When people think about real estate investing, what they typically think about is active investing. In active investing you do the work to make the investment succeed. And if you don’t do the work, your investment will likely not be successful. This is what a sponsor does, but you don’t have to be leading a syndication to be an active real estate investor.
If you talk to someone about real estate investing and their immediate reaction is “I don’t want to deal with tenants and toilets” or “I don’t have time for that”, chances are they are thinking about actively investing in real estate. At least, some of the downsides of it.
More concretely, for most people, they think about real estate investing as actively managing a single family rental (SFR), where they interact with the tenant directly or possibly through a property manager they have to supervise. This can be through a completely separate property, a separate unit on the property you live in, or through having roommates, but the work is effectively the same. You are the one in charge of the day-to-day decisions and if you don’t do it, it doesn’t get done.
Owning and renting a SFR is a common way to start out your real estate investing career as it is something that most of us have some relevant experience with. Most people have rented an apartment at some point in their life, if only for a short period of time. And, if you are thinking about real estate investing, you usually already own your own home or are on your way to buying a place. Single family properties are affordable, with low, fixed rate debt available and prices significantly lower than apartment complexes or commercial real estate. It is how I got started – with an up and down duplex where the tenant in the basement paid almost all of our mortgage – and I still actively invest in a couple of SFRs. While some people start out bigger – with a four-plex, or directly into larger multifamily or commercial –this is a tried and true path to enter the world of REI.
Actively investing in real estate has a lot of advantages:
- You have complete control over the investment. If you want to take a little longer between tenants to fix up the unit, you can. You get to decide who rents the unit (as long as you follow the laws and don’t discriminate). You decide the rental rate and how long the lease is. And, if you want to change to a different model, for example trying out vacation rentals, or sell the property, you can.
- You get all the profit and tax benefits of owning the rental. You get to write off your expenses and depreciate the property. The cash flow goes directly into your pocket every month, no need to wait for someone to send you a check.
- You have the opportunity to learn as you go. In general, you can make small mistakes that let you learn how to be a better landlord at a scale that allows you to absorb mistakes without catastrophic impact on your finances. For example, having no renters and having to cover a mortgage payment on a $250k mortgage on a house is very different than having to cover a mortgage payment on a $10M hotel.
- You are investing in an asset class outside of the typical stock and bond portfolio, which provides diversification and reduces the volatility of your overall portfolio. If you focus your investment on generating cash flow, it doesn’t matter whether the price of the property goes up or down since your income isn’t tied to the value of the asset.
However, these advantages have corresponding downsides:
- You can only scale so far while retaining all of the control before you run out of time and money. Moving from being in control of everything and making all of the decisions to having a scalable business is a huge change, and one that many investors don’t make. Not making the switch to a scalable business means that instead of gaining time freedom from your investments, you are effectively creating another job for yourself.
- If things do not go to plan, you are the one who has to come up with additional funds to keep the property afloat and the deal going. Whether it is a new water heater, a foundation repair, or just floating the holding costs while looking for a new tenant, the money has to come from you. If you can’t make the payments, you can lose all or part of your investment.
- You generally don’t have as experienced a team and have to learn things yourself. While being a life-long learner is a great thing, you can accelerate your learning curve by working with great people who have more experience than you do. Without the team to learn from, you are often making mistakes that a more experienced investor would have avoided, setting back your progress.
- Real estate is an illiquid asset, so it takes time to sell and get all of your money out of a property. It can take anywhere from 30 to 120 days (or more) to close. In many cases, this is can be an advantage, since it prevents you from making bad decisions in the heat of the moment. However, it also generally means that the transaction costs for buying and selling are much higher than they are for more liquid assets where the transactions have been optimized.
For those with a strong desire to learn and build a generational source of wealth, actively investing in real estate is a fantastic option. Ultimately, with enough effort and education, you can scale your investments to generate whatever cash flow, and ultimately wealth, you desire. But you need to be someone who really enjoys the work or you won’t be able to handle the ups and downs.
Scaling takes one of two forms. The first is to keep your deals the same size and increase the number of properties you have. In this case, you go from owning 1 “door” (ie SFR) to 5 to 10 to 100 or more. This is the more straightforward path. You look at how much each property cash flows and the amount of cash flow you need to determine how many properties you need to own to meet your goal. Then you buy properties until you hit that number. At some point, you will need to change how you are doing things as what works for 1 rental doesn’t work for 100. For example, you will likely need to change how you get financing since most traditional lenders won’t let you have more than 10 loans. You also need to put systems in place to avoid being overwhelmed with day-to-day tasks since having to manage maintenance on 100 units takes a lot more coordination than on 1. However, you also get economies of scale, with your contractors often being able to provide discounted rates for ongoing work.
The second way to scale is to keep the number of properties relatively small, but increase the size and cash flow from each property. This requires moving into different asset classes, for example multi-family apartments, retail shopping centers, industrial warehouses, or agriculture. Moving into a different asset class can be challenging given the differences in the tenants, applicable laws, liabilities, financing, and taxes. However, if you find the right team, you can often leverage economies of scale and have higher rates of return on these properties. For example, having on-site maintenance on a 200 unit apartment complex can be more affordable than having subcontractors maintaining 100 units spread across the state. This can also lead you into partnerships or syndications, which is a great way to build up your team and get access to people with complementary skills and expertise.
Which path is right for you and how much you need to scale depends entirely on your personal philosophy and goals. If you find all you need is income from 7 paid off properties in your market, your path would be very different than someone who needs 100 doors to meet their goals.
If you go down path of active investing, I encourage you to build up a strong professional network and a peer group that will support you and help you through the tough times. Find some events that interest you and attend them – there are a lot to chose from, including local gatherings hosted by a local REIA chapter [1] and general events like Limitless [2] where you can be exposed to a broad range of people and topics. For those interested in becoming syndication sponsors, I recommend attending more focused events [3] to find like-minded people and accelerate your education since the experience required is a little different. In general, I have found the community to be welcoming and supportive of new investors. The abundance mindset is plentiful in this space and people are willing to help you however they can.
But being successful as an active investor is not easy. Don’t underestimate the amount of time and energy that it will take to become successful. Real estate is not a way to get rich quick, but rather a steady path to wealth. Don’t expect things to always go your way. You will encounter setbacks along the way so it is important to move forward at a rate that will allow you to absorb the lessons of these mistakes so you don’t repeat them.
I encourage people who are highly motivated to actively invest in real estate to go for it.
For everyone else, it is important to realize that there is the opportunity to passively invest in real estate as well. This gives you the primary advantages of active real estate investing – the cash flow, tax benefits, and portfolio diversity – without having to spend the time actively managing your properties.
If you have any questions about this post, please email them to me at blog@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.
[2] https://limitlessexpo.com/
[3] https://realestateguysradio.com/events/how-to-raise-money-for-real-estate-investing/
This article is my opinion only, it is not legal, tax, or financial advice. Always do your own research and due diligence. Always consult your lawyer for legal advice, CPA for tax advice, and financial advisor for financial advice.