103: How to Start Building a Real Estate Portfolio
Episode Transcript
Welcome to episode three of season one of the growing Empire Show. Today we're going to talk about how to get started building a real estate portfolio.
00:11 Welcome to Growing Empires, hosted by real estate entrepreneur and trusted investment advisor, Jennifer de Jesus. Growing Empires provides insight to building wealth through passive income-producing real estate investments for those who want to build and manage a more profitable real estate portfolio.
00:29 So how do I get started building a rental real estate portfolio? And since in this season we are talking specifically about passive income, we are going to talk about the steps that you need to take to find a rental property that will allow you to generate passive income.
00:44 So we're going to talk first about the factors of a great property: location, location, location. I'm sure you've heard this before, but location is one of the key factors that allows the value of your property to remain consistent. It also can be the number one reason why somebody does not rent to your property. Rentability is another one of those factors that we've got to consider. How quickly is your property going to rent and how consistently is it going to stay rented? Then we're going to talk a little bit about cash flow. And cash flow is the money that you're going to generate after you pay all your bills and expenses. And last but not least, we're going to talk about appreciation. Nobody wants to buy a property that tomorrow is worth less than it was today. So we're going to talk about how to find properties that are going to naturally appreciate versus properties that have the potential to lose their value. Let's get started on location. So location really has nothing to do with where you currently live. You may want to buy property in your current local market with the assumption that you're going to self manage.
And if you're thinking about doing that, then you might not even want to listen to this episode. First we want to take out or we want to decline properties that have some kind of extenuating circumstance that would create an uncomfortability to tenants for future rentals. Some of those things could be located by power lines. Not everybody feels the same about power lines. But some people believe that power lines cause cancer. And whether that's true or not is not really important. But it's something to consider when you're locating a property. You want to make sure that you're not on top of the highway, where noise is a factor or by a train, where again, noise is a factor. All of these things could be things that would affect the ability to not only rent your property, but for the property to increase in value. And location, most importantly, you need to consider what is the demographic of that particular area?
The best investment properties are located in areas where the population is increasing and the job market is very stable. In the next season we're going to actually talk about the real estate potential of the Lehigh Valley. And that's Lehigh Valley, Pennsylvania, which has a very consistent job market and is a fabulous place to invest in real estate. So definitely stay tuned for season two, when we specify a little bit more about location. Rentability is the next factor that we need to consider. Like everything else, you want to have the one product that's in great demand. Okay, so if you are investing in an area where there's very little population, okay, let's just say for an example, I want to invest in an area that has a population of 5,000. Or I can use my money wisely and invest in an area that has a population of 100,000 people—which one do you think is going to have a high rentability? It's going to be the one that has 100,000 people. So you're going to want to pay attention to the demographics of the location that you're investing in. And then you want to also pay attention to what else is happening in the market. So you never want to be the biggest house on the block. And you never want to be the smallest house in the block.
You never want to be the most improved and you would never want to be the least improved, you always want to make sure that your investment properties cover somewhere in the middle. You want to be able to get a good understanding of what is adequate or average to above average condition for rentals in those areas in the area that you're trying to invest, and what would be considered an over-improved investment property.And it's we're going to go into detail about why you don't want to over improve your property. But for our rentability factor, everybody wants a nice clean apartment, in a nice area, where they feel safe, where they can go outside, leave their windows open, maybe leave their door open. And you're going to want to think about regarding rentability, you're going to want to think about things that are important to tenants. You're going to want to put yourself in their shoes for a minute. So think about things like parking, laundry facilities, anything that makes life more convenient is going to be something that's in high demand.
So from a rentability factor, if you know I'm buying a property that's located next to a highway and it's super noisy and I work nights, so I sleep during the day and during the day is when most people are traveling on the highway, that's going to be a rentability problem for you. So the other things that affect rentability are access to the unit, right? How many stairs are there to get in? Can I get my furniture in? You know, those are things that tenants will think about. So from a rentability standpoint, not only do you want to consider the location, but you want to consider the population of the area, but you also want to consider what factors would be important to tenants. Cash Flow is going to come down to does this property achieve the goals that you have lined up? Right? So if your goal is to replace your income from your job, will you be able to get enough cash flow out of this property that if it doesn't replace your income immediately, does it give you the opportunity to buy another investment property, where combined, they could potentially replace your income?
