The real estate asset class is expanding. Make the right choices for your capital.
Over the years, our real estate company has found there are three major, universal decisions every investor must face (and make) before pulling the trigger on an investment: picking a property type, choosing a strategy, and selecting a market. Navigating that process has always been crucial to getting good returns, but it is constantly becoming more complicated as our asset class and our sector expand in scope and definition.
Here is how we deal with these deal-making and -breaking decisions:
1. Update your property types and asset class vocabulary
As most investors know, real estate is considered an asset class, much like stocks, bonds, and cash. Similar to stocks that have companies in various industries, real estate as an asset class is comprised of several different property types. So, when it comes to property types, real estate investors have many options.
On a high level, real estate is oftentimes separated simply into residential and commercial with multifamily being considered residential to some investors and commercial to others.
You likely think of real estate in the following three categories (single-family, multifamily, and commercial) but it’s important to break commercial property down a little further for our purposes.
Conventional industry definitions break the commercial definition down into:
Specialty, which can include properties such as hotels, self-storage facilities, mobile homes, farmland, etc.
Over our 20-year real estate career, we have found most investors select a specific property type for personal reasons. Investors are compelled to choose a property niche by both the financial rewards of that property type and by their own perceived ability to understand or relate to that specific property type. Put another way: Investors choose property types that they know (or can learn about) and that they believe can have an appealing monetary return. The key is making that assessment correctly.
Like most things in life, property type is a personal choice.
2. Identify the right strategy for your property choice
After determining which property type to pursue, choose the right real estate strategy for that asset class.
In general, real estate investors choose whether to own or lend and whether to be active or passive. These choices usually lead to one of the four following strategies.
• Buying and Holding
• Loaning via Notes
Deciding which strategy is best is similar to determining which property types to choose. What makes sense for one investor might not work for another.
Unlike property selection, strategy decisions usually come down to time horizon, investor temperament, and personal and professional risk tolerance.
For example, some people are more short-term oriented and prefer flipping houses to holding them long-term. Others are planning for decades ahead and choose to buy and hold. Some investors want to be active with their real estate while others are more passive. We have found that investors can be successful by implementing any real estate strategy. The key is to thoughtfully choose the strategy that matches needs and desires.
Even more than property type, strategy is a personal selection for each investor based on their unique circumstances.
3. Drill down into the right location
Strategy and property-type selection are a chicken-and-egg scenario. Do investors chose their strategy and then select their property type or do they find a property type and then determine their strategy? At the end of the day, it is very difficult to say which selection is made first. It is truly subjective.
Location, however, will nearly always be the third decision investors make once they have selected their strategy and property type.
The question all investors ask themselves once they have answered the first two questions about strategy and property niche is, “Where to invest?”
The real question, however, should look more like this: Can you implement your property type and real estate strategy in your area or do you have to go outside your local market?
The key to answering the market location question is to get enough information about an area to understand the following three keys of the successful investor model.
Successful investors know their numbers. They understand what good investments look like.
The best way to know values is to evaluate comparable investments (comps) and to analyze each investment’s cash flow. By looking at similar investments, investors can discern what makes a good investment and what investments to avoid.
Investor Takeaway: If you know values, it is infinitely easier to determine whether an investment makes sense or not.
Once investors are fluent in investment values, their next step is to look for opportunities. Knowing values allows investors to quickly decide whether an opportunity is worth pursuing. The key to finding opportunities is to be good at sourcing. Sourcing is a fancy term that means finding as many opportunities as possible. It is important to have as many sources as possible to compare opportunities.
Investor Takeaway: By reviewing multiple investment opportunities, investors can make better decisions.
The final key to investment success is to make deals. Knowing values allows investors to find opportunities. But, investors must make deals to actually take advantage of the investment options they find. Making deals is all about evaluating, negotiating, and orchestrating a closing. The best opportunities are only good if an investor can make an investment.
If investors know their values, then it is easy to determine whether there are opportunities to implement their real estate strategy in their local market or if they will have to go to another location to make deals. Essentially, selecting a market is all about knowing values, finding opportunities, and making deals.
Investor Takeaway: Once your strategy and property type are determined, finding a market is simple.
Douglas Skipworth, CPA, CFA is the Co-Founder and Principal Broker at CrestCore Realty in Memphis, TN. CrestCore manages over 2,500 units for approximately 500 individual investor clients, of which Douglas and his business partner Dan Butler are the largest. Connect with Douglas at email@example.com.