Most real estate investing advice is geared toward people who can’t wait to quit their jobs. But what about those of us who love our jobs and never intend to quit them, or those of us who need the financial security of a steady job we’re already trained to do? The following is my answer to this question. My name is Jordan Thibodeau and I’m a fourth-generation real estate investor and the founder of the Silicon Valley Investors Club. I created this guide for professionals that are interested in real estate investing but don’t know where to get started.
After reading this guide you should learn the following:
- How you should manage your money before making your first investment.
- How your career provides you with an advantage over other investors
- Why having uninvested cash is a strength
- How to keep yourself emotionally prepared to invest
- Understanding the principal-agent problem in real estate
- The power of walking away from a deal
- Why you shouldn’t invest in Fix and Flips
Three types of real estate investing you should focus on
- Trouble with investing in multiple states
- The importance of a blended approach to real estate investing
- And much more!
I started investing in real estate back in 2013 under the exceptional guidance of my father, an experienced real estate investor himself. At that time, the market was deeply distressed. It was an optimal time to buy.
While real estate is currently in vogue, many people are feeling the pressure to deploy capital as if money is going out of style. Control that impulse! The real estate cycle has shifted from a buyer’s market (roughly 2009 to 2015) to a seller’s market (2016 or so onwards). In this market, the returns aren’t as high as they used to be, and I’m seeing people do risk things in the market such as taking out home lines of equity or loans on their stock portfolio to buy low yielding real estate investments. I’m seeing syndication pro formas with assumptions that good times will last forever, which isn’t how the business cycle works.
At this point in the market, money is cheap, and deals are being bought at a premium, which is a bad sign for investors because the risk/reward equation is now skewed towards more risk for each marginal unit of reward. When the cycle slows down, then you will see money becoming harder to obtain and home values retreating, which makes it easier to find sound investments. At that point, you are in the driver’s seat and you will have an opportunity to buy real estate at a discounted price.
Before you get started investing in real estate, you need to make sure that you’re covering the basics. Assuming that your company matches your 401(k) contributions, you should max out those accounts and invest in a target retirement index fund. An employee match is pretty much a risk-free rate of return that you won’t be able to beat anywhere else. Then you should set up a Roth IRA, assuming you qualify.
Next comes savings. As cliché as this advice sounds, it’s imperative that you live below your means by maxing out your savings and making sure that you don’t buy extraneous things simply to impress others. Having adequate savings will provide you with the financial security to walk away from any situation or real estate deal that you don’t feel is treating you fairly. As a rule of thumb, aim to put aside several months’ worth of living expenses. As well as bolstering your investing self confidence, this safety cushion will also help you keep your head above water if you ever lose your job or suffer a major illness. Speaking of safety cushions, make sure that you have insurance that lets you pay for your own disability coverage, or else you can expect a higher tax bill at the end of the year.
The Benefits of Working in a STEM Field
If you work in a STEM field, then you likely have a steady paycheck, a generous 401(k) program, and the resources to easily qualify for a mortgage. These attributes give you an advantage that most investors lack. While full-time real estate professionals are pressured to find deals in a crowded market, you have a good job that allows you to be patient when examing real estate opportunities.
How do you know when it’s a good time to buy a property?
Market timing can be a dangerous game to play because no one knows what will happen in the future with regard to real estate prices. That being said, it doesn’t mean we either become super aggressive in a market or super conservative, we maintain a position of balance where we continually look for opportunities in the market, but never pressure ourselves into thinking a particular opportunity is the end all be all and that there won’t be any future opportunities.
The Importance of Having Selection Criteria
Each person has their own criteria that fits their return goals, and you need to create your own. But as a baseline, after all expenses (mortgage, taxes, insurance, property management, operating costs, long-term capital improvement reserves, etc.), you should at the least hit a cap rate of around 5-6% based on historical returns, the value of your time, and assuming the property’s price is in line with comparable properties. I’m not saying that’s a cap rate I aim for, but if you’re shooting for anything lower, you are not providing yourself with a large enough margin of safety to ride out the unexpected, and you aren’t adequately compensating yourself for the time you will invest in managing the property.