05:58 The episode will continue and just a moment.
06:02 It's true passive income from real estate investing is the secret to building wealth. However, portfolio development takes a great deal of time and experience to be successful. It's important to protect your portfolio so that it remains strong and can continue to provide you with passive income you desire. I help investors bulletproof their investments by developing a portfolio strategy that hedges economic cycles and provides for consistent income growth. I can do that for you too. Start by scheduling a call with me at growingempires.com. Whether you're a new investor or have several properties that need better management, I can help. Schedule a consult today at growingempires.com, that's growingempires.com, and we'll make your portfolio stronger than ever.
Cash flow is really the money that you're making after all of your expenses are paid. So you collect rent, then you pay your mortgage, you pay your taxes, you pay your insurance, you potentially pay utilities, then you have to pay for vacancy or what they call carrying costs when a tenant is not occupying the property, and then you also have general repairs and maintenance on the property and potentially even capital improvements. Things like roof windows boilers, you know, that sort of thing. So, after all that’s said and done, after you've paid all of your expenses, after you have paid your mortgage, your bills, your taxes, utilities, everything, how much money is left over, that's your cash flow. So when you're analyzing cash flow, you're going to want to look at how much money will I make this year, how much money will I make next year? And how long am I gonna need to have this property or hold this property to be able to realize the cash flow that I'm looking to achieve?
Appreciation is really the value of your property growing. Appreciation can actually be achieved two different ways. The first way that appreciation is achieved is just natural market conditions, right? So the value of the properties in the area are increasing, how much are they increasing? In our particular area, properties increase anywhere from 2 to 4% per year. That's natural appreciation. The other way to achieve appreciation is something that I like to call forced appreciation. I don't even know if that's a real technical term, but it's certainly one that I made up and one that I use commonly to talk to clients about appreciation.
Because it’s a big key factor in buying safe investments or investments that will shield your risk from economic changes. So appreciation, forced appreciation, let's say, is appreciation that is achieved by you doing work on the property and maybe not you specifically, but in general, a plan that is put to place on your property. So how you force appreciation in a property is a couple of things. One is you increase rents. Two is you decrease expenses, and three is that you could actually do repairs and maintenance to the property that allow you to achieve market rent on a property. Okay, so let's say for a quick example, I get ten thousand dollars a year out of gross rent. And if I threw everybody out of that property, and I did some renovations, I would be able to achieve $20,000 a year gross income. That is appreciation, the difference between the two is appreciation, right? And you can achieve appreciation very quickly in passive investments if you find a partner that is able to understand your financial goals for the property.
09:31 So, for example, when we take a property on a new property that we help somebody invest, the first thing that I do with the investor is I sit down and I talk to them about their financial goals. I mean, and quite honestly, I know this long before they buy the property because we've got to make sure that the property is the right one. But those goals that we identified, and the cash flow that that we projected to determine that this was a good investment are the same goals that we use starting day one, when we are trying to now map out a plan to get to that forced appreciation. Okay, so it's very important when you're looking at factors of a property, and finding the great rental properties that you're going to look at location, rentability, cash flow and appreciation. And I cannot stress enough that if you do not know all the answers to all these questions that you need to seek professional help from a market expert or an investment expert that can help you identify the right types of properties to buy.
So, let's fast forward. Let's say that now we've determined what location we're going to buy in because it has a great ability to be rentable, achieve good cash flow, and is going to appreciate Well, we've identified the location, the next step is now we've got to find the property. So to find the property, again, a couple things that you need to know. You need to know the market. You need to know all the nuances of the market. You need to be able to learn how to value properties, and which evaluation makes the most sense for whatever your goals are. Everybody values properties very differently and I learned this very early in the game. It does not mean that there is one right way. As a matter of fact, there's not a right way. And I don't know that I've even seen wrong ways.
But what I have seen is I've seen people take valuations that they saw online and use them as their gospel for their own potential investment properties. And if that valuation does not match the type of investment that you're trying to buy, or whether or not you want a passive income vehicle or an active income vehicle, you're going to have some problems. And then we're going to need to analyze rents and the competition to determine whether or not this investment property makes a sound investment property. We need to make sure that we can nail down expenses and sometimes that's hard based on the type of property you're getting and who the seller is. We're going to need to be able to locate bargains and negotiate deals, and all of those things are the factors that truly affect the acquisition of the property. You need to know and be able to classify what type of investment property you're going into. So do you prefer A-class property properties that really are the cream of the crop? The best condition highest-end finishes. In the best areas in hot markets, usually in downtown areas where those units only appeal to a very small population of people. B-class properties are typically in a little bit more suburban areas or nicer sections of the city.
