Blog | Real Estate

4 Real Estate Fundamentals First

If you build your house out of sticks and straw, just like the fairy tale, your foundation will be weak and the house will eventually come tumbling down.

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Real estate investing gives you greater control over your money than other asset classes — provided you first take the time to build a strong foundation

Let’s pretend you’re building a house. You want the strongest foundation possible, right? In order to make your foundation strong you need to know what makes up the foundation you have, get rid of anything that makes the foundation weaker, and build and add what will make your foundation stronger. If you build your house out of sticks and straw, just like the fairytale, your foundation will be weak and the house will eventually come tumbling down.

The same is true when it comes to investments: You want to start with the real estate fundamentals — build your strong foundation — in order to decrease your risk. Let’s examine why.

The housing and the stock market crash of 2008 shook some investors to their core, leaving them to believe that "investing is risky." Sure, all investments have some element of risk. But the real problem is that not everyone defines "investing" the same way.

Most people think of investing as any situation where you put down money with the expectation of getting a return on your money. Unfortunately, what many people think of as investing is actually gambling. This is why so many people were burned by those events nearly a decade ago. Many so-called "investors" bought into the real estate market when it was hot, prices were soaring, and they invested on the hope that home values would keep going up and up. They even took on properties that cost more to buy and maintain than they could be rented for. Then, pop! The bubble burst and their gamble left them in financial ruins.

On the other hand, experienced investors who understood the real estate fundamentals refused to buy houses that couldn’t cash flow (and we all know that cash flow is queen and one of the keys to achieving financial independence — more on that shortly), and sold properties they’d acquired before the boom for a nice profit. Doesn’t that sound like a much better (and less risky) business model?

Becoming a savvy investor

When it comes to real estate investing, what sets the “gamblers” apart from the true investors is having an understanding of the fundamentals. Knowing and following the fundamentals takes much of the risk out of investing. Again, there’s always some level of risk, but by sticking to sound investment strategies and planning for ways to cover the downside, the risk can be greatly reduced.

Essentially, the largest risk you face is not actively improving your financial intelligence— and thereby not building your foundation or following the fundamentals. You must educate yourself and continue learning every day.

So if you’re new to this asset class, start with these four real estate fundamentals that I always abide by:

  1. The investment must put money in my pocket. First, I look for cash flow. Second, I look for appreciation. A successful investor is in the business of building her asset column. So any investment that doesn’t put money in your wallet is a liability, not an asset.

  2. The investment must stand alone. An investment cannot survive off the cash flow or funding of another investment — meaning you cannot use the wealth of one business to keep a subsidiary business afloat. Each business must be profitable on its own. The same is true for investing.

  3. I want to control the investment whenever possible. In real estate and my businesses, I control the income, expenses and debt. I’m always looking for ways to improve the investment and increase its value or the value it returns to me. This is where the ongoing education comes in handy.

  4. Every investment must have an exit strategy or exit options. This is a hard and fast rule: Always know when you will sell before you buy. This decision could be based on any number of factors: price, date, market events, or even personal events. Robert and I tend to hold onto our real estate investments as opposed to selling them.

    However, we always know what it would take to sell. In 2006 during the peak real estate market, we were offered a generous price for one of our apartment buildings — one that was operating at maximum cash flow. What did we do? We sold that property and moved the profit into a grander apartment building that gave us a much higher return on investment.

The freedom of choice in real estate

So why are we focused on real estate? Real estate is my favorite investment vehicle for many reasons. It's fun, profitable, and it gives me the freedom to control my own investment.

Money is one of the most stressful parts of life. And the biggest reason why is that oftentimes, people feel like they don't have any control over their money. Everyone is clamoring for your money, whether it’s your utilities or insurance or mortgage or taxes. Many times, you don't have a say in where your money goes.

You also have limited control over the money you invest. You can choose where to invest, picking your preferred asset class. But even the savviest investors with tremendous financial knowledge are limited in their power to control how an investment performs.

This is precisely why real estate is so enticing. When you invest in real estate, you have 100% control over your investment. You do the research, you call the shots, and you profit from the results.

For many hard-working people, this is music to their ears.

Let's say you invest in a company, or buy a share of their stock. You can do your homework and study market trends, but at the end of the day companies are run by people who aren't you. They make decisions and moves that affect your money.

But if you put your money in a real estate investment you call the shots. The power is in your hands, and so are the profits.

Below are three things you get to control when you invest in real estate. All of these decisions are within your power, and the profits you make become extra cash that you can do whatever you want with.

  1. How you profit

    When investing in real estate, there are two things you can invest for: cash flow and capital gains.

    My preferred method of investing is for cash flow. When you invest for cash flow, you invest in properties that will provide a steady stream of income each month that you can pocket.

    Investing for capital gains, on the other hand, involves buying a property and then selling it for a one-time payoff.

    When you buy a real estate investment, this choice is yours to make. What will you invest for? Do you want to make a long-term investment, and profit off the steady flow of cash each month? Or do you want to flip the property quickly, and invest for a one-time sum?

    Both strategies can be lucrative when executed correctly. And the great thing is, you have direct control over how you will receive your returns.

    Many investment vehicles don't give you the choice in how you will profit. Or if they do, there are a lot of rules dictating when and how you will receive your returns.

    But with real estate, you have more flexibility to earn the profits when and how you want to. You can set rent, and buy and sell properties when you want to, without anyone dictating how you profit.

  2. Your investment's value

    You have the power to directly increase your investment's value.

    Almost no other asset class lets you have this type of impact or control. You have no say in how stocks will perform or what commodities are worth. So many external factors, from politics to war to economy cycles, have sway of your other investments.

    But in real estate, you can take action that will directly reflect in your profits. You can make improvements on the property, increase the square footage, get creative with the property lot, and increase the efficiency of the property's operations, all the increase your ROI.

    How many other investments can say that? If you invest in a company, that doesn't mean you can start rearranging their business operations to make it more profitable. You have no power to increase or decrease the price of oil so that you get better returns.

    But with real estate, the power is in your hands. And while it can be a huge responsibility, it also symbolizes sweet freedom.

  3. Who you work with

    If you invest in a business, or purchase a share of a company's stock, do they call you up every time they decide to hire a new employee? Of course not!

    But when you invest in real estate, the choice of tenant is yours to make. You get to choose whether you rent your house to a group of rowdy college kids or a nice newlywed couple.

    You also control who you invest with. One of the best parts of real estate investing is getting to use other people's money (OPM) to purchase your investment. You don't have to fund the whole investment by yourself, but can approach other investors to help you purchase the property.

    If you put together a strong deal, you will attract plenty of investors who want to give you their money. The best part is that you get to choose who you work with.

    Finding and building the right team of investors is vital to your investment strategy, which is why you need to work with people you trust. Not all investments allow you that choice. Other people's actions and choices affect your money all the time. Real estate investing is one area where you have some say in the people who surround your investment.

So if you take the time to learn these real estate fundamentals (and eventually live and breathe them), start with small opportunities, gain experience and increase your financial education, and you too can become a savvy investor.

Original publish date: November 02, 2017

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