Homeownership is dwindling, and renters are on the rise. In fact, new rental households have grown by 770,000 a year since 2004. This means it is a prime time to build an extensive real estate rental portfolio.
Homeownership is dwindling, and renters are on the rise. In fact, new rental households have grown by 770,000 a year since 2004.1 This means it is a prime time to build an extensive real estate rental portfolio. While most people can figure out how to acquire one or two rental properties, few know how to build a portfolio of 25 properties or more. If you utilize the right strategies, you can grow your portfolio by leaps and bounds. You will then make the money you need to enjoy your retirement.
Successful real estate investor Grant Cardone recommends sticking with multi-family real estate if you want to build a vast portfolio.2 Cardone owns over 4,000 apartments, and they have made him a wealthy man. He states that a simple internet search allows him to find 49-property units that are priced at $35,000 per unit. These units come with an 8 percent cap. That means he can buy the entire 49-unit property for $1,750,000 and net a nice profit each year. If he were to make a cash deal for that rental property, he would earn $140,000 each year after paying for his expenses.
You probably don’t have that much cash on your hand, but you would need to put some money down. Let’s say that you have $450,000 to put down. Maybe you have a retirement account to pull from or you are using a self-directed IRA for your investments. You also might pull from your home’s equity or use one of the other countless financing options available.
You put the $450,000 down and finance $1,300,000. That means you would earn $62,000 a year after expenses.
You cannot possibly get this type of return with a house and you also can’t possibly acquire so many rental properties so quickly unless you go with this type of a strategy.
Of course, jumping into the multi-family rental property game full force might be a little bit intimidating. You want to acquire over 25 properties, but you might not want close to 50 immediately. Cardone recommenders starting with 16 units to get your feet wet. These units should be multi-units that are all at the same address. Then, continue to add to your portfolio with additional multi-unit properties, and you will be up over 25 properties in no time at all. at the same time, you will maximize your profits while minimizing your risk. That is what is so great about multi-unit properties.
Warren Buffett is known as one of the most successful investors of all time, and a lot of his success comes down to the snowball method. This method is almost embarrassingly simple. More embarrassingly, though, people tend to ignore it and don’t use it. If more people used this simple method, more people would have large investment portfolios. That means more people would be raking in the money.
In order to understand this method, you must first understand how you make a snowball. You take a little bit of snow and roll it into a ball. It is very small at first, but you continue to roll it and it gets bigger and bigger. If you were to continue to roll that ball of snow, it would soon be large enough to make a snowman. In fact, you could roll it up into a ball that is larger than your entire house if you had the means to do so.
The same is true with investing. If you roll your investments into each other, they will grow. This is called the snowball method.3
In order to understand this process, look at an example.
You have purchased your first rental property, and you are extremely excited. It is a small property that nets you $500 each month. That means you will make $6,000 each year from that property after you pay your expenses. It might not be a lot, but it is a start.
Now, let’s say that you’re interested in buying a new property that requires a $25,000 down payment. You are making $6,000 a year from your current property, so it will take you just over four years to save the money you need for that property.
The four years pass, and you finally have the money for a down payment on your next property. You put the money down, and you net $500 a month from this property. Now, instead of making $500 a month from a single property, you are making $1,000 combined from two properties. That means you are earning $12,000 a year from your rental properties.
Now, instead of needing over four years to come up with the $25,000 down payment for a new rental property, you can come up with the money in 25 months. When the 25-month mark hits, you buy a third rental property. Now, you make $3,000 a month.
As you can see, as long as you save the money you earn from the rental property, you can cut down on the time that you need to wait between acquisitions. Soon, you will be able to buy a new property every few months. This is a great way to fast track the process and acquire more than 25 rental properties.
If you are not sure if you can go without touching the income, look at getting a self-directed IRA so you have to put the money back in the account. Then, it will be easy for you to direct the IRA to purchase a new rental property when it is time.
Coming up with the capital necessary for owning 25 or more units can be a daunting task. Banks are tight-fisted with money, especially for people who already have multiple mortgages with them. You can have perfect credit, but the banks will stop loaning you money after you have several mortgages. That makes it almost impossible for the single person to build up a nice portfolio.
