Real Estate Investment Strategies
How to find the right one for you
If you have been bitten by the real estate investing bug and are thinking of getting your feet wet, you will need an investment strategy. Will your strategy involve buying foreclosed homes, purchasing commercial properties or just land? The answer is not always as easy as weighing one option over the other, since you have to consider a variety of factors such as your personal situation, potential tax consequences, available cash and financing options, current real estate market trends, etc.
There are several real estate investing strategies that may work for you and what you want to achieve. Three of the most frequently used real estate investment strategies include:
- Bargain purchase
- Increase value
- Double-digit cap rate
Bargain purchasing simply refers to buying real estate that is at least 20 percent below the current market value. Buying foreclosed homes is a common form of bargain purchasing. With the increase-value strategy, the investor generally focuses on purchasing real estate at the current market value, but selectively chooses properties that have unrealized potential. For example, you find a home for sale on the real estate market, or possibly a foreclosed home that you determine fits your buying criteria. You purchase the property, perform the necessary remodels or renovations that will increase the property’s value, and eventually sell when the real estate market is strong. Investors tend to favor this strategy if they know they can increase the value of their real estate by at least 20 percent within a six-month period.
The primary difference between bargain purchasing and the increase-value strategy is the holding period. Bargain purchasing often has you flipping properties as quickly as possible in order to make a profit while the other will see you holding the property for a longer period of time in order to realize the maximum gain.
A real estate investor using the double-digit cap rate strategy would likely buy a property that has a capitalization rate of 10 percent or more. The capitalization rate is the net operating income (rent minus operating expenses but before debt service) divided by the purchase price. In layman’s terms, it is the cash-on-cash rate of return a buyer would get if they owned the property free and clear. It should be noted that it is often difficult to find properties that have double-digit capitalization rates. Typically, these types of rates are found temporarily in depressed markets or in small market niches.
The real estate investing strategy you choose will depend on several considerations. The first is deciding how much time you have available to devote to your real estate investments. A strategy that entails flipping or rehabbing can become extremely time-consuming if you intend to carry out much of the work yourself. If you decide to do this full-time, it may be a non-issue. However, if you have a full-time job and your free time is limited, you may not want to select a strategy that is so time-intensive.
Another consideration is how much cash you have available or your ability to access financing. Buying foreclosures can require large cash reserves while buying judgments secured by real estate or purchasing at builder auctions, require little or no cash.
People skills are also an important consideration in real estate investing. Do you like dealing with people, if so, to what extent? A strategy that has you holding property longer-term may mean that you will be a landlord. If you are thinking about a real estate investment strategy that involves pre-foreclosures, would you be comfortable approaching and talking to people experiencing financial difficulty? Less direct contact with people might have you leaning toward the idea of buying foreclosures since the only people contact you would likely have is with the representative of a bank or the sheriff running a public auction.
While the current condition of the real estate market may be a consideration in your real estate investment decisions, it will not dictate your strategy. If you follow a proven, time-tested investment strategy, you will find that regardless of the trends in the real estate market, you will generally invest following the same strategy. Sure, you may have to tweak it a bit, i.e. pay a little more in a hot market or scale back your offer in a cooler market, but your strategy will remain the same. Stick with a solid strategy and you should be able to continue purchasing low enough to remain profitable while still adjusting for real estate market trends.