January 15, 2022 • 6 min read • Real Estate

 

In the nearly limitless world of investing, real estate is often viewed as a reliable choice. Real estate can even be a starting point for first-time investors, given its tangible nature and ubiquity. However, getting started in this asset class can be intimidating for those who do not know where to begin. In this article, we will walk through some of the basics of getting started in real estate investing.

 

 Real Estate Property Types and Zoning

The multiple types of real estate offer investors the ability to choose which type is most suitable based on varying investment and income needs at any given time. First is residential real estate—a type of property developed for people to live in. Apartment complexes, single-family homes, and multi-family homes (four or more units) are all examples of residential real estate.. Next, is commercial real estate, and this consists of property that is solely for businesses, mixed-use, or any other property that is zoned as such. Though many consider larger multi-family properties (4+ units) as commercial, we will distinguish the two as separate in this article. 

Zoning is an effective way of organizing a city into sections. Each area or lot will have a designated zoning regulation laws or ordinances, meaning that only certain types of buildings or land usage will be allowed on each lot (often referred to as permitted land use. Raw, undeveloped land is another type of real estate, though it is a much more tedious project to invest in. Look for future Yieldwink articles about real estate investing and raw land development. 

 

Before Beginning to Invest…

There are some useful steps to take before investing in real estate. First, it is important to have an understanding of the basics of real estate before learning more about investing terminology (see Terminology section). Get to know current local market conditions and trends. This could make or break one’s investment outcome. Of course, real estate requires a down payment, so it is critical that investors save enough capital for a down payment and any other closing costs necessary for the purchase. Additionally, build relationships with real estate agents, attorneys, and mortgage lenders. These connections may make the difference between investing at a premium or a discount. 

When getting started with real estate investing, it can be easy to get overwhelmed or bogged down with the specifics involved. Prior to jumping on the phone or visiting a website to find your investment property, become familiarized with a few key terms that investors use to determine the desirability of an investment, usually based upon financial metrics.

 

Terminology

The following are a handful of key metrics to become familiarized with when beginning real estate investing:

  • Net Operating Income (NOI) – The NOI is a calculation that takes into account all the revenue an investment property brings in (rent, laundry income, etc.) minus any operating expenses (insurance, taxes, maintenance costs, etc), but before accounting for your debt service (mortgage).
  • Cash-on-cash return (CoC) – This is a basic measure of investment performance that calculates the amount of cash an investor has made over a set period of time (typically one year). It is calculated by taking the net operating income and dividing it by the cash invested in a project over that same period of time. Single family home investors will typically consider this metric. For example, if $100,000 was placed as a down payment on a property that cash flows $10,000 a year, the property has a CoC return of 10% ($10,000/$100,000). An investor's CoC return should be based on the risk involved in the investment. 
  • Capitalization rate (Cap rate) – This is another one of the most basic metrics for measuring an investment property's performance. The capitalization rate, sometimes called the “cap rate”, is a ratio that shows the net operating income as a percentage of the total value. Higher cap rate properties are higher cash-flowing, though typically come with a higher level of risk. This financial metric is more commonly used on commercial and multifamily properties.
  • Internal rate of return (IRR) – This measures the overall profitability of a project based upon your initial cash outlay and all expenses over the life of the investment. It is calculated by taking the initial cash investment and annual returns and discounting them at a compounded rate of return.
  • Debt coverage ratio (DCR)– This is one of the most important real estate metrics that determine if you can get financing for your property. The DCR measures how much net operating income will be available to pay back debt service (loan payments, property taxes, and insurance). This ratio is calculated by taking the net operating income and dividing it by annual debt service. Lenders typically like to see a debt service coverage ratio (DSCR) of over 1x. 

 

In addition to the key metrics above, below are a few other important real estate terms to know:

  • Tenancy – This term refers to the relationship between a landlord and a tenant.
  • Lease – A contract that states the terms of a tenancy. This includes where the property is, how much rent you will charge, when it is due, and etc.
  • Property manager – A person who manages real estate property on behalf of a renter or owner. They are responsible for maintaining the property as well as securing suitable tenants and collecting rent from them. 
  • Operating expenses – These are all expenses related to running an investment property such as utilities, repairs, and etc.

The Investment Process

Now that common terms and financial metrics have been established, it is time to dive into the investment process. Once a prospective investor has identified their area of interest and investment criteria (specific COC or IRR targets), it is time to begin testing the waters.

For single-family homes, investors can use the Zillow mortgage calculator to get a rough estimate of the monthly mortgage cost, which is based on the deposit amount. Insurance companies can provide quotes for homeowners’ insurance, and this number may be factored into the mortgage calculator.  Property taxes are often determined using the local county website; however,  after the property has been purchased, the assessment value of the property may increase, causing an increase in property taxes. It is best to consult an attorney or the local county tax assessor for more information. Once determined, visit a website such as www.renometer.com or zillow.com to view local rental rates among similar properties. It is prudent to track the results for each property to determine the average CoC in the area. This will help identify what some may call a "steal" of a deal. Investors will usually consider CoC and IRR for single-family homes, as opposed to cap rate, which is more often utilized in multi-family or commercial properties.

Speaking of multi-family, larger projects come with larger responsibilities. Multi-family properties require heavier due diligence. As the first steps of diligence, it is important to determine the cap rate of the property and then to compare it to other similar  properties that have sold in the area. This would be a good time to utilize an agent/broker to have them run comparisons with recently sold properties in the area. Ensure that the appropriate documents have been collected from the seller needed in order to conduct buyers’ due diligence. Have an attorney review legal documents and hire an inspector to inspect the property within the due diligence phase. Provided the complexity involved in larger purchases, we recommend beginners start small and then scale up over time. 

Usually in larger deals, syndications will involve two or more investors. This method of investing is common amongst passive investors—who are investors that want to collect the cash flow from the investment but do not have the time or desire to be part of the day-to-day activities of operating the property. In this case, sponsors/managers take control of the day-to-day activities for a small fee (typically 2% of invested capital). Passive investors prefer syndications, as they allow the investors to participate in larger deals for the  higher return potential and cash flow. Not all managers are the same, so diligence is due when choosing a manager/sponsor for a syndication. The Yieldwink platform, www.yieldwink.com, offers investments that can be syndicated amongst multiple investors. 

Closing Statements

As a first-time investor, due diligence is imperative. Real estate is largely considered a team sport, so be sure to align with the right team of lenders, agents, and attorneys. With the right team and proper due diligence, it is only a matter of time before a real estate empire is born. For those that prefer being a passive investor to avoid the everyday chores that come with active investing, consider crowdfunding platforms or syndicated offerings. Yieldwink.com offers highly vetted, institutional-quality investments for all investors. The platform also offers complete passive strategies for investors. For more information or to sign up to learn more, visit www.yieldwink.com.

 

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