Real Estate investing intrigues many potential investors. It is time-tested and proven. It has the ability to be highly profitable. Unlike a paper stock, it is tangible--it’s a real thing that you can see and maintain and improve. Real Estate has a ubiquitous quality: “For Sale” signs are ever-present; most people know someone who rents a place or two as a part-time landlord. Despite the many opportunities and the chance for profit, the unknown prevents many people from exploring the world of real estate investing. In this “Beginner’s Guide,” we hope to demystify the unknowns for those new to real estate investing by looking at the basics. We hope this will serve as a launchpad for further readings and discussions into the world of real estate investing.
A fundamental question to ask is this: “What role do I, as an investor, want to play?”
To illustrate the distinction between active and passive investing, let’s use a metaphor: The active investor is the driver of the car. Beyond driving, the active investor decides the destination, the route, the stops. The active investor knows what’s going on under the hood of the car. If something goes wrong, the active investor is under the hood assessing the problem and choosing the next steps to fix the problem: fix it, call a mechanic, or--who knows--trade it in. For some of you, that might sound like a road-trip worth taking. For others, that might sound like--well, too much. Consider passive investing. Metaphorically speaking, the passive investor gets to ride along. The passive investor sees the sights and experiences the journey without needing the expertise or having the obligations of the active investor. The passive investor is critical: the passive investor’s resources--the “gas money,” so to speak--make great trips possible.
Active investors embrace the demands and possess the real estate knowledge that comes with “driving the car.” As operators, they often handle the duties of the property manager--tenant calls, listing apartments, vetting prospective tenants, handling repairs, while simultaneously controlling the financial and investment side--setting rents and managing occupancy, managing insurance, forecasting and budgeting for capital expenditures, and more. For the active investor, it is a full-time job.
Passive investors place capital in the hands of active investors, a move that is based on trust and confidence. They grow their wealth through the expertise of the “drivers.”
REITs are Real Estate Investment Trusts. These companies own income-producing real estate; investors essentially buy stock in these companies, thus, investments in REITs behave similarly to stocks. This is neither good nor bad; their attractiveness and value is determined in large part by an investor’s goals.
Our focus at Evergreen is PRIVATE REAL ESTATE, not REITs. Private real estate offers more control to the investor and is a longer-term investment with less volatile, more predictable returns.
Two broad categories of property are commercial and residential.
Commercial includes retail, office buildings, hotels, and medical centers to name a few. Residential encompasses living spaces for individuals or households.
Residential property can be further subdivided into single-family and multifamily.
At Evergreen, we focus on residential, investing in both single and multifamily properties.
There are an estimated 45 million rental properties in the United States. Of these, 16 million are single-rental units; 13 million are 2-9 unit rentals; 16 million are rentals with 10 or more units.
Being an owner of real estate affords benefits not found in traditional financial assets like stocks and bonds. The following are some of the primary benefits:
Below is a checklist of considerations in determining whether or not to pursue a real estate investment:
For the passive investor, the syndicator matters:
EXPERIENCE: Has the real estate investment company established a credible portfolio? How much experience do they have in the field? How have your interactions gone with the syndicator?
FUNDING: Is the syndicator raising the capital privately or are they crowdfunding? Crowdfunding involves an intermediary party whose job is to attract investors. Incentivized by transaction volume, the more deals they make, the more money they make. The marketing appeal and packaging of crowdfunding may lack the careful vetting and due diligence that are trademarks of private capital raising; crowdfunding rarely has the relationship between investor and sponsor that is a hallmark of private capital raising.
LENDING: What type of lending is being used? Different lenders will use different underwriting standards. [Underwriting is a process that a lender will use in verifying income, assets, debts, and property details in issuing approval for a loan.] The type of lending will reflect the level of risk of that loan. Here are three types of lending:
By knowing the type of lending being used, an investor can gauge the degree of risk in the investment.
The property:
BUSINESS PLAN: Does the business plan match with investment goals? Consider your investment goals, including but not limited to overall rate of return, annual cash distribution strategy, and length of investment.. Does the business plan for the investment match up to those goals?
MARKET and SUBMARKET: What is the market and submarket for that area? The location of the property matters. And not all markets and submarkets are created equally. This is not to say that challenging markets need to be ignored; however, the margin for error in challenging markets is small. Better markets and submarkets are more forgiving of the unexpected. Some considerations for the market include the following: population growth, job market (diversity of job sources or dominated by a single entity); job growth history; and landlord tenant laws. These are several areas where due diligence needs to be performed to assess the strength of the investment.
HOLDING PERIOD: What is the holding period? How long does the syndicator (or you, if taking an active investing role) plan to hold the property: a quick flip, a five-year hold, a ten-year hold? Knowing the plan will help you evaluate whether or not it matches investment goals.
ROI: What is the return on investment? Calculating the ROI will give a fair projection as to whether or not this investment aligns with your overall investment goals.
LEVERAGE: How much leverage is being used on the investment? Leverage, in simple terms, is using debt to finance a property. The amount of leverage used can be measured by LTV (loan to value ratio). LTV is calculated by the amount of the loan divided by the appraised value of the property, multiplied by 100. A $140,000 loan on a $200,000 property would have an LTV ratio of 70%. (A common range for LTVs when looking at multifamily properties in quality markets with experienced managers is 55-75%.) The amount of leverage, combined with the intended strategy, relate to the risk of the investment.
EXIT STRATEGY: What is the exit strategy? At the end of the intended hold period, what are the options? Common options include buy and hold, selling, refinancing, and 1031 exchanges? Does the syndicator have an idea, based on past history, of what would work best for that property at that time? What factors would cause the syndicator to change strategies?
This article serves as a starting point, a primer on real estate investing. Going back to the article’s original topic: Do you see yourself as an active investor or a passive investor? If active, the challenges are many, exciting, arduous at times, and often rewarding. We would love to talk with you if you need a sounding board as you embark on your real estate investing journey. If passive investing is more suited to your lifestyle and investment goals, we would love to partner with you. We encourage you to contact us for a visit or phone call.
If you are interested in learning more please contact our office at (724) 900-0009 or e-mail Mark Brooks at mark@evergreen-pgh.com.