Staying in the Game
Many of you are super eager to get started in real estate, and that’s great! But you have to understand that real estate is a multi-decade endeavor—not a one-year sprint. The real gains from real estate appear when years of rent increases, appreciation, and equity build-up (from paying down your mortgage loan) combine to help you build your wealth and develop a debt-free, income-producing asset. As time goes on, your property’s loan-to-value ratio will decrease, allowing you to pay off your loans completely and free up more cash flow or roll it into larger properties.
But in order to be successful, you have to develop enough staying power to ride out of the ebbs and flows of the market. Many investors have been shaken out of real estate investing because they failed to expect the market to go down and paid too high of a price for real estate. Some investors have short-time horizons of five years or less, which increases the volatility of their returns and increases the odds of them selling their properties in the midst of a downturn.
The truth is that if most investors were able to hold on to their cash-flowing properties (purchased before the 2006 peak) to the present day, they would now be back to breaking even.
Principle-Agent Problem In Real Estate
Real estate agents, syndicators, wholesalers, and other real estate professionals who make money off of transactions have short-term incentives that can go against your long-term goals. This isn’t a ding against these real estate professionals. I know many of these professionals, and the ones I associate with do their best to balance their interests and their fiduciary’s interests.
I don’t begrudge them for trying to make a living, but you have to understand they only get paid when money changes hands, so they have the incentive to pressure you into an investment that doesn’t make sense. You will also find other investors trying to sell their poorly performing properties at the peak of the cycle to offload their duds to newbie investors. Just because an investor-owned a property doesn’t mean it’s the right property for you. Make sure to do your due diligence.
Pyrrhic Victories in Real Estate
Competing for bad deals lowers your return on real estate, causes undue stress, and leads to poor decisions. It’s as if you are fighting for the lowest return on your time and money. If you don’t remember anything else I said here, remember this: There will always be another deal. Having the ability to walk away from a deal (or anything else in life) is the most important power to have in real estate. Most investors can’t do this, and they will suffer the consequences. Because you have a job, you have the power to walk away from deals when the real estate market gets out of hand. And more importantly, being that you have a job you are provided with an hourly measurement of what the market thinks your time is worth.
Comparing Yourself to Others Will Only Hurt You
As tempting as it may seem, you cannot allow yourself to become distracted by what others think about you and your expenditures if you want to be a successful investor. Now, that doesn’t mean that you should ignore what your educated friends and colleagues have to say about the topic; that would also be unwise. What you need to do is find a happy middle ground between “I’m only making this investment due to a tip from a friend,” and “I’m making this poor investment based purely on my own research.” Somewhere between those two extremes lies the best-case scenario: “I have taken my friend’s advice into consideration and made this investment because I have done my due diligence and decided that it is a promising investment.”
What Does This Mean for You?
Now is a great time for you to build your real estate investing network, learn about real estate investing, and save your money. This is also a time to be cautious when it pertains to deploying capital in real estate. Sure, you might be able to find an opportunity here and there, but you have to take it slow.
Which Types of Real Estate Investing Should You NOT Do?
Fix & Flip or Major Rehab Projects
You should not do any fix & flip or other major rehab projects until you are already established and confident in real estate investing. These strategies are out due to the major time requirement demanded, the know-how involved in managing such a project, and the increasing cost of construction labor due to a shortage of contractors. Not to mention, if you miss appraisal or your expenses balloon, you’re going to have a bad time. Right now, BRRRR is in fashion, but once properties start missing their appraisals, you will see why that method can be so risky and was part of the reason people failed catastrophically in 2006.
Tax Liens and Note Investing
These investments are technically doable, but they miss out on rent growth and appreciation. As appreciation is a quantitative measure of the desirability of a particular area and the average person’s willingness to pay premium prices to live there. Therefore, the inability to appreciate impedes our ability to raise rents down the road. Other downsides of tax liens and note investing include the fact that the foreclosure process can be lengthy, that there are no guarantees that other parties won’t try to bid up the house price via a shill, and that those of us with full-time jobs don’t have the time to head down to the courthouse and bid on failing properties.
