Many new investors dream of having a full real estate portfolio. However, it's not always so easy to know how to get there when you've barely purchased any real estate. With that in mind, below is a guide to building your real estate portfolio. You'll learn what a real estate portfolio is, how building one works, and how you can track metrics to measure its success.
What is a real estate portfolio?
At its core, a real estate portfolio is a collection of investment assets in the real estate sector, all held by one group or individual. Also known as a real estate investment portfolio, this catalog can include both current and past real estate deals, as well as different types of real estate assets.
Although no two investors' portfolios will look alike, portfolios can include investment properties, rehabs, or real estate investment trusts (REITs) or real estate mutual funds. They can also include properties from different asset classes, including single-family homes, apartment buildings, or commercial property.
While all portfolios look different, they all have a similar function: They all help real estate investors get closer to achieving their financial goals. While many investors dream of building a portfolio that will let them achieve financial freedom, some use their portfolios to achieve more tangible goals, such as paying for their children's college educations or saving for retirement.
How to build a real estate portfolio
Every investors' portfolio will be unique, but the creation process tends to follow the same general pattern. We've listed the steps for you below. Follow them to get started on building your portfolio ASAP.
Step 1: Get clear on your goals and investment strategy
Since the whole point of building and maintaining a real estate portfolio is to help you achieve your financial goals, the first step is to have a clear vision for what you'd like your portfolio to achieve. Are you an investor hoping to create another source of reliable monthly income to help with bills? Or are you hoping to build a business that will allow you to achieve financial freedom?
In this case, there is no wrong answer, but knowing your end goal for your portfolio will help you decide on your investment strategy. Keep in mind there are lots of different ways to invest in real estate. With a buy-and-hold strategy, you can buy investment property and rent it out for profit. Meanwhile, with a fix-and-flip strategy, you can buy properties, fix them up, and then sell them for much more. Alternatively, if you're looking for more passive income, you can invest in a REIT similarly to how you might invest in stocks.
When you're first starting out, it makes sense to pick one investment strategy and stick to it. You can worry about diversification later.
Step 2: Create your real estate investment business plan
After you've picked out your objectives for your portfolio and investment strategy, the next step is to create your real estate investment business plan. While this may seem like a lot of work, it's worth doing. Creating a business plan will help you get clear on specific, shorter-term goals and help you come closer to achieving your objectives. It will also help you define the strategies you intend to use to achieve those goals.
Also, while it's not a requirement to do so, if you do intend to bring partners in to help you finance or manage your first investment opportunity, having a completed business plan can help assure them you're serious.
Step 3: Buy your first investment property
Then, it's time for the most exciting step: Your first real estate transaction. You'll want to work with a team of experts with experience in the real estate industry, including a real estate agent and lender. They can help you identify the best real estate deals and financing methods for you.
But when you're buying an investment property, it all comes down to the math. Once you have a property in mind you think might make a good investment opportunity, perform a investment property analysis in order to make sure it makes financial sense.
Step 4: Buy more properties over time
Over time, it's important to grow your portfolio, which means buying new properties and adding them to the mix. However, when you're juggling multiple pieces of rental property or multiple properties in the process of being renovated, it can be hard to keep everything organized.
To that end, we recommend keeping a real estate investment spreadsheet to help keep all the numbers straight.
Step 5: Diversify
Eventually, it will be time to diversify. At its core, a diversified portfolio ensures you're taking less risk with your investments. There are a few ways to diversify your portfolio while still keeping your money in real estate, including:
- Diversifying your real estate market: If you've been investing in your own neighborhood, consider spreading out some of the risk by doing long-distance investing and exploring other markets.
- Diversifying your asset class: If you still want to focus on mainly acquiring rental property, consider branching out into apartment buildings or commercial spaces. Meanwhile, if you still want to stay within commercial real estate, consider buying and renting out a retail space rather than an office space.
- Diversifying your investment strategy: If you've been mainly buying investment properties, you could consider investing in a REIT, a real estate mutual fund, or a real estate ETF.
How to measure the success of a real estate portfolio
The easiest way to measure the success of a real estate portfolio is to hire a portfolio manager. Most portfolio managers will conduct an initial investment audit and make recommendations on how to strengthen your portfolio based on the results.
However, if you're interested in taking a DIY approach, it's important to look at every investment individually. Below are a few metrics you can use to measure each investment's success:
Net cash flow
Another way to describe net cash flow is simply to call it a yearly measure of the property's income minus its expenses. In addition to deducting for expenses like unit maintenance or utilities, you can also deduct your debt service payment if you've been financing the property.
At its core, net cash flow will tell you whether you're making or losing money on the property.
Next, you can find your cash-on-cash return by taking your net cash flow and dividing it by your initial investment. This measure can easily help you see how your investment is performing in real time. Additionally, you can use this metric to compare your property to other available properties on the market to determine if your income is falling behind the curve or exceeding expectations.
Economic vacancy rate
For a multi-unit property, your economic vacancy rate can help you decide whether it's time to raise rent. Typically, having a 100% occupancy rate means you're charging below-market value. In that case, while raising rent may mean a greater vacancy rate, it can increase your overall profits.
To find your economic vacancy rate, multiply the number of vacant units in your building by 100, then divide that number by the total number of units in your building. With this metric, it can also help if you know the average vacancy rate for your type of property in your area. That way, you have a basis of comparison for your property's performance.
The long-term benefit of holding real estate Investments is capital appreciation. If properties in your area are appreciating at a great rate, it may be worth keeping a property, even if your immediate income is limited.
Ideally, you'll want to look for your real estate market to have an appreciation rate greater than or at least matching the national average.
The Millionacres bottom line
Building a portfolio of private real estate investments is no easy task. However, with a little luck and a lot of due diligence, it can be done. To that end, use this post as your guide to building a great real estate investment portfolio. Armed with this knowledge, you should be able to create a portfolio that's aimed at helping you achieve your larger investment goals.