial properties – Industrial properties consist of large “high cubed” warehouses. This asset class caters to the supply chain industry where the storage and movement of products is the function of the property. Property size can be as small as 20,000 square feet up to 1 million square feet. Newly constructed warehouses command the highest rents. Warehouse location is a critical factor and proximity to interstate systems is crucial.
Flex/office/warehouse properties – This property type is unique in the sense that they are smaller properties, include office areas, and have smaller warehouse capacity. Flex properties can easily be converted to all office space or all warehouse space.
Retail – This asset class can include the small multi-tenant strip center, all the way up to major shopping malls. Retail rents vary by market, location, property age and property condition.
Multi-family apartments – This asset class can vary from very small 8-12 plex buildings to large multi-building units with hundreds of apartments. Apartment rents are driven by the market and demand. Apartment properties can require a higher time requirement for management.
Land – Farmland is valued for agricultural and farming operations. As development activity continues to grow, farmland increases in value. Farmland close to developing communities and cities naturally increases in value. Land that is in the direct path of commercial development can command high prices. Land tends to have a lower cash flow than residential or commercial properties, but generally has less involvement from the investor’s standpoint.
4. Game Plan and Exit Strategy
Just like having a business plan is important in the business world, so is having a business plan for your real estate business. Considering outlining your goals and strategies for your real estate portfolio. Do you want to invest in residential properties or commercial? Do you want to buy and hold real estate, or do you want to improve the properties and sell them quickly? If you are wanting to invest in residential real estate, are you wanting to lease long term, lease short term, Airbnb or VRBO your property? It is also good to have an exit strategy for the properties you invest in. Timing the market on when to exit is probably the most challenging, and I am not sure if anyone gets it right every time. Regardless, the most important factor is to be financially sound so you can exit on your terms versus having to exit because of financial hardships.
5. Financial Feasibility
Once you have determined your desired area or areas to invest in, doing an analysis of the feasibility of your investment will do wonders when finding the right property. Based on your cash available, you should be able to determine how much you are able to afford for the purchase price. It is also important to do a market analysis in those desired areas to see what average rent prices are. An easy way to do this is via Zillow.com or Apartments.com. Once you understand those two things, you can dive further into factors such as: property taxes, maintenance costs and financing. A good resource is mortgagecalculator.org because it factors in purchase price, taxes, insurance, PMI (private mortgage insurance) and HOA (homeowners association), if applicable. Another tool to help you figure out some of those costs is via the county assessor’s website or Zillow. Having all these numbers will give you a better understanding of the financial aspects of the desired property and whether it will meet you overall financial objectives. NOTE: It may take looking at 20 or more properties to find the one property that will help you meet your goals.
When trying to determine how much real estate to own, a general rule of thumb and what we typically recommend to our clients, is to not have more than 20% of your net worth in one asset class, like real estate. We also recommend having three to six months of expenses in an emergency fund for your personal household, as well as having the same saved for each rental property. That way if you have things that need to be fixed or have a vacancy for an extended period, you have the cash available to take care of those needs without tapping into your personal reserves.
6. Legal Considerations
Navigating the legal arena is an important piece to consider when investing in real estate. Work with a team of realtors, attorneys and insurance professionals to ensure you are avoiding potential disasters. Another important consideration is whether you buy the property in your individual name or as an entity like an LLC (Limited Liability Corporation). We recommend working with a real estate attorney who can help you navigate best practices, but here are key considerations for either option:
Purchasing property in your personal name may allow you to close on the property with a lower down payment if you are going to finance the purchase. You may be able to stretch the amortization of the loan to 30 years, as well. If you are buying a multi-family property and living in one of the units, many people might buy in their personal names. Many residential mortgage lenders will only allow you to purchase a property with up to four units. For properties with more than four units, you will need to use a commercial lender. One consideration if you are going to buy the property in your personal name is to work with a property casualty insurance professional to ensure you have enough liability coverage in place to cover you in the event something happens.
