About a month ago, I published my personal written financial plan to help act as a guide for anyone still working on crafting their own. Real estate investing is a big part of my plan.
On my financial priority list, #4 is
Since posting my financial plan, I have received a ton of emails from medical students, residents, fellows, and attendings all expressing interest in learning more about my real estate investing strategy and asking for more specifics.
And I am really happy to share my strategy here for you!
What are the different real estate investing strategies?
Before getting into my personal strategy, I’d like to review some of the basic different ways that someone can invest in real estate.
My preferred vehicle is active real estate investing so I will cover that in more depth a bit further down in the post.
Passive real estate investing
Passive real estate investing is any investment into real estate that you make with your money alone. You contribute no “sweat equity” to the venture.
You simply hand your money to someone else (usually a group) and they use that money to invest in real estate. The most common forms of this type of real estate investing are syndications and funds.
In a syndication, you and a number of other people pool your money to buy and invest in one property. In a fund, you are contributing along with others to a large pool of money used to invest in many real estate investment properties.
If you performed your due diligence well with the passive investment that you choose, they do well and you receive a return based on the structure of your investment.
These investments can use Buy & Hold, Buy & Sell, Fix & Flip, or any other real estate strategy to turn a profit. They are all passive in this instance because you are not the one doing the work.
Sounds pretty sweet right?
Why I don’t invest passively in real estate (yet)
As you can see, there are advantages to passive real estate investing.
For one, you don’t have to contribute any sweat equity to the investment. You contribute your money and when the investment does well, you get paid.
The flip side to this, however, is that the performance of the investment is decidedly not in your control.
You had better be sure that you trust the syndication or fund that you are giving the money to. Because if the investment loses, you don’t get any profits and lose your money as well.
For this reason, it is extremely important to perform extensive due diligence on these investments before going into one.
The problem here is that any past performance cannot guarantee future performance and again, there is little control. These funds will often set out pro forma or expected returns. But these are really just guesses. They have no responsibility to live up to these returns.
Lastly, the real money in these investments is going to the people who are putting in the sweat equity.
Of course, the active partners of the fund or syndication are going to set things up so that they see the majority of profits if the investment performs well. I mean this is really only fair. You’re paying a big tax in exchange for being able to be passive in the investment. And, while we’re on the topic of taxes, many of the tax benefits in active real estate investing don’t pass to you as a passive investor.
I’m not saying that passive real estate investing is bad. Many people do it very well, I just prefer an active strategy. If passive investing sounds like it’s up your alley, I suggest you check out Passive Income MD’s blog.
Active real estate investing creates true wealth
Active real estate investing, in the meantime, is any form of real estate investing in which you are actively involved (duh!) and getting your hands dirty. This doesn’t necessarily mean that you swing the sledgehammer or fix the toilet. But you are involved in the operations of your real estate business.
There are many forms of active real estate investing. These include Buy & Hold, Buy & Sell, Buy, Fix, & Sell, Buy, Rent, & Hold, etc. Again, the commonality is that all of these pursuits require your active attention beyond just writing a check.
Active investing allows the investor to adjust and personalize the amount of control that she wants over her investments
She can buy a property, rent it out, and self-manage the property. Or she can buy that same property, hire a property management company, and just get a profit/loss statement every month. This can be adjusted anywhere along the spectrum and changed at any time.
Most importantly, in active investing, the profits all go to YOU! You can then decide if you want to pay employees to defray some of the hassle or if you want to just pay yourself.
TPPS real estate investing strategy
Ok, with that primer set, let’s get into my actual real estate investing plan. I must acknowledge Kenji and Leti at Semi-Retired MD, who taught me so much of what has become my REI strategy.
My wife and I have chosen to focus on Buy, Rent, & Hold multifamily investment properties.
There are a number of reasons that we decided on each of these sub-strategies:
- Buy – Well, you can’t own real estate without buying it so there’s step #1
- Rent – By renting the properties, we can have the tenants pay our mortgage with their rents. In addition, since the total rents exceed the mortgage/tax/insurance/etc. payments, we keep the extra money as cash flow.
- Hold – The overall real estate market is not unlike the stock market. They both go up and down in the short term. However, in the long term, they generally go up. So, in buying properties that cash flow and holding them for a long time, we can increase the chance that the property gains value by the time we eventually plan to sell it.
- Multifamily – By increasing the number of units under one roof, you decrease the cost per unit, increase profit in general, and make your business more efficient. Right now, we are starting with 2-4 unit properties but will go bigger in the future.
