There’s a reason so many dating websites exist. Not everyone is a good match, and the process of finding ‘the one,’ for many people, is just that… a process. At the same time, limitless factors and human intricacies come into play: personality, lifestyle, goals and preference just to name a few. Investing in real estate can be likened to the world of dating. Not every investor or aspiring investor is best suited for every deal. Real estate is a robust industry with investment options running the full gamut of size, complexity and risk. Understanding your personal real estate investing profile, and within that the types of real estate investments that best suit you as an individual, is a personal decision. One we believe not only worth exploring, but paramount to your success.
As an industry, real estate has been around since mankind planted roots, post our hunter gatherer days. Real estate as an area for investing and growing wealth has become increasingly popular over the last five decades. Since before the Pacific Railroad, the first transcontinental railroad in the US, people have laid claim and profited from the sale of raw land. Even today, people continue to buy land hopeful its value will appreciate. Typically in raw land deals investors rely on a long term buy and hold strategy. Others purchase land with the intention of making improvements to add value as their strategy. Take for example a little area of Central Florida Swampland that now houses the largest, most visited theme park in the world. External factors can increase land value as well, like when municipalities invest in redevelopment efforts turning previously dilapidated areas into hip entertainment districts. Just ask Tony Hsieh of Zappos who moved his company headquarters and his personal home to downtown Las Vegas just steps away from the famous Freemont Street Experience.
Single Family Homes, Rehabs & Vacation Rental Properties
In today’s day and age, single family homes are one of the most common real estate investments in the US. Even people who don’t consider themselves real estate investors take pride in their primary residence as an investment vehicle. Some attempt to monetize their home by dividing their primary residence into multi-family housing, like the Greeks in Astoria Queens or the Irish in Boston. Many are successful, but just as many run into trouble with inspectors based on zoning regulations or when trying to sell their single family home that has been subdivided to include four kitchens.
Other investors in the single family home sector typically use one of a few strategies. Some buy homes to use as rentals. As a long term strategy investors hope to generate cash flow while covering the mortgage and property carry costs, while in theory the home appreciates overtime. Investors looking for shorter term strategies in this sector tend to buy homes with the intention of making enough improvements to able to sell them for a profit without the long term carry costs. Most recently when we think of investors rehabbing properties we think of the short sale and foreclosure properties, but in the early 2000’s, some investors were able to turn profits by buying into new home developments, holding for a few months and then selling. Rehabbing, or property flipping as deemed by the reality TV shows that glorify real estate investing, continue to gain attention as federal and financing regulations come into play; a topic we’ll save for it’s own future discussion.
Another strategy in the single family home market is to buy a property in a major tourist market that can be used as a vacation rental. The explosion of web-base ecommerce has made this sector even more accessible and popular with sites like airbnb.com and VRBO.com offering investors self management tools. Investors interested in vacation rental properties need to pay close attention to local and state regulations. Hawaii continues to increase regulations for investors with rental properties. For example, absentee investors who aren’t full time Hawaiian residence pay an increased property tax rate and may be required to register for an annual business license with strict stipulations. One requirement currently in consideration in Hawaiian legislature is that investors be required to have an on island property contact. If you didn’t factor professional property management costs into your vacation rental overhead, that could have a serious impact on the profitability of your investment.
Multi-family homes as investment continue to be a hot and expanding sector in the US. We shared more on that topic in our last blog post here. Multi-family homes, like duplexes, triplex and quads, are typically viewed by banks, for financing purposes, the same as single family homes. This allows investors to realize economies of scale since one loan can secure multiple units. Investors are able to generate income by renting out all of the units, or occupying one as their home and renting out the rest. Fewer buyers are looking for multi-family homes than single family homes, so investors in this sector face less competition.
Within residential real estate, investors categorize apartment buildings into two groups: small and large. Since the definition isn’t set in stone, generally speaking, apartments with less than fifty units are categorized as small, and those with more than fifty units large. Apartments are categorized by their size due to the differences in associated financing parameters. Small apartments typically rely on commercial lending standards. Instead of being valued based on comps, like single and multi-family housing, small apartments are priced and sold based on their income. Meaning, how many units are rented and their current average rent. Investors interested in exploring small apartment buildings as an option need to evaluate the strength of the rental market in the building’s area; specifically, a markets vacancy and delinquency rates. Often small apartment buildings utilize onsite staff for management and maintenance who will work for significantly reduced labor costs in exchange for being able to live on site. Small apartment buildings are among the less competitive real estate investment options since the more difficult financing keeps many small investors away, but the small size keeps them below the interest threshold of professional real estate groups. Investors who are able to add value by increasing rent, or decreasing expenses and increasing management efficiencies can realize significant returns.
