Traditionally, there are a few ways to make serious money as an entrepreneur. They include business ownership; securities investment and speculation; and, perhaps the most personally rewarding, real estate entrepreneurship. Not for the faint of heart, making money in real estate is filled with potential challenges and pitfalls. But with an understanding of the various real estate entrepreneurship strategies, proper implementation, assessment, and adjustment where necessary, one can make substantial profits. The first step is understanding how to make money in real estate.
In this article, we will cover, 1) strategies for making money with real estate, 2) determining return on investment (ROI), 3) making money with residential real estate, 4) building a business based on commercial real estate, 5) real estate financing, 6) economic trends affecting the real estate market, 7) keys to success to become a real estate entrepreneur, 8) challenges of being a real estate entrepreneur, and 9) examples of real estate entrepreneurs.
STRATEGIES FOR MAKING MONEY WITH REAL ESTATE
There are a number of ways to make money in real estate, including, but not limited to:
- owning and renting residential property;
- buying and selling residential property;
- improving residential property to increase its value;
- investing in mortgage notes;
- owning and renting commercial property;
- buying and selling commercial property;
- investing in commercial real estate;
- and investing in real estate securities, such as real estate investment trusts (REITs) and municipal bonds.
Broadly speaking, each strategy involves determining your goals, researching your market, finding the proper asset(s), financing the purchase of the asset(s), receiving income from the asset(s) and/or selling the asset(s) at a higher price than what you have paid for it. Real estate entrepreneurs typically estimate ROI – the return on investment of the asset in question, as a way of evaluating whether it is worth purchasing.
ROI, in a real estate context, can be calculated in a couple of ways. The basic ROI formula for any investment is:
ROI = (Gain from investment – Cost investment)/Cost of investment
But this method does not fully incorporate costs or changes in equity. Two alternate methods are the Cost Method:
Cost Method of ROI = Equity/Costs of purchase and improvements
which incorporates any anticipated changes in equity, and the Out-of-Pocket Method:
Out-of-Pocket Method = Equity/Costs of purchase and improvements + loan-related costs
Most real estate investors prefer the Out-of-Pocket Method. These formulas should be taken as a starting point, as they do not take into account factors like time spent on repairs, tenant management, sudden falling real estate prices, difficulties selling the property, or other unforeseen occurrences that can affect the success of failure of a real estate investment.
MAKING MONEY WITH RESIDENTIAL REAL ESTATE
There are a number of ways to make money in the residential real estate market, including making home improvements, flipping houses, owning and renting property, investing in residential real estate, and investing in mortgage notes.
Real estate entrepreneurs often make improvements to residential properties to increase their value. They use this increased value to justify selling the property for more than they paid for it. This strategy is commonly employed when flipping houses. Sometimes, entrepreneurs will look for distressed properties – properties with liens on them, or in need of substantial repair in order to be issued a Certificate of Occupancy. The latter are known as fixer-uppers, and should be carefully assessed prior to purchase to ensure profitability.
Buying and Selling (Flipping) Houses
One of the most common ways to make money with residential property is by flipping it. this involves buying property, often at a discount to its market value, and selling it for a higher price. Frequently, once residential property has been purchased, the new owner will make improvements, designed to drive up the value. Once the entrepreneur is able to obtain an appraisal for the property substantially higher than what they paid for it (minus expenses), then they will sell it for a profit. The typical time frame is 30 to 60 days. The difficulties of obtaining a mortgage for a property other than one’s primary residence can make this a high-risk strategy.
Often entrepreneurs will flock to areas in which real estate prices are rising. They may buy a residential property at or above market price, and/or at a premium to its underlying value, with the expectation that they can sell it at an even higher price. This can be a dangerous game however, as rising asset prices often are a part of an asset bubble – in this case, a real estate bubble. When the bubble bursts, it’s not uncommon for investors to lose more than they paid for the property.