When you purchase property via an LLC, and are financing, you might end up working with a commercial lender, and you may want to increase your down payment. Typically, the more you put down, the better the interest rate you will get. If you are allowed to put 20% down, a lender may change the type of loan to an adjustable rate or shorten the amortization to 20 or 25 years. The plus side of purchasing with an LLC is you typically are covered from a liability standpoint except for what assets are in the LLC. So, your individual assets are generally protected from a liability concern. There have been lawsuits where a person may pierce the LLC and pursue an individual’s assets, so it is important to work with a property and casualty agent to have a backup plan in that type of event, aka liability insurance. It is also important to work with a real estate attorney for best practices for your LLC.
7. Financing Options
Having favorable financing is key to making sure you meet your financial objectives with your investment and to help mitigate some financial risk. Be sure to connect with multiple banking institutions to explore your different financing options. It is always good to have two or three lenders available when looking to make a deal because some banks will have more favorable terms than others. Some areas you will want to consider are interest rates, loan terms, down payment requirements and closing costs. The other consideration is whether to purchase individually or through an entity like an LLC. If you purchase in your individual name, you may be able to put 20% down for a conventional loan. If you are purchasing it through an LLC, or if the property has more than four units, it may have to be a commercial loan. I have seen commercial loan approvals with as low as 15% as a down payment, but generally it is going to be 25% or more down when closing.
8. Property Management
If you are looking at rental properties, you will want to consider who will handle property management. Will you want to do the property management from start to finish, or will you want to handle only some of the tasks and hire a property manager to do the rest? If you decide to take on the property management, will you handle the management tasks and calls that come up or will you outsource to hired professionals? If you hire out the “fixes,” it’s a good idea to create a file of trusted contacts you can call at any point who are reliable and timely to fix things that come up. Think of people you know personally or have had do work on your personal property. It is important to have these people on speed dial because inevitably things will come up and it saves time and hassle knowing you have someone who you trust to do the work. On the flip side, if you hire a property management company, it will generally be hands off for you, since they handle nearly everything. The tradeoff is that they can be very expensive, which eats into profit margin. Some will charge more than the first month’s rent and then 10% of monthly rent.
A key strategy to deploy in real estate, just like the stock market, is one of diversification. Consider spreading your risk by implementing investing in various types of properties, whether that be land, residential or commercial. Another consideration for residential properties is using different rental methods such as long-term leasing, short-term leasing, Airbnb and VRBO. Investing in real estate, outside of your stock/bond portfolio, can provide an added layer of diversification. When investing in different asset classes, like real estate, one needs to be mindful that not every asset class outperforms the others year in and year out. When looking at an asset class performance chart, you will notice it is more uncommon for the same asset class to be the top performing asset class multiple years in a row. So, having a diversified portfolio can help reduce overall market fluctuations and the volatility of your overall investment portfolio.
If you are looking to invest in real estate and do it successfully, it requires a very strategic plan. There is much research that needs to be done with each ideal property to make sure it fits your financial goals. Continually educate yourself on real estate and financial markets and the economy and be sure to employ experienced professionals in the areas of financial planning, insurance, legal, financing and –property management, if applicable – to help you navigate all the complexities of real estate investing.
If you are interested in real estate investing and want to learn more about how it could help diversify your investment portfolio, our financial planning team would be happy to discuss your individual situation. Feel free to connect with us by calling (515) 225-6000 or request to be contacted online.
Tom Gayman, broker/owner of Performance Realty, LLC in Urbandale, Iowa, contributed to this article. A Des Moines native, Tom has nearly 40 years of commercial real estate experience in Des Moines and throughout the Midwest. Performance Realty is focused on one-on-one brokerage services and offers its clients a customized, service-driven approach to produce the results that clients expect. Services include tenant representation, land sales, site selection, and industrial and office leasing.