Large apartment complexes are the ones you see all over the country. Many rich with amenities like clubhouses, workout rooms and swimming pools. While the amenities attract renters and help the complexes command higher rent, they also bring higher expenses to manage, run and maintain. Large apartment buildings or complexes also have additional expenses for advertising and marketing to fill units. These properties typically cost millions, but can produce stable returns with minimal involvement. Many are owned by syndication, which are small groups of investors who pool their resources.
Moving beyond the residential and rental sector, some investors focus on the real estate wholesale market. Wholesaling is the premise of making money in real estate by finding good deals, entering into a contract to buy, but then selling the contract to another investor. Contracts in wholesaling typically need to be assignable. Meaning the initial buyer can actually sell the contract to another buyer without the owner’s permission. Real Estate wholesalers typically earn a flat fee per transaction and have a significant network of investors willing to buy their contracts. Sometimes even sight unseen. Hard work and complex dynamics with distressed time frames makes wholesaling difficult. However, successful wholesale investors are able to invest in real estate without a significant outlay of cash since they skirt closing on properties directly.
Alternate Real Estate Investments, REITs & Tax Liens
In looking beyond the traditional real estate investment sectors we’ve discussed, significant opportunities exist for investors interested in alternate options. Perhaps you’ve heard of some of these nontraditional real estate investments as investing in paper like REITs and tax liens.
REITs, short for Real Estate Investment Trusts, originated over sixty-five years ago. They were developed to give investors the benefit of investing in real estate with the ease of traded investments like stocks and mutual funds. Investors like the liquidity of being able to buy and sell REITs like stocks while getting the scale and transparency of publicly traded corporations. Through REITs investors can invest in large scale portfolios tied to all aspects of real estate like apartments, bonds backed by mortgages, commercial developments, hospitals, hotels, nursing homes, offices, shopping malls, student housing and more. REITs are categorized into two main types: equity REITs and Mortgage REITs. Equity REITs generate income from rent or the sale of properties they own. Mortgage REITs invest in mortgages or mortgage securities tied to commercial and/or residential properties. As an investment vehicle, REITs have proliferated both in the US and beyond with REIT offerings now in more than 30 countries. There are even REIT based mutual funds and ETFs (exchange traded funds).
Tax liens can be issued for all types of property – residential, commercial, raw land. When owners fail to pay their property tax, the government has the authority to place a lien against the property. The tax lien is issued for the amount owed plus any fees and penalties of course. Property with a tax lien cannot be sold or refinanced until the lien is paid. Investors can buy tax liens at auction. Tax lien holders then have two ways to make money on their investment. The first is a right to collect interest on the lien from the property holder at rates from five to thirty-six percent for up to a year. Alternately, if the owner fails to pay the monies owed to the lien holder, the investor as a right to claim their property. The laws differ by state, and property seizure will not happen without a lawsuit, that will get expensive and complicated quickly, but a determined tax lien holder will be given ownership. With such attractive returns, tax liens can be a lucrative investment, although not without risk. Individuals interested in investing in tax liens need do their homework. Investors need significant market knowledge as well as an understanding of the law and an ability to manage the complexities that can arise, like multiple tax lien holders for the same property.
How do you know what’s right for you?
Shotgun weddings don’t have a high long term success rate, neither does rushing into real estate investing without a solid understanding of the type(s) of real estate investing that suits you best. For example, not everyone is cut out to manage tenants.
Dealing with renters and property maintenance takes a certain type of hard work that doesn’t outweigh the returns for everyone. You have to take stock in what you like, what you’re good at and what style fits with your goals, both short and long term. Your availability to capital, risk tolerance and personality will all also come into play.
While we’ve hardly scratched the surface of the potential of real estate, our aim is to educate and inform you on real estate today, so that as an investor or prospective investor you are more empowered. Make sure to check out our comprehensive real estate investment training program where we will teach you all of this and more. As always, we look forward to your comments, questions and ideas. Thank you for reading!
The NEBDG Blog, by our Tax & Legal instructor Mark J. Kohler, is "The Real Estate Investment Conversation You Can Rely On." Mark J. Kohler is a CPA, Attorney, Radio Show host and author of the books “The Tax and Legal Playbook- Game Changing Solutions For Your Small Business Questions” and “What Your CPA Isn’t Telling You- Life Changing Tax Strategies”. He is also a partner at the law firm Kyler Kohler Ostermiller & Sorensen, LLP and the accounting firm K&E CPAs, LLP. For more information visit him at www.markjkohler.com. Let us know if there is a topic you would like to discuss!