When you’re putting your real estate investment plan together, you probably start right at the end: imagining solid returns after experiencing limited volatility along the way.
But while the end goal is exciting, you won’t get anywhere unless you start off right. And we don’t mean a deep dive real estate market analysis (yet). Success all starts with you.
While you may uncover or be presented with tempting opportunities to invest, you must be certain any deal matches your capabilities, goals, and investment preferences in the first place. Otherwise, you could be regretting unintended consequences that could stretch your finances and cause you stress.
To help maximize your chances of success, here are the key questions to ask yourself before investing in real estate.
Will I be an active or passive real estate investor?
This fundamental question is a hard left or a hard right, as these paths are divided by a thick line.
Two criteria will determine which is right for you: whether you’re hands-on or hands-off with your investment and your tax benefit preferences.
Hands-on or hands-off
Active investors take a hands-on approach. They have the expertise and the available time for tasks like scouting properties, putting together financing, or managing the property themselves. While some of these tasks can be outsourced, such as using a property management company to handle tenant leasing and building maintenance, it’s your project and potentially your headache whenever anything goes wrong.
If you want to take full control and you can handle tenant calls in the middle of the night when the heater breaks, this is your road.
Passive investors put up capital and then hire experts for each aspect of the deal, such as investing in a real estate fund. Though they may make some decisions and have some oversight, they are not involved in the day-to-day management of the investment.
If you want to invest in real estate but lack the time, desire, or expertise to be in control, this is your road.
Tax benefit options
Both active and passive investments have tax advantages.
1031 exchanges can allow active investors to defer their capital gains taxes. They also enable a “like-kind” exchange of real property. For example, if it meets conditions, an investment property in one market can be traded for property in another, even if that market is out of state or a different class, such as trading single-family property for a multifamily property.
Thanks to the Tax Cuts and Jobs Act (TCJA), passive investors can take advantage of what are known as pass-through investment structures. This can bring a 20% tax deduction.
Through the TCJA, both passive and active investors can invest in qualified opportunity funds. Contributing to these funds allows you to defer and reduce capital gains taxes for any contributions.
What’s my successful real estate investment?
Some real estate deals are quick fix-and-flips for cash while others are long-term, appreciation-driven strategies for building wealth over time. Before you review any opportunities, you must be clear that your investment goals line up with those of the deal.
To help you define success, consider your target return on investment and other benefits, liquidity needs, and your retirement or other investment goals.
Return on investment and other benefits
While making money is the basic aim, you should define it more specifically. Sit down with a pen and paper or fold open your laptop and write out your goals.
- What’s your target return on investment (ROI) and will this deal meet the mark?
- Are you interested in real estate to build toward long-term wealth or see what profit you can turn as a side hustle?
- Do you want to own a property with secondary benefits, such as a vacation rental with occasional free stays for family and friends?
Can’t overlook this one. Real estate investments can make it tricky to get your money back on short notice, and you need to make sure your finances are in shape without your capital at hand.
- Can you part with your capital for an extended period, or do you need the money back in the near future to pay a debt or cost?
- In a financial emergency, would you still have enough money to cover your expenses?
Retirement or other investment goals
You’ll want to match your investment’s maturity date with any retirement or other important timelines.
- If you’re using this investment to boost retirement savings, are you decades away from retirement or a few years away from retirement?
- Will profits from this investment be used to pay for a specific cost, such as your son or daughter’s college tuition?
Putting it all together
Real estate investing can help create long-term wealth or shorter-term gains.
But like going out for a hike without considering the terrain, you need to be sure about where you’re headed or you could end up wearing sandals in the mud, so to speak. Be sure to ask yourself these key questions before you pick an investment and set your course.
Now that you know what to consider when investing in real estate, you can outline the steps in your pathway to realizing your goals.
At Birchstone Investments, we help investors create passive income streams and grow long-term wealth through strategic multifamily real estate investments. If you’re interested in learning more about commercial real estate investment, join our investor community today.