Fortunately, there is a way around this problem. You can form a partnership to acquire real estate. Then, after you become successful, you can branch out and start doing your own thing.
During the partnership, you and your partner can pool resources to buy properties. Then, you can sell the properties for a profit, dissolve the partnership, and start investing on your own. This might take several years or even a decade to accomplish, but you will be making money that entire time. As long as you have money going into the bank, you aren’t wasting your time. You’re just building your assets and getting to the point of taking control of your investment portfolio.
You have to be very careful about how you do this, though. Some people get burned because they don’t know how to properly form a partnership.4
Many enter into general partnerships, which are basically handshake deals. The partnership is established without paperwork. It’s an automatic partnership that forms when the two people start doing business together. While you can formalize it with a document, it doesn’t have all of the protections you will get with some other partnerships. You could end up losing your personal and business assets based on the actions of your partner. You will not have the protection you need while doing business. If someone wants to enter a general partnership with you, walk away. You need to have a legal document in place that will protect your assets. Otherwise, you could lose everything even if you go into business with someone that you trust.
A corporation is a different story. If you incorporate, you will have some protection if anything goes wrong. The corporation will be separate your income from your personal finances. It will be like a fictitious person that holds onto all of the assets.
When you incorporate, you limit your liability if anything goes wrong. That means if something happens and your corporation gets sued, the person doing the suing can go after the corporation’s assets but not your own. You can only lose what you have invested and nothing more.
There is one issue with forming a corporation, though. Let’s say that one of your shareholders gets sued for something that doesn’t have anything to do with the corporation. It could be a different business dealing entirely. The creditor could still take the shareholder’s shares. These are considered the shareholder’s personal property, so they are up for grabs even during an unrelated lawsuit. That could hurt your corporation a great deal. In fact, you could end up going bankrupt and losing your business if this happens.
That is why many real estate partners choose to form an LLC. This is a less formal type of partnership, but it offers a great deal of protection. Your liability will be limited, and you will be protected from creditors. That means if a judgment is issued against one of your partners, the creditor can’t seize anything from the business. The creditor can take your partner’s personal assets, but he or she cannot touch your personal or business assets.
This also has a less complicated tax model than the corporation does. You will file your taxes as a partnership, and the partners will receive K-1s. Your business income will pass through to your own personal taxes, so while you will file the business taxes, you won’t pay taxes as a business. You can also deduct real estate losses with the LLC, which you can’t do when you file as a corporation. That can save you quite a bit of money.
The C-B-A Strategy is an excellent option if you want to grow your investment portfolio quickly.5
First, it is important to understand that investors often use the letters C, B, and A when describing rental properties.
A Class C property is a property that is old and needs renovations. This property might be in a bad neighborhood, but that isn’t always the case. Sometimes, it is in a good or decent neighborhood but just needs a facelift. However, the facelift it requires is typically pretty major. You will have to go beyond putting in new floors with this type of property. It typically lacks many of the amenities that renters want.
Class B properties are well maintained, but they aren’t top-notch. They have the basic amenities, but the amenities might not be the newest and greatest. These are still nice properties, though, and they will make lots of renters happy.
The top-notch properties are the Class A properties. They are new with the best amenities, and they are in the nice neighborhoods. As a landlord, there isn’t really anything you will need to do with these properties. You can purchase them and put them directly on the market.
You might want to acquire all Class A properties to rent, but that is a rookie mistake. You aren’t going to make as much money or be able to acquire as many properties if you go with Class A properties. It’s not that you shouldn’t buy any of them, but if that is all that you have, your profit margins will be tiny and you will have a hard time building your portfolio up to 25 or more properties.
You also need to be careful with building your portfolio with Class B properties. This is the sweet spot for most real estate investors, so it is the place with the most competition. That hurts your profit margins and makes it harder to acquire as many properties. You will end up paying top price to outbid other investors, and that will crush your bottom line.
Instead, you need to spend much of your time going after Class C properties. The competition is really low for these properties, so you can get them at a real steal. Then, you can upgrade the property to a B property and make a lot of money on the rental.
You do need to do your research before jumping into a Class C property. The cap rates can be much higher with these properties, but only if you know exactly what you’re getting yourself into with each purchase.