Owning and Renting Property
Many real estate entrepreneurs buy residential property to rent to others. Expenses can be considerable, including closing costs, maintenance and upkeep, property taxes, any existing debt, and problem tenants, among others. Because of this, this strategy makes sense when the rental income minus expenses is a net positive. This is known as a cash–flow positive property.
Once you purchase one property and build up some equity, lenders typically will lend you money for additional investment purchases (usually no more than 80% of your accrued equity).
Investing in Residential Real Estate
Other entrepreneurs buy and hold several residential real estate properties for property appreciation and rental income. Historically, in the U.S., home prices have appreciated over the long-term, and some analysts, such as Bespoke Investment Group, predict that globally, home prices will continue to appreciate over time. Some entrepreneurs purchase a property or multiple properties they feel will be appraised at a much higher value over a long time horizon (15 to 30 years or more). They may then sell those properties for a profit, keep them as a store of value, or hold onto them in the hopes of further appreciation. Long-term buy and hold strategies often involve improvements on the properties in question. Additionally, they often employ a property manager or the services of a property management firms to manage their holdings, uninterested in the day-to-day work of being a landlord. Again, these entrepreneurs look to build portfolios of properties for which the rental income minus expenses (including the services of a property manager/property management firm) is a net positive.
Investing in Mortgage Notes
Some real estate entrepreneurs buy and sell mortgage notes, to and from other investors, banks, and financial entities. The entrepreneur who owns a mortgage note owns a homeowner’s mortgage debt and is entitled to the mortgage payments the homeowner might otherwise pay a bank or other mortgage originator.
Zhang Xin, China’s Self-Made Real Estate Billionaire
BUILDING A BUSINESS BASED ON COMMERCIAL REAL ESTATE
Another way to make money in real estate is building a business based on commercial real estate. The most common is a holding company – a business entity designated as the “owner” of residential or commercial real estate property. Such an entity often provides the true owner certain tax advantages and insulates them, to a certain extent, from some forms of personal liability relating to property ownership. One can, and should, set up such an entity to buy; own and rent; and invest in commercial property.
Buying Commercial Property
Some real estate entrepreneurs seek to make their fortunes buying commercial property. Much like with residential real estate, they can do this with the intentions of making improvements on the property, driving up the value, and selling it; renting the property to commercial tenants; or holding it for price appreciation, in addition to rental income. Commercial real estate is often thought of, but is not limited to “office space”; it also can include retail storefronts; industrial buildings; multifamily apartments (usually four units or more); hotels; land; entertainment venues, such as casinos or concert halls; or sporting venues, such as stadiums or golf courses.
Owning and Renting Property
Commercial property rental income can be extremely lucrative, depending on the property, location, and tenants. A long-term lease of a retail space in a centrally located building could be worth anywhere from tens of thousands of dollars to millions of dollars per year depending on the location and size of the space.
Investing in Commercial Real Estate
Real estate entrepreneurs often invest in commercial real estate, developing portfolios of properties that not just provide lucrative rental income, but are also expected to appreciate in value over time. Many of these investors roll over the profits from their successful properties into new ones, leaving the daily management of the properties to property management firms.
Investing in Real Estate Securities
Real estate entrepreneurs can also invest in real estate securities, including, but not limited to REITs and municipal bonds. REITs are a form of limited partnership that is securitized. The limited partnership invested the monies raised from the sale of its securities on the capital markets in real estate, usually commercial. The limited partnership handles the day-to-day management of the portfolio of properties, including buying and selling them. The securities trade on the capital markets based on the market assessment of the limited partnership’s value.
Municipal bonds are issued by cities and states to raise funds for a number of different municipal initiatives, including capital construction projects. By investing in the debt issued to finance the securities, you are, in essence, investing in public property. Municipal bonds often come with certain tax exemptions, which can be advantageous to bondholders.
