What Type of Real Estate Should I Invest In?

So you've heard about this cool thing called real estate and want in.  You've saved up or recently came into some capital and want to put it to work.  Problem is, you don't know where to start.  Here is the two step process that I came up with to help...

The answer to this question is going to be heavily dependent on your financial goals and a term I like to call "CTR" (Capital, Time, Return). Understanding the dynamics of each of these for your situation is going to steer you in the right direction when it comes to evaluating real estate investing. 

On the capital side, the amount of funds that you have to invest may eliminate some asset classes all together.  Some commercial real estate, mainly office and retail, naturally have a higher acquisition price as well as higher capital requirements on an go-forward basis.  These are asset classes that traditionally are not an individual's first investment out the gates for this very reason.  While they can provide high levels of stable cash flow (who doesn't love mailbox money?!), they also have substantially larger risk and if you don't have reserves to cover a shortfall, you can lose your shirt pretty quickly.  I don't want to bore you with a deep dive of every scenario, but just know that you should be taking a prudent viewpoint when it comes to the amount of capital you have and what is a realistic real estate investment (Remember: there is a big difference between being able to buy something and being able to afford something).  This is a marathon, not a sprint.

Second, not sure how much time you want to commit to these potential investments, but this is a HUGE piece of the puzzle.  I can't count how many times I've heard an investor say, "I can manage this myself" or "I'm fine hopping on a plane to see my investments".  95% of the people who say that end up either selling that investment or hiring a property manager in 12 months.  This lack of self-awareness can lead to big financial mistakes if not managed properly.  It's OK to admit that you don't want to actively manage an investment.  If that's the case, then similar to 'Capital', your potential investments will continue to narrow (i.e. not a ton a of time, you're probably not flipping homes on the side).     

Last, but certainly not least, is return. Not all returns are created equal.  Let me say that again, not all returns are created equal.  A 7% cap in Nashville is not the same as a 7% cap in the Bay Area.  You might get a nice apartment complex in Nashville with high demand in a good location and quality tenants.  For that same cap rate in the Bay Area, you're probably in a non-desirable location and slum-lording.  This should go without saying, but understanding the market dynamics is crucial.  Another piece to return: Everyone wants to purely base their investment thesis on the highest cap rate. Don't get me wrong, I want to get the highest return possible just as much as the next investor, but there is one key component that is rarely talked about. Risk. Just because a property has a lower cap rate doesn't mean it's an inferior investment. While the return might be lower, in theory, it is also has less risk relative to a property with a higher cap rate.  This might be because it's already stabilized, in a more desirable location, etc.  Whatever the rationale, remember that you get what you pay for.  If you find a mobile home park that has a 15% cap rate you might think it's a deal of a lifetime! But think through what you need to do in order to realize that type of return.  What headaches are involved? Are you going to be paid on time if at all?  As the late, great Biggie Smalls says..." Mo Money, Mo Problems".

There are many aspects to consider when investing in real estate, but the first step is to look internally to make sure you are crystal clear on your financial goals. From there, identify your risk tolerance and follow the CTR steps.