Begin by looking at the upgrades that you will need to do. Think about everything that will go into upgrading this to a Class B property. If you don’t know much about upgrading a property, you need to work with someone who does. Have the person go with you to look at the property ahead of time. He or she can give you a quote on what it will take to get the property up to Class B standards.
Once you calculate all of the expenses, make your offer. Make your offer lower than the asking price based on the amount of upgrades that you need to do. You can often buy properties at 25 to 50 percent off the MLS price based on the needed repairs. Since these properties don’t have a great deal of interest, low bids are often selected.
After you purchase the property, you need to begin the repair process. Do all of the necessary upgrades to turn it into a Class B property. This might include adding amenities such as a washing machine, a dryer, and stainless steel appliances. Don’t be surprised if you also need to upgrade the flooring and other items as well. People expect quite a bit out of a Class B property, so don’t hold back.
If you follow this strategy, you will be able to acquire a lot of properties at a low price. After you do your upgrades, you can get the same rental price you would get for a Class B property, meaning that the return on your investment will be high. Then, you can use that money to buy even more properties. It won’t be long before you have more than 25 properties in your rental portfolio.
Babe Ruth is arguably the best baseball player of all time. He hit 714 home runs and had an all-time batting average of .342. While those numbers are impressive, that means that he failed more than 6 out of every 10 times he came up to bat.
That’s a lot of failure for someone who is regarded as the greatest of all time.
The point is that even the greats fail, and sometimes, those failures come in bulk. You will hit some home runs with your rental properties, but you will also swing and miss a few times. At times, you might find great tenants that pay their rent on-time every month and at other times you might let a tenant slip through the tenant background check cracks. If you hold onto your poor performing properties, it will hurt your rental income and make it difficult for you to acquire more.
The key is to know when to hold onto a problem property and when to unload it. There are some things you should consider when determining what to do with your property.6
First, you need to look at the whole financial picture of the property. Write down how much you earn from the property when it is rented out. Then, write down how much you lose when it isn’t rented and come up with the number you have made or lost since you’ve owned the property. When you take emotion out of the equation and look at the raw numbers, you will get a much better idea of how the property is truly performing. After doing this, some people are surprised by how much they are losing, while others are pleasantly surprised to see that they are making more than they realized.
You also need to consider the real estate market for the property’s location. This will help you determine if the property will gain or lose value in the coming years. It is harder to part with a property that is going to grow in value. You might want to hang onto it until the market shifts and then sell it when you can make more. However, if the market isn’t solid where the property is located and it looks like it is going to get worse, the time to unload it might be now. If you don’t rid of it soon, you will end up hemorrhaging money.
It’s important to understand that you cannot grow an investment property portfolio if you are holding onto dead weight. Get out from under the property and move forward with properties that will perform better.
While many real estate investors choose to go it alone, there is actually a benefit to going with a real estate agent and a wholesale brokerage firm. If you try to handle all of the deals on your own, you will be overwhelmed. It will be difficult to build your portfolio because you will have so many deals to sift through. You can increase the number of deals analyzed by going with a company. This will help you close more deals.7
You need to be smart about this. Don’t go with one basic agent and broker. Instead, you need to find agents and brokers that specialize in each of your markets. That means you will likely need to get more than one.
As with any investment, putting all of your eggs into a single basket comes with a risk. Real estate markets fluctuate, and if you have all of your investments in one type of real estate or one market, you will get hit hard when the market drops. However, if you diversify your investments, your high-performing investments will cover you when the market drops for some of your other investments. This will allow you to grow your investment portfolio much faster. When you have properties from various segments making money, you can take that money and buy more properties quickly.
First, you need to analyze the different risk categories. 8
Location is the first category. Let’s say that you live in Missouri, and the St. Louis real estate market is hot. You can buy apartment buildings in the inner city, improve them, and rent them out. You are making a ton of money, but what happens if that market goes bust? If all of your property is in downtown St. Louis, you are going to be in real trouble. Avoid this problem by branching out. You can buy some property in St. Louis and some across the river in Illinois. You can also buy some property in the suburbs of St. Louis. Don’t just move over a street or two. Diversify your portfolio’s geography so you will reap the most rewards.