And then C-class properties are really your truly your paycheck to paycheck type of people. And C-class properties could also be your government-funded housing, Section 8 housing, that sort of thing. So knowing the market is going to require you to know what class of property you're going to want to get into. And it's going to require you to know what to expect from the tenancy pool in that particular market. The best way to do this, quite honestly, is to find a real estate professional in your local area that has hands-on experience with investment properties, and has their pulse on the rental market in that local area. Then you're going to need to learn how to analyze rents in the competition, right? So if I'm going to buy a property and I'm looking at a property that everybody's paying $500 a month for rent, I need to know if that is market rent below market rent, grossly low, what exactly is it? And what is the endgame for that unit? What is the max rent that that area is willing to bear? What is the max that somebody is willing to pay to rent that property or keep it consistently rented year after year? This is something that's really important that you do not guess at. So many people go into markets and they invest and they think if I make the property look the nicest people are going to pay anything that I want to get.
And sometimes rents are determined by what an investor puts into the property. So if they spent, you know, let's just say $10,000 to renovate a unit, and they now need to get that investment back in under a year, they're gonna want to ask $1,000 or more for rent per month, right? And if, if that's the case, is that market rent for that area? Or is that too high? When I watch people look at rents, I look at people that think that the market can be similar to what the market is in other areas. And that is completely wrong. And I will tell you that you want to stay away from that. You have to have a local expert that can help you analyze the rents and know exactly what your competition is, so that you can make sure that your property can achieve that.
14:23 Just because you improve the property to the the most amazing unit that's out there does not mean that your rent can go higher than what market rent is for that local area. And I cannot say this enough, because I watch people make this mistake all the time. Remember what I said before, you never want to have the biggest property with the nicest finishes and you never want to have the property that is the smallest with the least amount of finishes. Those are the extremes that you just want to stay away from. You want to find yourself in a comfortable place somewhere in the middle, if you want to make sure that your investments are going to be recession proof, and you're able to shield your risk. So know your competition, know what's being built in the area, know how those finishes compared to where you are and where your location is and what amenities you have in your building. And then after you've analyzed the rents and the competition, that's kind of like your ceiling for lack of a better explanation, that's your ceiling. That's, that's where you can go to, right, to really sustain occupancy.
15:29 Then you need to nail down your expenses. This can be a very, very, very difficult task, depending on where you're buying properties. But specifically, you want to look for things like who pays what expenses, what expenses are landlord paid expenses, and do they make sense? One of the most common expenses that I see miscalculated or misunderstood is insurance on properties. Reissue rates on insurance are not the same as what a current owner probably has. So the current owner says that my insurances $1,000 and you think to yourself, that sounds kind of light, it probably is light, because reissue rates are much higher on insurance. The other thing that is a factor and insurance rates are, how many policies do you have? Are you getting any kind of bulk discount? Do you have liability policies on top of your homeowners or your hazard insurance, all of those things are going to affect your insurance rates. So it's important that you check with an insurance company to help you figure out what insurance is going to be in your local area.
Taxes are really simple to find out. You just need local tax records to know what the tax costs are. So the most important thing that you've got to find from the seller is you need to have a history of expenses. And most sellers are reluctant to give you this information, but you're going to need to insist that you have a good foundation understand what the past expenses are so that you can help predict the future expenses. One of the ways to do that is you can get a T-12. A T-12 is a trailing 12 months is what that stands for, trailing 12 months of expenses, and if you get a T-12, it will tell you exactly what the owners spent and the entire last year that they own this rental property. That is going to help you have a really good indication of what to expect in the future. If you cannot get a T-12. You can ask for utility bills, you can even call your local utility companies to figure out what the average bill is for that utility. I suggest that you never ever listen to a seller—a seller is going to tell you, and their agent, quite frankly, they're going to tell you what, what you want to hear. They're going to tell you, oh, my water bill is only you know, $500 for the year, when you know that that's not the case. So you can call the local utility companies, you can get a copy of the bills.
