There are a lot of different ways to invest in real estate. The right way for you may not be the right way for me, and that’s ok. Success in REI does not look the same for everyone. It is important, however, that you understand why you are investing in a certain asset class, deal, etc. My favorite podcasters refer to this as your personal investment philosophy [1].
Since I am sharing a lot of my opinions in these articles, I want to share how I think about my Real Estate Investments.
- I am a long term investor. I would be happy if I never sold an asset, just got a steady, and steadily increasing, stream of income coming in with a high cash on cash return. While most syndications have a target duration of multiple years, I generally won’t look at ones that are less than a 5 year expected hold unless there are some other compelling factors. I have even found a deal that has a 25 year expected hold time, and am super excited by that. I understand that not everyone shares that perspective, but ideally, I would never sell a well performing property. If ultimately I need the money back, I would prefer a cash out refinance to a sale.
- I am an investor not an operator. There are ways to invest in real estate that require active management and continuous involvement – for example, managing short term rentals, operating a residential assisted living facility, or being a realtor or property manager. Those aren’t for me. I enjoy being an investor and managing my investments, and even talking with the boots-on-the-ground team, but I do not want to be directly involved in the day-to-day management of the asset. That is why I carefully select partners who enjoy that work.
- I invest for cash flow, not appreciation. Most deals have a value-add opportunity inherent in the syndication, which drives increases in profitability over time. For me, the resulting impact on the asset value is a nice additional source of income, but I focus on deals that are cash flow positive from the start. The profits should increase over time as the value-add strategy comes into play, but I don’t want there to be a long stabilization process before investor distributions start. This means that I avoid development deals and major value-add opportunities despite there being huge potential profits to be made there. I view my passive income as an eventual replacement for my paycheck and thus want consistent long term returns.
- Reducing taxes isn’t my primary objective. I certainly don’t want to pay more taxes than I need to, and work with a great accountant team to make sure that I don’t, but many of the REI strategies that are touted as reducing your taxes (for example, cost segregations and bonus depreciation) require you to be a real estate professional in order to really benefit, which I am not (and won’t ever be as long as I have a day job). While these strategies do reduce the taxes I pay on my passive gains, they don’t affect my active income, which is a bigger contributor to my taxes. So I look very closely at any deal where reduced taxes are called out as a primary benefit. There definitely are some interesting opportunities to explore, but since most real estate deals already have favorable tax treatment, I don’t let taxes drive the investment decision for me.
- I prefer assets outside of residential rental real estate. Residential rental real estate, and in particular multi-family apartments and short-term rentals, have been a hot area for the past several years. I am not interested in that space and have been avoiding syndications that focus on it. While there are definitely many reasons to consider it, and I know several very successful syndicators in that area, I am concerned about the increasing role that governments are playing in this space and the rate at which the rules are changing. With new eviction restrictions (including the moratorium), rent controls, and other laws (for example, barring or limiting short term rentals) being regularly proposed and passed, I am looking for something a little less politically charged. Instead of trying to “fight city hall”, I prefer to invest in asset classes where there is less interest from politicians. An interesting exception to this general rule is the area of mobile home parks. In this asset class, you typically rent the land to people who own their own home. I really like that asset class because you are renting the lot to owners of the home, and thus avoid many of the problems with residential rentals.
- I realize that real estate is a cyclical market. I don’t try to time the market, but knowing that asset classes rise and fall over time means that I am comfortable looking outside of what is currently hot into asset classes that might not be in favor at the moment. One of the benefits of this approach is that I can buy properties in an out-of-favor asset class at a discount. This contrarian philosophy is one of the reasons I am looking to grow my investments in retail strip malls right now [2]( disclosure, I am invested with Aspen). Strip malls are grouped in with other retail real estate (such as large shopping malls) that are going through rough times and thus sell at a discount that allows them to cash flow from day 1. It also contributes to my lack of interest in multi-family since that asset class has been extremely hot for the past few years and currently has extremely low cap rates. That said, I do prefer asset classes where the peaks and valleys of the cycles are gentle as I want to be able to hold the asset through good times and bad, and that does require consistent cash flow.
- I like to diversify across asset classes. There are two conflicting philosophies about diversification. One is to specialize into a niche and become the expert on that area. The other is to diversify and spread out your risk. I fall into the diversification camp, in part because I find many of the asset classes interesting and believe they bring different market dynamics and risk profiles to my overall portfolio. Beyond SFRs that I own, I am invested in storage units, mobile home parks, agriculture, notes, strip malls, and even a car wash. I don’t want to exclude a great opportunity simply because I can’t become an expert on the asset class. Instead, I chose partners that are experts in the specific niche to mitigate the risk. I feel that since I can’t predict when an asset class will move to the next phase in its cycle, I reduce my risk of my cash flowing falling dramatically at an inopportune time by investing more broadly. I don’t get to benefit from the great peaks but my cash flow remains solid through the valleys as well.
So that sums up my philosophy on REI. Where do you fall?
If you have any questions about this post, please email them to me at terence@mbc-rei.com, I will reply to the questions that are straightforward and will turn the questions requiring more detailed answers into future blog posts.
For additional reading:
[1] https://realestateguysradio.com/resources/developing-your-personal-investment-philosophy/