This article is Part 2 in a short series of blog posts where I will lay out my business and investing strategies at a bird’s-eye level. The Rich Dad books talk about focusing on what you’re good at, but diversifying in terms of the type of asset that you own (as opposed to diversifying across industries within one asset class). I’ve taken that concept and applied it to my own passions, as well as the knowledge that I’ve gained from all of the reading and research I’ve done over the past couple of years, to determine just what business and investing vehicles I plan to use and how I plan to leverage them.
This article talks about how I plan to augment my investing portfolio in the “REAL ESTATE” asset class by owning properties and renting them out.
Real estate as an investment has been a concept since the dawn of man. Historical figures have gone to great lengths to accumulate land, including funding expensive explorations and even waging huge wars. That’s because, for those who owned real estate and knew how to profit from it, it’s been one of the most consistently lucrative investments throughout history. After all, it’s a product that solves one of the basic human needs – people will always need shelter and a place to stay, and they’re not exactly making more land right now.
The Place in My Portfolio
I once read that, while there are many different avenues by which people attain their wealth in the first place (things like businesses or even the lottery), many of those who end up keeping their wealth store most of their money in the form of real estate. I don’t remember where I read this, and I’m not sure if it’s necessarily true, but it makes a lot of sense! After all, you don’t want to keep large sums of money in a savings account where its value will just get inflated away, right? That’s why, though I plan to get rich through my software businesses, I’m going to use that wealth to buy up rental properties to enhance, increase, and store my wealth by funneling excess cashflow from my businesses into assets like real estate.
The great thing about rental property is that it functions like a cross between a big business and a commodity. Unless something extreme happens, a piece of real estate is going to hold its value when compared to pretty much anything you can buy – food, luxuries, even cash (I talk more about why this is important in Part 4 of this series on commodities like gold and silver). But unlike other commodities, real estate assets also provide the second source of value that you can only get from a business-based asset – cashflow, in the form of rental income. What his means is that the capital you put into the asset at the start will come back out at the end (even when adjusted for inflation) and, at the same time, you will receive a periodic paycheck from the asset, too.
Plus, at the time of writing this, interest rates are at an all-time low as the government tries to increase the velocity of money and boost the economy. This means that prices in the stock market are going up and up, while the cost of investment capital is going down. It seems to have put the stock market into a bubble, which makes it overall an expensive and unattractive investment (more on this in Part 3) while making investments like real estate more easily attainable (and the return on real estate investments is higher, since the up-front cost is lower if you can get the capital!). This is a great time to invest in real estate. Once the interest rates spike, things might change – houses would probably be more difficult to come by, and the stock market could fall, making it easier to pick up a whole bunch of low-price stocks.
When you hear about “real estate investing,” what do you think of? Obviously not real estate agents or owning a personal residence – those are the furthest thing from “investing.” Some might think I’m talking about “flipping” houses – buying a property in need of some repair, doing the maintenance, and then selling it for a markup. This seemed to get really popular around the time when the housing market was booming and television shows about house-flipping were popping up on every channel, but as we saw when the market crashed in 2008, this is a very high-risk gamble and only seems like a good investment in a booming market — at least, that’s the way I see it. Some might be able to make it consistently profitable, but I also have friends who can consistently make a tidy profit on sports bets, and I’m not one of them.
My strategy, however, is to invest for income – money that comes in periodically for the duration of ownership of the asset. In real estate, this means buying properties that I can rent to tenants at a rate that produces a net profit each month. There’s a lot less risk in this than flipping houses. If the market crashes, you’re not looking to sell anyways – just hold the property and continue getting your monthly rent. In fact, market crashes are supposed to be the best time to acquire more properties! And if the market hits an all-time high, you can always sell if you want to.
Many people shy away from rental real estate, though, because it sounds like a lot of work. After all, there is the whole business aspect of it – the property must be managed and maintained, rent must be collected, etc. What many people don’t realize is that this whole process should be automated – many people have done it in the past. You can hire a property manager and simply give him a cut of the profit (which works best at scale), or you can implement your own process. Personally, I’m kind of excited about the prospect of automating the process myself – with the use of technology and hiring a good assistant to answer the phone. There is one obstacle to doing this, however, and that is time. I may end up hiring a property manager so that I can focus my limited time on more profitable tasks, like building my businesses.
What Kinds of Properties?
There are all sorts of properties out there – normal houses and vacation rentals, multifamily homes and apartment complexes, even things like farmland and data centers are considered a form of real estate. Owning a data center might be pretty sweet, but that’s way out of my price range and focus for now (not to mention requiring a completely different skillset to manage). Apartment complexes are the same – they can be very profitable, but you need the systems already in place and either a lot of cash or a wealthy partner to acquire one. Maybe someday.