Asset class is next on the list. This refers to the type of property that you purchase. Property types are varied. You can get retail, industrial, senior housing, multifamily, single family, and other types of real estate. The real estate market doesn’t always move as a whole, which is why it is so important that you diversify by asset class. Sometimes, the entire market goes up or down, but other times, a single asset class is impacted by a change. For instance, retail real estate might go strong while single-family homes take a nose dive. While many investors put all of their money into a single asset class, it is wise to invest across asset classes so you can continue to make a strong income year after year. Then, you can ride out the various cycles that the asset classes go through. Your portfolio will remain strong and healthy so you can take on new investments.
The risk profile is also a risk category. There are four risk categories ranking from low risk to high risk.9 You want to diversify across these risk profiles when building your portfolio.
Core assets are low-risk and your safest bet. These are typically your Class A properties. It is easy to fill the properties with renters, and those renters usually have high credit scores so they are likely to make their payments on time. In addition, they are less likely to bail out on the property. However, because these properties are already in perfect condition, you cannot add any additional value to them, so your return is low. They do have a major benefit, though. They rarely lose tenants during an economic downturn. The rest of your properties might be empty, but your core assets should stay full. That makes them worth purchasing, even though you might receive meager single digit returns each year. Still, those returns will help you make mortgage payments, which is critical if you’re going to have a portfolio of 25 or more properties. Consider adding a few core assets to your portfolio so you can enjoy the security they provide.
Core-plus is the next step on the risk assessment ladder. These are very similar to Class A properties, but they have something that creates an additional risk. Think of these as A- or B+ properties. The risk might be due to the property’s location or the age of the property. Unlike a Class A property, you can add an additional value to this property, but the value is small. That makes your returns higher than you will get with a core asset, but the returns still aren’t as high as you will get with a riskier investment. You can expect to get a 10 to 14 percent return from these properties.
That brings you to value-added rental properties. You can increase the value of this type of property by fixing a problem. For instance, these properties are often in need of a renovation. You can usually pick a value-added property up for below the market value, fix the problems, and rent it for more. Because you can add so much value to one of these properties, you can expect to make a return of around 19 percent a year. However, since these properties are often in bad areas, you might have some trouble with your tenants. It is critical that you screen your tenants so you aren’t left holding the bag if they leave. VerticalRent offers a tenant screening service that will prove very valuable with these types of investments.
Finally, there are opportunistic rental properties. These properties can reap quite the reward, but they come with some serious risk. If all goes well, you can expect to earn a return of over 20 percent a year, but you have to overcome some serious issues. You might have to deal with structural issues in a home or a serious vacancy problem with a commercial property. You need to know how to deal with these properties in order to get a return on investment.
You need to diversify your risk profile, but that does not mean that you need to pick up opportunistic rental properties. If you have the level of expertise required, you can dip your toes in the water. If not, stick with core, core-plus, and value-added properties. This will let you attract different renters in different markets, providing you with some security as the market changes, along with a nice reward when everything goes well.
When you first begin your career as a real estate investor, you need to buy local. Stick with property around your own home so you won’t have to register an LLC in different states and get to know property managers both far and wide. You also won’t be stuck filling taxes in multiple states, which can be a real headache.10
Start small by entering into a few local markets. However, when you branch out to 25 or more rentals, you can make it your full-time job. At that point, don’t be afraid to enter into markets in different states. This can help you take advantage of attractive markets that are located elsewhere.
In fact, this is becoming a growing trend.11 Landlords note that the risks are the same when they own property in other states. They still might deal with vacancies or market collapses, but they can use property management services to take care of everything. Property management fees usually run around 7 to 10 percent for the management and are typically around 3 percent for acquisition.
If you decide to do this, start by choosing your market. Look at the state laws, since some states have tenant-friendly laws and some favor the landlords.12 If you choose a state with tenant-friendly laws, you could end up paying the price. You might have a hard time evicting a non-paying tenant in such a state, so be careful.
You also need to analyze the market’s trends. This is especially true in regard to the population. A growing population speaks of good things to come. However, if the population is decreasing, you can expect jobs and businesses to leave as well. That can hurt your chances of getting and keeping renters.