You can also ask for a Schedule E off of a tax return. A Schedule E is it's a rental property portion of a tax return. So a Schedule E would be another good thing that you could get. And then once you've analyzed the rents and then you've nailed down the expenses, you're going to be to create a valuation of the property, you're going to want to make sure that your valuation is not a one step valuation, right. We're not just valuing cap rate cap rate does not tell all the stories that you need to know about this investment property to make a decision whether or not it's the best investment property for you. So make sure your valuation is complete. We want to make sure that we're considering debt and equity.
We want to make sure that we're considering depreciation. We want to make sure that we're considering appreciation, cap rate, cash flow, cash flow before and after taxes. And you're going to also want to make sure that you are looking at your return on equity. Those are all the functions of a great valuation of a property. Then after we have figured out how we're going to value a property, we know the market we analyze the rents and the competition, we've nailed down expenses. Now we've got to negotiate the deal. And negotiating the deal could be a hard task. It depends on the current market of wherever you're investing. So it's important that you know the market as I said before, because you need to know are you in a buyers market or in a seller's market. And if you're in a market that has low inventory, you can expect that there's going to be a lot of competition. So you're going to need to prepare for this. And that may cause you to need to react faster, so that you do not lose a potential deal. If you're in a market where there's a lot of inventory, you probably can be more aggressive in your offer.
So there's a lot of different strategies to negotiating the best deals. But it all comes back to knowing the local market and knowing that the segment that they're in, perhaps you're going to want to find deals and locate bargains other ways. You might not want to look on market, you might want to find off market deals, you might want to look at short sales or foreclosures or sheriff sales, things like that. I definitely challenge you when looking for deals, especially if you're looking for on market stuff, I think the most important piece of information that I can give you regarding sourcing deals in general is you never want to be doing what everybody else is doing. You never want to be doing what everybody else doing. So if everybody is buying properties on market, you want to buy properties off market. If everybody's sourcing properties off market, you want to buy the on market stuff and so on and so forth. Essentially, you always want to be going in a different direction than what the typical market is doing. Because that is where you are going to locate in source and be able to negotiate the best deals for yourself.
So we have identified where we're finding properties, we found an area that we're going to invest in because location is great, the rent ability is good cash flow is possible. And appreciation is awesome. Then we've identified the properties, we've gone out, we've contacted a local market expert, they helped us to know how to locate bargains and negotiate deals. They know the market really well. We've analyzed rents and competition, we've nailed down our expenses, and we were able to valuate the property and really figure out where we feel comfortable buying this deal. Fast forward to we own a couple of investment properties. Now what? How do we scale? Now you've got one or two properties under your belt, you own your first maybe first and second investment property, and now it's time to continue to build that real estate portfolio. So how do you do that?
Well, the first thing we want to do is we want to rinse and reuse our cash flow. So as we talked about cash flow before cash flow is the money that you are making after all your expenses are paid. And as long as you don't need to pull out that cash flow currently, and you're trying to build that passive income portfolio, what you want to do is you want to take that cash flow that you've generated off of your first investment property, and you want to figure out how to reuse it to buy more investment properties. So your very first investment property likely is going to use a little bit of your personal income—money that you've made over the years or saved over the years. But after you get past that first property, the wealthiest people in the world figure out how to reuse their money or use somebody else's money even more importantly. So it's very common for people to start with 5, 10, 15 $20,000 and then never invest another dime of their money if they do it correctly.
And through season one, I hope that we're able to show you quite a few ways to do that. And over the courses of, you know, the next couple of seasons, you're going to hear us talk a lot about reusing that money, reusing that capital, reusing that cash flow. And we're going to keep repeating that process until we're in a position where we can roll up, then we're going to utilize things like a 1031 Exchange to trade up to a better property that has greater cash flow, a larger portfolio or to add additional units to our portfolio. So just keep in mind that real estate portfolios, although the very first property that you buy may require some of your time, attention and beginning capital, if done right, your passive income can be generated by using other people's money other people's time, other people's attention and none of your own money in the future. And that is the secret to building wealth. I hope you enjoyed episode three. In episode four, we're going to talk about how the money works in real estate investing. Until next time, take care.
23:16 For more information about how Jennifer can help you plan, develop and manage a strong real estate investment portfolio, visit GrowingEmpires.com,
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