Real Estate Portfolio: What You Need To Know About Building One
Real estate has proven to be a worthwhile investment, but putting together a solid real estate portfolio can be intimidating – especially for the novice investor. Building a real estate portfolio can be a smart and effective way to diversify your investments, generate passive income and build long-term wealth.
However, building a portfolio requires careful planning and strategy. Investors must have a clear understanding of their investment goals, risk tolerance and available resources to build a successful real estate portfolio.
Here’s a look at how to build a real estate investment portfolio and the potential benefits that come with it.
What Is A Real Estate Investment Portfolio?
A real estate investment portfolio is an accumulation of current and past real estate investments or related assets held by an individual or entity that are generating a positive cash flow and appreciation. Real estate portfolios can include commercial and residential real estate, land, rental properties and real estate investment trusts (REITs).
Not every real estate portfolio will look the same, but it’s important for anyone thinking about investing in real estate. Building and diversifying your portfolio is essential to mitigating potential risk. The size and composition of an investor’s portfolio can vary widely depending on the investor's goals, risk tolerance and available capital.
How To Build A Real Estate Portfolio
Here are the keys to building a real estate portfolio when you’re ready to take the next step in your real estate investing journey.
1. Understand The Basics Of Investing In Properties
One of the main reasons why many investors get into real estate investing is because of their ability to generate passive income. This can happen in several ways.
When you purchase a rental property, you can lease units to tenants for monthly rental income. While you may incur expenses, rental income should ideally cover all expenses and leave you with a positive cash flow. Another way is to invest is REITs, which are companies that own, finance or operate income-producing real estate assets. By investing in REITs, investors can earn dividends, which are paid out to shareholders on a regular basis. You can also bring in passive income through the appreciation of the property’s value. Over time, real estate tends to increase in value due to the housing market, location, interest rates and improvements made to the property.
If you decided that buying an investment property is the right decision for you, then you’ll want to consider how to buy investment property and how you’re going to manage the asset.
Pick a location and the property type – residential, commercial, industrial or land – and secure financing either through a mortgage lender or crowdfunding with a group of investors. To help with managing your investment, consider making connections with professionals in the industry, such as real estate attorneys, real estate portfolio managers and professional property managers. Investing in a single property may be possible to manage on your own, but when you’re building a portfolio with several investments in different areas, you’ll want the help of professionals you can trust.
2. Calculate ROI With The 1% Rule
The 1% rule is a general guideline that real estate investors use to determine if a potential investment is worth pursuing by measuring the price of the investment property against the gross income it could generate. To pass the 1% rule, the monthly rent must be equal to or no less than 1% of the property’s total purchase price. This can be used to help figure out how the property should generate a positive cash flow or help you determine what to charge in monthly rent.
While the 1% rule isn’t directly related to an investor’s return on investment (ROI), it can still help when making ROI calculations. Aside from the purchase price of the property, ROI takes into account other factors, including rental income, operating expenses and financing costs.
In terms of rental property, you can first use the 1% rule to determine what to charge in monthly rent. Once you know the annual potential rental income, you can use this number to estimate your net operating income, which is equal to the annual rental income minus annual operating expenses (maintenance, insurance, property taxes, etc.).
Subtract your operating costs from your potential rental income to get your potential net operating income. Then, divide your net operating income by the total value due on the mortgage to get the ROI. Here’s the formula:
ROI = (Annual Rental Income − Annual Operating Costs) ÷ Mortgage Value
3. Learn About The Local Real Estate Market
Knowing your local real estate market can help you make wiser investment decisions. Real estate is local, and each community has its own market trends that dictate what’s in demand, the best neighborhoods to purchase as well as what people are willing to pay. If you don’t take the time to learn about the local market, you could be missing out on investment opportunities.
By knowing current market trends and conditions, like supply and demand, you can determine the current value and future potential of a property and decide whether a property is worth the investment. For example, if the local market is experiencing a surge in demand with a limited supply of properties, prices go up.
While no area is perfect, investors should look at these factors when evaluating a potential local market:
- Appreciation: Steady appreciation makes renting and selling easier and can impact profit potential over the long term. Appreciation is typically achieved in two ways: passive or active. Passive is what occurs naturally over time while active refers to an increase in value as a result of making repairs or upgrades to boost its value.
- Affordability: Affordability is relative to the income of the local demographic. Investors typically stay away from areas where there’s a large gap between median income in a given area compared to the minimum monthly rent required to turn a profit.
- Population growth: Areas with sustained population growth tend to be more favorable than others. When more people are moving into an area, rental demand and competition typically increase.
- Job stability: Areas with better job opportunities attract more buyers and renters. It also indicates what the real estate market will look like in the near future.
