Real estate is a solid asset with which investors can build wealth. In a way, many Americans are already invested in real estate: almost two-thirds of Americans own their home, according to statistics from the U.S. Census Bureau.
And over the last several decades, investing in real estate beyond their front door has become increasingly popular among Americans.
It’s not hard to understand why: since 1963, the average sale price of houses sold in the United States has risen from $19,300 to $542,900 (as of the third quarter of 2022), according to research from the Federal Reserve Bank of St. Louis.
Even discounting the historic rise in real estate prices during the pandemic, prices have risen dramatically: in the first quarter of 2019, the average price was $375,500. Real estate is one of the most promising asset classes.
The investor who wants to know how to build a real estate portfolio should settle on goals and develop a strategy to achieve them, and a time horizon in which to do so. They’ll need to get acquainted with real estate analytics. They should know the financing options. And they should take advantage of all relevant tax deductions.
What is a real estate portfolio?
A real estate portfolio can be thought of as either a collection of properties or a summary of the investor’s real estate career. Those who want to secure funding for real estate deals should be able to present documentation of their investing history in order to convince others, whether banks or potential partners, of their reliability and business acumen.
What should be included in a real estate portfolio?
An investor can think of their real estate portfolio as a résumé. It could include the investor’s philosophy of real estate investing and even testimonials from past or present lenders or business partners.
The real estate portfolio could discuss the investor’s objectives and how they plan to achieve them or have made progress toward them.
Numbers tell the story of real estate deals, showing whether they are profitable or not, and over what span of time they performed. Each deal should include information on purchase price, transaction and holding cost, repair cost, sale price, and profit.
The real estate portfolio should indicate how deals were financed, showing how the investor found a buyer for the property, as well as repair and maintenance costs and monthly operating costs, including property management expenses.
Books for beginners
Many a real estate investor starts on their investing career by reading numerous books on real estate, on investing, and on personal finance generally. In the latter category is Robert Kiyosaki’s best-selling Rich Dad, Poor Dad: What the Rich Teach Their Kids About Money That the Poor and Middle Class Do Not!
Those without much money to start with might get inspiration from Brandon Turner’s The Book on Investing in Real Estate with No (and Low) Money Down: Real Life Strategies for Investing in Real Estate Using Other People’s Money.
To learn more about Mynd’s philosophy of buying and holding real estate, and the role the company’s co-founders played in building the market for single-family rental properties, investors can check out their memoir, The Big Long: How Going Big on an Outrageous Idea Transformed the Real Estate Industry.
Settle on goals and develop a strategy and a time horizon
Different investors have various goals, different levels of risk aversion, and varying amounts of time they want to remain in the real estate market. Those aiming for short term profits should pursue different strategies from those seeking steady income over decades.
Among the most widely pursued strategies are:
- Buy and hold. In this scenario, the investor buys a property and leases it to a resident, collecting rental income. In addition to the monthly cash flow, the investor gets tax deductions, and benefits from the appreciation of the property over time.
- Short-term rentals. The popularity of sites like Airbnb and VRBO has made short-term rentals viable for many who own properties in desirable locations. This strategy offers flexibility: the investor may wish to live in a property for two months and rent it to short-term renters for the rest of the year.
- House flipping. Flippers buy properties in need of repairs, fix them up, and quickly sell them. Investors with a network of trusted contractors and an eye for good deals — houses that have good potential and can be sold at a profit even after making necessary repairs — can make money quickly this way.
- Investing in real estate investment trusts (REITs). These are corporations that act like mutual funds for real estate investors, allowing them to invest without owning any physical property themselves. The investor purchases a share of a REIT, much as they would buy shares of stocks or mutual funds, and the trust pays dividends to the shareholders. (Read more about REITs
Get acquainted with real estate analytics
Analytics are tools that indicate the success or failure of various real estate investments.
Some of the most commonly cited analytics are:
- Capitalization rate, aka cap rate: the rate of return that a real estate investment property is expected to generate in a single year.
- Internal rate of return: More complicated than cap rate, IRR lets investors know what they can expect to earn, on average, over an extended period of time, or lets them calculate what is commonly referred to as an annualized rate of return. Learn more
- Cash flow: the amount of money an investor has left over after deducting all expenses from their income each month.
- Cash-on-cash return: cash flow divided by the initial investment.
- After repair value (ARV): a property’s estimated market value after it undergoes specified repairs and renovations.
Mynd offers a free cap rate calculator and a rental property returns and income tax calculator.
Know the financing options
There are many ways an investor can finance the purchase of a rental property. The investor can use leverage, or borrowed money, to allow them to make only a partial down payment on a property but immediately begin to earn all the rental income.