For now, I’m focusing on standard single-family 3 bedroom/2 bathroom houses in middle-class neighborhoods. Lower-class properties seem to be cheaper and present a higher profit margin at a glance, but require a lot more management, and the processes are harder to automate. Upper-class people tend not to rent, so filling those properties seems more difficult. However, a middle-class family is likely to move in and stay for several years (meaning turnover is lower), especially if they have children to be enrolled in nearby schools. They also seem to have a tendency to be responsible, paying their bills in full and on time. As a bonus, some of them might even be like my parents – doing the small, easy maintenance work around the house on their own, rather than going through the whole hassle of bringing the maintenance guy out to take a look at it.
Additionally, I’m looking into owning a few properties in areas where young professionals tend to rent. This would be my peer group, so I would understand them better. Plus, I would potentially be able to purchase multifamily homes (duplexes and such) without having to own property in lower-class neighborhoods.
In general, the plan is to own properties in good neighborhoods and rent to quality tenants; I understand that this might be easier said than done! No better way to figure it out than to just do it, right?
The Steps to Successful Real Estate
There seems to be a pretty defined pattern in real estate investing. As long as you know how to run the numbers and prove that the property is profitable before purchasing it, and as long as you find quality tenants, it should be pretty straightforward.
As with software business, real estate is a broad topic and summing it up into a few steps doesn’t really do it justice. I’ll probably expand on the topic in future posts, although not nearly as much as other topics within my core focus. If you’re truly interested in real estate investing, feel free to ask me to talk about it more. Additionally, you can get a lot of information from the BiggerPockets community – it’s a great resource, and the main place I’ve learned about the subject!
As before, though, I’m going to go ahead and sum up the process anyways. At a bird’s-eye level, the steps to being a successful real estate investor are:
- Find Your Market. As I said, there are many different properties and many different markets, and each one requires a different approach. Do you want to put in the extra effort to rent to lower-class tenants for a higher return? Or would you rather potentially sacrifice some of your profit margin for great tenants, as I’m hoping to do? You have to decide on a market first, and then go after it.
- Find a Great Deal. Great deals are everywhere, but so are bad ones. The thing about real estate is that you usually have most, if not all, of the numbers in front of you to determine what a deal is. I won’t go into the math in this post (you can find great examples on BiggerPockets, as well as Ken McElroy’s The ABCs to Real Estate Investing), but the idea is to make sure that each month your rental income (likely similar to other rentals in the area) will net an acceptable profit after your mortgage, taxes, insurance, maintenance, and all other expenses have been paid. You don’t ever want to have to dig into your own pockets to pay for a repair – the property should be able to pay for itself!
- Buy the Property. Once you know that the property is a great deal, you need to purchase it. Most of the time, you’ll want to finance it in some way – this not only nets you an exponentially higher return on your investment, it takes less money out of your pocket and allows you to acquire more properties. However, once you’re at the stage where you can’t get any more bank loans, this step gets more difficult – I still haven’t even thought that far ahead myself! There are all sorts of financing solutions out there, though — you just have to go find them.
- Systematize and Automate. Property management can be a lot of work. The home must be maintained and repaired, and you have to make sure the tenant pays rent. These are the things most people don’t want to do, but as software developers and entrepreneurs, building automated systems around processes is what we do best! If you can systematize and automate this part of your real estate business, it becomes easy passive cashflow. Once you build a system, you should be able to just add any new asset purchases to the system without any extra effort, which means that any automation you do works better and is more profitable as you scale.
- Rent the Property and Buy More. Once you have a process in place and tenants in your properties, you just have to focus on the investor and entrepreneurial tasks – buying more properties and growing your business!
Again, there is obviously a lot of complexity involved in each of these steps. As I continue to learn by doing, I’ll try to add some information! Let me know if you want to read more, too – if the topic generates enough interest, I might expand on it some more.
Get to It!
Real estate is not a primary goal in my life right now, but it’s something I have in the back of my mind. In fact, when it came time to find a new place to live last year, I decided to purchase a house following the guidelines above rather than rent an apartment uptown, even though I don’t intend to stay in one spot for very long – because I can rent it out once I move! I’m actually looking to do the same again near the end of this year, with the intention of starting to rent the property I’m currently living in.
As with any sort of investing, you can take it slowly – do a little bit of work on the side to accumulate assets and learn the system, and start to really expand and grow as you understand more.
Real estate isn’t for everyone, either. But as I said in the introduction, it’s been the most consistent way to get rich for all of human history, and the majority of the wealthy own some real estate in order to store and expand their wealth. That’s why I plan to pursue real estate, even if it doesn’t end up being my most profitable venture.
These are my plans, and that’s how they fit my goals. What about you?
This is just Part 2 of the Getting Rich Through…. series.