4. Diversify Your Real Estate Portfolio
Having a diverse set of assets in a real estate portfolio is a must to potentially minimize risk, maximize returns, hedge against inflation and build stable income streams.
Diversification spreads your risk across different property types and classes and reduces your overall exposure in a volatile market. For example, if you invest everything in a single property or location, you could suffer significant losses if the market or property doesn't perform well. This is why many successful real estate investors spread their investments across different properties in different markets. The most common real estate investment types are commercial real estate (hotels, retail, offices), residential (multifamily properties, houses, vacation rental properties), land and REITs.
5. Know Your Financing Options
There are several financing options available for investment properties. Take a look at these options:
- Fix-and-flip loans: This is a short-term financing option that real estate investors use to acquire, renovate and resell a distressed property. These loans not only cover the costs of fixing up the property, but also the expenses associated with marketing and selling it. These loans are typically secured by the property itself, and lenders determine the amount investors can access by evaluating the loan-to-value ratio (LTV) or after-repair value (ARV) of the property. For example, if you buy a fixer-upper for $150,000, the lender may only cover 90% LTV, or $135,000. Similarly, if a lender only offers 75% ARV, they will only lend $150,000 on a property worth $200,000 after repairs. Depending on their preference, investors can choose from various fix-and-flip loan options, including hard loans, personal loans and seller financing.
- Traditional mortgage: A regular mortgage can be used, but the mortgage process may be different for investment properties. Also, Fannie Mae only allows up to 10 mortgage loans per investor so if you have more than 10 properties in your real estate portfolio, you may want to consider a different option. Another difference is that investor-friendly lenders require a down payment of at least 15%, which is usually not required when you buy a primary residence, with a 680 qualifying credit score. If your credit score is lower, the lender may require a larger down payment.
- Buy, Rehab, Rent, Refinance, Repeat (BRRRR) Method: The BRRRR Method is an alternative to financing a real estate portfolio. It’s a type of real estate investment strategy that involves purchasing a distressed or undervalued property, fixing it up, renting it out to tenants, refinancing the property through a cash-out refinance and then repeating the process by reinvesting the proceeds into another rental property. Investors have several options for financing a BRRRR investment property, including hard money loans, private loans and conventional loans.
Benefits Of Building A Real Estate Portfolio
Investing in real estate and building a real estate portfolio have several advantages. These include:
- Tax benefits: Buying a rental home or multifamily property has tax-saving opportunities thanks to Uncle Sam. Most common costs associated with buying property qualify for deductible expenses you can claim on your taxes, such as mortgage interest, property taxes, property insurance, building maintenance and repairs, property management fees and qualified business expenses. Investors can also deduct the cost of rental property over a set period of time, known as depreciation. Other tax benefits include saving on capital gains taxes by waiting at least 1 year before selling appreciated property and taking advantage of incentive programs, like the 1031 exchange or investing in Opportunity Zones.
- Passive income: With certain types of real estate investments, you’re able to earn passive income that is greater than the ongoing expenses associated with the property. This difference in income and expenses is known as positive cash flow. Passive income is also available through REITs in the form of dividends or by using crowdfunding platforms to pool resources with other investors to finance real estate projects.
- Generational wealth: Generational wealth refers to the creation of long-term wealth that can be passed down from one generation to the next through the ownership and management of real estate assets. Investors can build generational wealth through the purchase of income-generating rental properties, the development of commercial or residential properties or the acquisition of raw land for future development.
Do You Need A Real Estate Portfolio Manager?
A real estate portfolio manager is a professional responsible for managing a real estate portfolio on behalf of an investor. Real estate portfolio managers use their expertise to oversee and maximize real estate investments to help their clients achieve their financial goals and build long-term wealth through those real estate investments. Some of the main tasks they perform are:
- Monitoring analytics
- Creating a real estate business plan
- Selecting properties
- Assessing risk
- Distributing profits
- Looking for opportunities to buy or sell real estate assets
- Developing investment/portfolio strategies
A real estate portfolio manager isn’t a requirement when investing in real estate, but hiring one can be a smart choice for investors who want to offload some tasks and still build their real estate portfolio. Plus, they’re typically knowledgeable about local, state and federal real estate regulations and can help investors navigate complex legal and financial issues related to their real estate investments.
The Bottom Line On Real Estate Portfolios
A real estate portfolio is your collection of real estate investments for the purpose of generating income and/or appreciation. A strong portfolio gives investors several advantages, including the potential for tax savings, passive income and building generational wealth. Building your portfolio involves careful planning, taking steps to learn the local market and mitigating risk by spreading your investments across various property types, like multifamily properties, office buildings, raw land or REITs.
If you’re ready to begin investing in real estate, kickstart the mortgage approval process to get financing for your next investment.