Where Should I Invest? Adventures in Real Estate Acquisitions, Part One
I’ve been spending the past couple of months looking to acquire some real estate to add to my personal portfolio. I’ve been an investor in stocks, index funds, 529 accounts (gotta pay for the girls’ college someday!) and retirement funds, and have managed a good deal of real estate for clients.
This is the beginning of my personal real estate adventure.
My husband and I are looking at a couple of different options and are excited about the following ideas:
Buying a vacation home which we can rent out on a short-term basis when we aren’t there for a much higher return on investment (ROI) than a traditional rental, with the added bonus of being able to use it for our own personal enjoyment. I love this idea, but am finding that it’s slim pickings. With little to choose from and lots of competition, this is proving time consuming to find, visit, write offers, escalate offers, rewrite offers, and still lose out. We’ll likely have to wait until the spring when more people put homes on the market for sale to find something good.
Buying a four-flex or bigger and managing that asset for cashflow. This sounds less fun and more like my day job. I bring in more money at work with more perks and fun work friends, so I’m less into this idea. It’s like bringing work home for way less money. I’ve done my best to move past the late-night emergency calls as I’ve moved up in my property management career, and I really don’t want to go back to that place!
Buying land and developing our own vacation home, which we could rent out when we aren’t there. After reviewing what this process looks like with a friend who is doing it, this gets a giant heck no from me. Project delays, permitting issues, pricing and supply chain concerns? No thank you. I prefer my passive income to be… actually passive. :)
Buying land and putting tiny homes technically classified as RVs on it. This sounds at once amazing and exhausting. It’s a bigger project than simply buying a property and renting it out. However, it also seems like a fun creative outlet. Each tiny home could be built and shipped to me in 4-6 months’ time, where I could customize it to my liking. Given the cost ($100k-$150k per home), I could buy a few acres of land and put 2 to 4 of these on it for the price of buying one existing vacation home.
So, how do you begin to evaluate the potential investment options and compare them side by side? Even more difficult, how do you do that when they are TOTALLY different investment vehicles - stocks vs index funds vs real estate vs investing in that business you and your friend dreamed up?
There are a few things to consider before you even start comparing returns on a chart.
How much money do you have to start with?
This will set the bounds of what you can invest in. This could be your down payment, typically at least 20% of the purchase price of a property. So if you have $100k, you can afford to buy a property for approximately $500k (a little less after you consider closing costs, appraisal fees and other typical buyer expenses). Outside of real estate, brokerage accounts, index funds and 529 college savings accounts often have a minimum you must spend in order to get started. Same with stocks - you can’t really buy half of a stock unit (well actually you can, but it’s not super straightforward - more on that here).
Another thing to consider is that a 50% return sounds amazing, but if you can only get it on an investment that you can’t afford to even dip a toe in, then that’s not really an option for you.
Small deals can also take just as much work as bigger deals, so don’t write off a potential idea just because the percentage doesn’t look high enough to you. A 10% return on a $100,000 investment may not be exciting enough to be worth your time and energy. A 10% return on $1,000,000 is much more attractive and could mean you can quit your day job.
How much money can you borrow and what will it cost you?
When purchasing a house, you can get a mortgage to cover 80% of the purchase price (or more if you are okay paying private mortgage insurance and have good enough credit to qualify).
Once you’ve identified a source of cash, and the interest rate, what will your monthly payment be? Can you cover it and still get the cashflow you want, after all your revenue and expenses are counted up each month?
I don’t recommend borrowing money to invest in stocks as it could be wiped out with nothing to show for it (although historically speaking that is pretty unlikely over the long term - but those short-term shocks could hurt you and your bank probably wouldn’t be happy). Meanwhile, even if I hit hard times, I will still have my property to rent out or live in, so having that collateral makes a big difference. So real estate has an advantage over some other forms of investment in that it has this built-in protection while also being able to buy while only putting some money down.
Are you wanting to earn money from that investment to use right away, or can you wait for a while?
I want to have the financial cushion to retire early if I choose to, which means I specifically do NOT want all my investments in retirement savings where I have to reach a certain age before I can withdraw funds penalty-free. A 10% penalty plus income and capital gains taxes can really cut into those earnings, even after considering a hefty company match. So I’m investing outside of my 401k as well.
I also am okay waiting, just on my own timeline instead of someone else’s. Can you reinvest your profits even for a short timeframe to earn greater rewards down the road? Or do you need it to cashflow immediately?
I enjoy creating new things, so the idea of creating another business and growing it into something huge is also exciting and worth the risk.
If you take money you’ve earned and spend it now, you won’t have it to invest and make more money with over time. If that’s okay with you and you aren’t trying to grow your stash of cash over time, then that strategy can work just fine - as long as you have a rainy day fund for when things break or need repairs.
How involved do you want to be?
Index funds are probably the best hands-off investments as they balance risk, are super low in fees, grow over time and you don’t have to know much about individual companies’ performance and and stocks in order to get a good ROI.
Rental property can be hands off too, but it will cost you in management fees - anywhere from 2%-30% depending on the property and total revenue it brings in. This means that it could end up leaving you owing money at the end of the month if you haven’t added up all the costs before signing on the dotted line.
Generally speaking, the best returns come from the projects you are the most involved in. You’ll know more than the average investor, you’ll see trends coming your way and will react more quickly, and you’ll build skills, relationships and other valuable assets that will help you achieve a better return than most.
My advice if you are looking for a larger return and to be highly involved in order to earn it, is to pick something you really enjoy so that it doesn’t feel like torture. If you haven’t found that one thing yet, then keep putting money away in your index funds and 401k, and keep on looking for new inspiration!
How much sweat equity are you willing to put in?
This is similar to the last question, but taken to another level. Are you willing to learn new things, roll up your sleeves and work hard? No shame if not - I certainly don’t want to do a ton of manual labor and frankly no one wants me to do it (honestly, I’m not very good at it!).
However, I can decorate with the best of them and I can whip up pro forma financial models and strategic business plans all day for fun, so I’m DEFINITELY open to earning my keep here.
Turnkey investments are usually lower ROI because someone else put in the work to prepare it for you, and they earned that return instead of you. You can still make money, it’s just less than you would have if you put in the effort yourself.
Knowing this, I should get a bigger cut of any deal I partner with someone on if I’m doing the legwork while they’re more passive.
If I invest on my own, I can expect a better return if I take a diamond in the rough and turn it into something gorgeous than if I just shove a “for rent” sign in the yard the day I close on the property.
How much of a financial cushion do you have?
If something unexpected happens - a stock market crash, a big leak at your income property, an eviction moratorium, you lose your job - how long would you be okay before facing financial trouble?
How likely are any of those things to occur, and what might they cost you?
Can you afford that risk?
Some risk is fine, even healthy - after all, no risk, no reward. Just know where to draw the line. That will depend on your personal financial situation and comfort level.
Next up: list out your acceptable options
Once you’ve gone through the above questions, you should have narrowed down your focus to areas that are attainable and engaging enough for you to warrant investing your time and energy in, in order to earn a healthy return.
But now, how do you compare them side by side?