Cash-on-Cash is our metric of choice
There are a ton of different metrics to evaluate real estate properties and they all depend on what you are hoping to get out of them.
For us, cash flow is numero uno. The way to measure cash flow is a cash-on-cash calculation.
Cash-on-cash = Yearly cash flow/Amount of money that you put into the property
In this equation,
- note that the yearly cash flow is the amount of cash you make each year after all expenses including mortgage, insurance, etc. are paid, and
- the amount of money that you put into the property is the exact amount that actually came out of your pocket
For instance, if I bought a $100,000 property with a mortgage and 20% down with $5000 of closing costs, the denominator in the above equation (amount of money out of my pocket) would be $25,000. If the property cash flowed $2500/year, $2500 is my numerator. And my cash-on-cash would be 10%.
Our goal is to find properties that will cash flow >10%. Most properties will not meet this goal off the bat. Instead, we look for ways to tap hidden value – ways to increase rent or decrease expenses – that others don’t see in order to reach our goal of >10%.
That cash flow doesn’t seem like that much…is it worth it?
Don’t be fooled by the initial numbers.
One property will not make us wealthy. In fact, the cash flow we get from our actual first property is a drop in the bucket compared to our W2 income. (In fact, it’s equal to 1.6% of our W2 income)
But we are not in it for one property, and neither should you.
Let’s go back to our example property.
We buy it at $100,000 for 20% down with a 15-year mortgage and have $5000 in closing costs. After monthly expenses, we cash flow about $208/month for an annual cash flow of $2500. We save this extra cash flow each month to reinvest in future real estate.
In 15 years, the property is ours, free and clear, as the last mortgage payment is made.
In that 15 years, we would have continued making cash flow each month. Plus, the mortgage is now paid off completely by our tenants. That means we have 100% equity in the property. Plus, the property likely appreciated in market value over that long time period (15 years) due to the upward trend of the overall real estate market.
Now we can take the money we made from cash flow to buy another bigger property and repeat the process.
But wait, there’s more
Let’s just say instead of buying one property in the beginning, we saved and bought one each year.
Now, say we used advanced techniques like forced appreciation to increase our cash flow and market value so we could sell the property at a profit sooner than 15 years.
Let’s say when we sell our properties, we do so using a 1031 exchange for another property so that any capital gains are tax-free.
Let’s say with each property, we take advantage of cost segregation/bonus depreciation to claim paper losses despite accumulating real profits from our real estate business. Now we have passive losses to offset passive gains on your taxes.
Or even better, let’s say we claim Real Estate Professional tax status and are able to claim these paper losses against our W2 income. This would save us tens or hundreds of thousands of dollars in taxes.
This is how wealth is created!
Let me break it down into one sentence
So, in a one-liner, the TPPS real estate investing strategy is to buy, rent, and hold multifamily real estate investment properties with expected cash-on-cash of >10%, taking advantage of the tax benefits of real estate investing to maximize our growth.
If you want to learn EXACTLY how I screen and analyze potential investment properties, read this post.
And I’m putting my money (lots of it) where my mouth is
In fact, my wife and I will be closing on our first investment property in a month or so. It is a duplex with an expected cash-on-cash of 11% in a “path of progress” neighborhood.
This is our strategy. We are sticking to it for the long haul. It’s in our written financial plan.
It does take work and effort. It is not passive.
But, who else can understand the benefits of delayed rewards like a physician?
Like I’ve said many times before, the hard road gets easy but the easy road gets hard.
I truly believe that this is the best way to build wealth.
And physicians are primed to take advantage of active real estate investing. We are high-income earners who can set aside the “seed” money needed for real estate investing with even a modest savings rate. Then real estate investing begins to act as gasoline poured on the fire (FIRE?) of our financial goals.
But it shouldn’t be your only strategy
With this being said, I am a proponent of a hybrid approach to wealth building. Many investors fall on one side of the fence – either stock market investing or real estate investing. I advocate for both.
Everyone talks about diversification. I believe diversification in modes of investing counts big time.
So here’s my advice, before getting into this kind of real estate investing, there are two steps that you must take:
- Learn how to invest in the stock market successfully without the need for a crystal ball
- Create a written, personal financial plan
What do you think? Do you invest in real estate? What is your strategy? Have you invested in real estate in the past and been burned? Would you try again with a different approach? Let me know what you think in the comments below!