The price-to-rent ratios are also important to consider. Keep in mind that what a home rents for in your state might not be the same in another state.
The Jackson, Mississippi market is a great example of this. A 3 bedroom 2 bath home might net you over $2,000 where you live, but if you want to make money in the Jackson, Mississippi market, you will need to cap your rent around $750. Otherwise, you will have a hard time keeping renters in the property. However, the property is really cheap, so you will still have a nice price-to-rent ratio. Do your due diligence before you buy a property so you know what the ratio will be in the area.
After you choose your market, you have to find property. If you want to limit your risk and your workload, you can go with a turnkey property that already has tenants in it. However, this will be more expensive to purchase and have a lower rate of return.
If you are interested in boosting your return, look for some Class B or C properties in other states. You will pay less to acquire the property and get a higher rate of turn. However, you will have to find a trusted company to go in and take care of the property for you so you can get it on the rental market.
You are ready to start building your portfolio, but before you begin, it’s important to understand that you can lower your risk with the help of VerticalRent. With tenant screening that includes credit reports and background checks, you can fill your rental properties with responsible renters. This will cut down on evictions and ensure that you receive your monthly rental checks. As those properties fill up, this will become more and more important, so check out VerticalRent today.
1Dionne Searcey. “More Americans Are Renting, and Paying More, as Homeownership Falls,” NYTimes.com, June 24, 2015, https://www.nytimes.com/2015/06/24/business/economy/more-americans-are-renting-and-paying-more-as-homeownership-falls.html?_r=0.
2Grant Cardone. “An Investor Who Owns 4,000 Apartments Explains Why Multi-Family Real Estate is the Best Investment He’s Made,” BusinessInsider.com, August 16, 2016, http://www.businessinsider.com/an-investor-who-owns-4000-apartments-explains-why-multi-family-real-estate-is-the-best-investment-hes-made-2016-7.
3Majdal Sobeh. “The Snowball Method in Real Estate Investing,” Mashvisor.com, October 19, 2016, https://www.mashvisor.com/blog/snowball-method-real-estate-investing/.
4Attorney William Bronchick. “Beyond the Handshake-How to Invest in Real Estate with a Partner,” TheLPA.com, https://www.thelpa.com/lpa/what/bronchick-investing_partners.html.
5Jimmy Moncrief. “2 Easy Steps for Growing Your Real Estate Portfolio,” Landlordology.com, Last updated on December 9, 2016, https://www.landlordology.com/income-generating-strategies/.
6Ilyce Glink and Samuel J. Tamkin. “How to Determine Whether to Sell Money-Losing Rental Property,” WashingtonPost.com, https://www.washingtonpost.com/news/where-we-live/wp/2017/03/20/how-to-determine-whether-to-sell-money-losing-rental-property/?utm_term=.2e24dc3e6562.
7“How to Build a Real Estate Porfolio,” FoxBusiness.com, May 10, 2012, http://www.foxbusiness.com/markets/2012/05/10/how-to-build-real-estate-portfolio.html.
8Ian Formigle, “How to Build a Diversified Real Estate Portfolio,” LinkedIn.com, May 16, 2016, https://www.linkedin.com/pulse/how-build-diversified-real-estate-portfolio-ian-formigle.
9Ian Formigle. “Real Estate Investment Strategy: Four Categories of Risk and Reward,” Crowdstreet.com, April 20, 2016, https://www.crowdstreet.com/education/article/real-estate-investment-strategy-risk-reward/.
10Mark J. Kohler. “Buy a Rental Property Before Year-End: Why and How,” Entrepreneaur.com, October 4, 2016, https://www.entrepreneur.com/article/283025.
11“Absentee Landlords Investing in Cheap Rentals Out-of-State,” Newsweek.com, October 9, 2016, http://www.newsweek.com/absentee-landlords-investing-cheap-rentals-out-state-507449.
12Ali Boone. “Out-of-State Real Estate Investing 101,” BiggerPockets.com, https://www.biggerpockets.com/renewsblog/2012/12/22/out-of-state-real-estate-investing/.