Among others, four principal ways to finance the purchase of a rental property are conventional mortgages, house hacking, borrowing from commercial lenders, and borrowing from hard money lenders.
Conventional mortgages meet the standards dictated by the two major government-sponsored mortgage agencies, Fannie Mae and Freddie Mac.
Borrowers are required to make a down payment that is determined partly by the borrower’s debt-to-income ratio and amount of liquid cash reserves. Most fixed-rate mortgages require at least 15 percent on a one-unit investment property. On two- to four-unit investment properties, lenders customarily demand 25 percent.
Borrowers have to demonstrate at least six months of mortgage payments in reserve, and possibly as high as 12 months, demonstrating that they can make mortgage payments even in periods of vacancy.
Borrowers will need a credit score of at least 640. To qualify for better rates, they will need higher credit scores, 740 or above.
Would-be investors may be able to get started by buying a multifamily property (with two to four units) and living in one unit while renting out the others, or buying a single-family home and renting out bedrooms, a finished basement, or an accessory dwelling unit (ADU).
This way, investors can buy an investment property more affordably, because, since they’re living in the home, they can qualify for a traditional mortgage. This is called house hacking or owner-occupant financing. In return for these good terms, the owner must occupy the property for 12 months.
Financing is easier to obtain for an owner-occupied property, with lighter requirements for credit and cash reserves, lower interest rates, and lower down payments.
The basic loan for an investment property is a loan like the one homeowners have on their residence. These residential loans are available only for properties with one to four homes.
There are also commercial loans, typically provided by smaller and local banks. Financing a property with five units or more puts the borrower into commercial loan territory. These loans bear higher interest rates, and the loan terms are typically shorter, meaning the monthly payments will be higher. Borrowers are also required to make a bigger down payment, usually 25 percent.
Hard money loan
Hard money lenders charge higher interest rates and generally lend for shorter terms. For example, a borrower might make interest-only payments for a term of five years, then repay the loan in full at the end of the term.
These loans might be most useful for a buyer who is looking to flip a property, not those who plan to hold on to it and rent it out for years, or other investors who are planning to refinance with a commercial mortgage when the building is leased out and producing stable income.
Renovate and upgrade properties
Renovations to rental properties can justify a higher rent, improving the property’s cash flow, and can also raise the value of the asset.
Investors should always be mindful of improving a property’s curb appeal, by paying close attention to landscaping, paint colors, and lighting.
Renovations to kitchens (which can be accomplished for less through recycled high-end appliances) and bathrooms tend to offer the best return on investment. Even though many former office workers are now working from home, home offices don’t always pay off.
Diversify the portfolio
Real estate presents a good opportunity to diversify an investment portfolio, since real property is not highly correlated with the stock market. (Investors can also align their rental property portfolios with various stock sectors by investing in cities where those industries are prevalent — logistics in Memphis, military bases in San Antonio, or fintech in Charlotte, for example.)
As an investor expands their real estate portfolio, they can think about diversifying into different parts of the country. Individual markets and submarkets can experience ups and downs. Diversifying into various regions, perhaps outside of the investor’s own home city or state, can protect the investor from being too deeply reliant on the housing market in one place.
Investors can also diversify into other kinds of properties, such as commercial real estate, multifamily properties, real estate investment trusts (REITs), mobile home parks, self-storage units, and raw land.
Take advantage of all available tax deductions
Most real estate investors write off costs like mortgage interest, insurance, property taxes, and ordinary operating expenses, like maintenance and repairs — understandably, as these are widely known tax deductions.
But there are many other tax deductions that rental property owners should take full advantage of when filing their tax return, such as expenses related to starting a business, advertising expenditures, utilities paid by the owner, and fees paid to property management.
Moreover, investors can take advantage of a tax break designed to help cover the cost of expenses for maintenance and repairs required to keep their real estate portfolio in good condition.
Depreciation allows property owners to recover some costs of an income-producing property, which the IRS estimates has an average lifespan of 27.5 years. Once a property is put into use, owners are permitted an annual deduction of 3.636 percent of the total cost of the property
Even if an investment property appreciates, the owner is still entitled to the tax break.
Work with a property manager
As a real estate portfolio grows, the work of screening tenants, keeping track of service requests, and planning improvements to multiple properties can get to be too much for the owner or even a small team. Property managers such as Mynd take care of many of the day-to-day tasks of caring for rental properties and keeping residents happy, in return for a portion of the monthly rent or a flat fee, allowing the investor to focus on growing their real estate portfolio.
The final tally on building a real estate investment portfolio
Many investors have found real estate investing to be a powerful way to build wealth. At the same time, no one should fall for get-rich-quick promises: building a real estate portfolio takes time and effort.
A partner like Mynd can help investors to find, finance, buy, manage, and sell real estate, developing a lucrative real estate portfolio.