REAL ESTATE FINANCING
Real estate purchases can be financed in any number of ways. The easiest is an outright cash purchase, for those who can afford to do so. However, many real estate transactions are debt financed. Some entrepreneurs use home equity lines of credit, buy new homes while renting out their existing ones, or purchase duplexes or multifamily homes. It’s critical to know the keys to obtain favorable loan terms, such as having a sizable down payment and a strong borrowing profile, and looking at neighborhood banking institutions and alternative lenders, such as peer-to-peer lending institutions for options and flexibility. Sometimes the property owner will even assume the note for your purchase, meaning you pay them directly, a method known as seller carry-back. A thorough understanding of real estate financing methods is critical to your success.
ECONOMIC TRENDS AFFECTING THE REAL ESTATE MARKET
Real estate entrepreneurs should be aware of a number of key trends affecting the real estate market. They include, but are not limited to:
- interest rates – how expensive it is to borrow money;
- homeownership rates – a gauge of demand for primary residences;
- rental vacancy rates – a gauge of demand for residential rental properties; and
- geo-demographic shifts – where people are moving to or from.
There may be more or fewer factors at play with your planned investment, but it is critical that you know how all the key trends affect your market(s) of interest.
KEYS TO SUCCESS TO BECOME A REAL ESTATE ENTREPRENEUR
Each successful entrepreneur’s path is different, but there are some commonalities. Successful real estate entrepreneurs are clear about their real estate goals, often writing them down before taking any other step. They understand their market(s), because they do thorough and rigorous research. They determine their time horizon and exit strategy before entry. They put together a team of professionals to compensate for their knowledge deficiencies, including but not limited to: real estate agents, contractors, lawyers, appraisers, lenders, marketers, and accountants. And they do their due diligence.
Real estate entrepreneurs need to be tenacious. Real estate investing is not an easy thing to do and there are many people trying to do it. Successful entrepreneurs stick with their plan, adjusting it to address challenges, often setting aside a set time per week to pursue their real estate goals. It is also critical to study trends and use them to find opportunities.
Barbara Corcoran on Risk-Taking, Failure and How to Get Back Up
CHALLENGES OF BEING A REAL ESTATE ENTREPRENEUR
In addition to the aforementioned asset bubbles, financing is one of the biggest challenges in real estate entrepreneurship. It is challenging to be successful with a less than stellar credit history, or during periods where regionally or nationally, lenders are making fewer loans.
Another challenge is finding properties that provide the proper return on investment. For one, there are many real estate investors and aspiring real estate investors. Further, many properties require substantial work, rather improvements, payment of liens, or other investments of time and money. The time required in particular may not make particular properties worth it to investors. Finding those ideal properties that, after the time and cost, provide a lucrative return requires tenacity.
Other challenges include the many variables at play. With a typical rental property – commercial or residential, a hundred things could go wrong over which the investor has little control, from inclement weather to nightmare tenants. Proper contingency planning is essential. In fact, contingency planning is one of the only things in real estate entrepreneurship over which an investor does have control.
EXAMPLES OF REAL ESTATE ENTREPRENEURS
There are many examples of successful real estate entrepreneurs, but perhaps none more visible and vocal than Donald Trump. Trump has amassed a multi-billion dollar portfolio of commercial real estate across the globe. Another is Steve Wynn, who helped revitalize the Vegas Strip, through the development and refurbishment of popular Vegas resorts, such as the Bellagio, which his company owns.
On a smaller scale, real estate entrepreneurs like Janet French, owner of SilverMoon Entities, rehab, flip, and acquire income generating properties. But not every entrepreneur makes their money through property ownership. There are a lot of steps in the process of acquisition and opportunities to make money along the way. For example, take Ankit Duggal, the founder and owner of RER, LLC, which started as a firm focused on structure short sales for homeowners facing foreclosure, and now makes money by flipping these properties. While their paths may have been different, each of these real estate entrepreneurs set goals, researched opportunities, implemented their plan, and made adjustments to overcome the challenges they encountered.
Image credit: Flickr | Gage Skidmore under Attribution-ShareAlike 2.0 Generic.