Development projects have a million ways to implode for first-time investors, and you really need to know someone you trust can walk you through all the intricacies of development. My family did make money off of our own projects, but that was after years of experience in investing in real estate, building experience in construction, and developing relationships with the city. We had great success, but we also had our butts handed to us on a deal. For newbies, I suggest staying away until you truly understand development.
Four Types of Real Estate Investing You Should Consider
Being that you have an awesome career to focus on and family responsibilities, you need to use an investment strategy that fits within those time constraints. I recommended STEM employees start with the following are three strategies when they begin investing in real estate.
REITs (real estate investment trusts) can also be a great investment vehicle. Instead of investing in one property, with a REIT, you can invest in a pool of properties managed by a professional team.
REITS have a few advantages:
- Instant diversification.
- You can start with a few bucks.
- What’s nice about REITs is that you can purchase shares in them via an online brokerage account and sell them at any time.
The downside of REITs is that they can go through violent price swings like any other stock, and this could cause you to sell when you shouldn’t.
Buy & Hold Within a Two-Hour Drive From Your Residence
This is hard for most of us to do in the Bay Area, but in an ideal world, you would be able to easily drive to your property to check on it and make sure your property manager is doing their job. If you decide to pull the trigger on an investment, buy something conservative. It should be a single family house or a small 2-unit duplex.
If you don’t have experience managing tenants, you shouldn’t set yourself up for failure by making your first investment a property that has 3+ units. Ease yourself into it by starting with a duplex. Most importantly, invest in a neighborhood that’s no lower than a B class area, which means low crime, with blue and white-collar workers, within the path of economic development.
Out-of-State Buy & Hold With a Property Manager
Many employees are doing this right now. They are buying properties out-of-state and using a property manager to manage them. I suggest you find one primary market to invest in and then do your market research on the state to learn about demographic trends, job trends, government climate for business, earning potential of residents, etc.
Then pick a city and neighborhood to research crime rates, schools, location relative to job centers, and the city’s general plan for development in the area. As mentioned previously, when you’re starting, don’t invest in a neighborhood lower than a B. The lower you go, the more crime and the more landlord hassles you will have to deal with (more on that for another post). And most importantly, get yourself on a plane to see the area in person. Nothing beats visiting an area before investing there.
What about Syndications?
Essentially, with syndications, you’re a silent partner in a deal for a large apartment complex or commercial building that’s already constructed. To succeed with syndication investing, you need to be either an accredited or sophisticated investor. Syndication is similar to buying a stock, but without the benefit of liquidity. When you buy a stock, you read the 10-K to understand the company’s business model, opportunities, management, and risks, then make a decision on whether or not to invest. Afterward, you’re basically a silent partner, and your hope is that the company does well so the share price increases and hopefully the company pays a dividend.
For syndications, instead of reading a 10-K, you will receive an offering memorandum, which is essentially a 10-K for investing in a large multifamily property, retail building, storage facility, or development deal. (Of these, development is the riskiest.) After reading the terms, if you like the deal, then you can write a check to the syndicator for an equity or debt position in it. Then, if the deal goes well, then you will receive regular rent distributions. After the holding period is over, you will receive your principal and appreciation.
Unfortunately, most syndications aren’t diversified and can be super risky. Also, your investment is not liquid, meaning you can’t get out of it easily. If the investment does well and you want to keep your money in the investment, then you have no power to do so because the syndicator has the mandate to exit the investment after a specific holding period is over. This can cause trouble because you will receive a lump sum payment at the end of the holding period (your original investment, its appreciation, and any residual rental income it has) and you will have to determine where to reinvest this money.
A Blended Approach to Real Estate Investing
By using multiple strategies for real estate investing, you receive the benefit of exposure to other markets while leaning on professional management to protect you from the potential hazards of entering a market you’re unfamiliar with. The big problem with partnerships and syndications is that they eventually end, leaving you with a chunk of cash that you’ll then need to reinvest—a hassle that many people don’t begrudge until they’ve had to try to find a new quality investment or syndication while being employed full time. By having a healthy buy and hold portfolio, you’ll still have exposure to the market while you’re looking for a place to reinvest your capital, and this is the ideal scenario to construct when you’re getting started in real estate investing.