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7 Proven Strategies for Real Estate Investing

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One of the first principles that I like to teach people thinking about real estate investing is the importance of understanding what type of income you are working for.

• Earned income, or income derived from a job or some other form of labor

• Portfolio income, or income derived from a portfolio of paper assets, such as stocks, bonds, and mutual funds

• Passive income, or income that is not tied to a specific time or activity, and that can flow to you without any specific current effort expended on your part

While there are three types of income, I like to focus on the last one, Passive income.

The primary example of passive income, accounting for some 80% of this type of income, is real estate investment income. Not only can real estate produce significant financial returns that grow over time, but, because of its regular cash flow, it is also the most predictable form of investment income. Plus, it offers many valuable tax advantages. It is for all of these reasons that real estate income is my favorite type of income.

That’s the good news about real estate investing. But the challenge is that generating income from real estate investments requires considerably more preparation, practice, and persistence than the other forms of income. While a great many individuals who invest in real estate can prosper to a degree, only those who truly master the essential skills and strategies of real estate investing can become successful on a large scale.

Here are seven real estate investing of the strategies I have found to be most helpful.

Strategy 1. Build a World-Class Investment Team

One sure way to keep your real estate investment returns small and your opportunities for growth limited is to try to do everything yourself.

While a desire to learn as much as you can in any given field will serve you throughout your career, feeling that you have to know everything yourself will greatly hinder your progress. And thinking that you have to do everything yourself is even more damaging. The fact is, even with tremendous effort, no one can know everything there is to know—much less do everything there is to do—in an area as complex as real estate investing. I have been investing in real estate for over 50-years. I still learn something from every investment I make.

Beginning real estate investors tend to lack an overall understanding of the real estate investment process, and so they either tend to be too cautious, too arrogant (and hence careless), or simply not know what they’re doing. Consequently, they make mistakes—often, one right after another. And while there is nothing wrong with mistakes in principle—mistakes can be one of the most effective learning tools, in business as well as in other aspects of life—too many mistakes often can lead to disaster.

The best insurance against making these disastrous mistakes is experience. But how do you get experience when you’re just starting out? You do it by leveraging the experience of others.

Now, some new real estate investors argue that, if they do all of the work themselves, they’ll be able to retain a higher percentage of whatever they earn. While that may be true on the surface, what these individuals fail to realize is that the right partners can increase the returns obtainable in investment venturesventure—sometimes dramatically so.

Strategy 2. Plan Your Tax Strategy

Usually, no one finds taxes to be a fun topic, but in real estate, taxes mean more money. I mentioned a moment ago that real estate investing has tremendous tax advantages—and it does. But you’ll be able to realize these tax advantages only if you set up your real estate investing activities in the right way from the beginning.

As it happens, several provisions of the U.S. tax code were written with the specific intent of encouraging real estate development and investing. These tax provisions give you the ability to shelter most if not all of the cash flow that your properties generate from federal and state taxation—and even to wipe out some of the taxes on personal income not related to real estate.

Because the government treats real estate investing as a business, you can deduct a wide variety of direct and indirect expenses that are associated with managing and maintaining a property, such as repairs, utilities, office expenses, property-manager salaries, advertising, and the like. But you can also deduct some significant “phantom expenses” like depreciation—costs that are recorded in the property’s books but that you don’t actually pay out-of-pocket.

But to make the most of your tax savings, you need a great deal of knowledge. Unfortunately, unless you’re a real estate or tax accountant yourself, you’re not likely to have all of the information you need. That is one more reason why you need a solid real estate investing team. Your financial team can help you craft a real estate investment tax strategy ahead of time that can maximize the returns you receive from your real estate investments—and legally and legitimately minimize the taxes that you owe on these activities.

Strategy 3. Plan Your Legal Strategy

My rich dad always said making money is easy, keeping the money is hard. Owning real estate can be a very lucrative method of generating income. But real estate ownership, like many business pursuits, comes with some significant risks. Legal risks—ranging from landlord-tenant relations to non-performance of contractual obligations—are among the most significant of these. Managing your legal risks will therefore be a critical aspect of becoming a successful real estate investor.

These factors make planning a legal strategy an essential complement to creating a real estate tax strategy.

But why do you need a sophisticated legal strategy? Isn'tAren’t having insurance and a good lawyer enough? Unfortunately, no. When the legal risks involved in real estate investing are not properly managed, litigants can win judgments against you that significantly reduce the value of your assets. In the worst case, they may even be able to take your real estate assets themselves—and, sometimes, even other un-related assets, like your business assets or personal residence.

Strategy 4. Know Your Market

There is a well-known saying in the real estate industry that the three factors that are most important in determining the value of a property are “location, location, location.” But the importance of a property’s location extends beyond obvious factors like whether a neighborhood is run down, or an office park is in disrepair. Indeed, the role of location in a property’s value begins before you even start thinking about geography. It begins with the property’s intended purpose.

Just as most successful business owners launch their entrepreneurial ventures knowing what type of product or service they want to sell, successful real estate investors almost always decide ahead of time the type of properties they plan to invest in. One reason for this is that the type of property you’re targeting will dictate the locational factors you should consider.

For instance, if you’re looking at renting apartments, the locallocational priorities of students, families, seniors, and other prospective renters are likely to vary widely.

Therefore, once you’ve chosen a type of property to invest in, you’ll want to carefully evaluate all relevant locational factors, such as transportation options, crime and safety, proximity of schools, retail establishments, and restaurants, population dynamics, zoning ordinances, property taxes, and many other factors—all of which will influence an area’s property values far into the future.

In my opinion the most important question to ask is about job growth. Are new jobs more likely to be coming into the area or are jobs likely to be leaving. Are the new jobs bringing in higher salaries or does it look as if they could be lower.

Even then, however, you’re not done, because statistics and fact sheets can tell you only so much. You’ll also want to drive the area in person in order to getorder get a feel for the location in the same way that a prospective tenant or homebuyer might do so. How long does it take to get to the freeway, the grocery store, or other businesses services? How noisy or heavily trafficked is the area during the day? How safe does it feel at night?

Strategy 5. Honestly Project Your Cash Flow

Once you’ve decided on a property type and investment location, it’s time to start looking into specific properties. As you do, keep in mind that your primary purpose in becoming a real estate investor is to generate positive cash flow. And to make the kind of money you want, each individual property you acquire needs to generate a positive return—otherwise, you’re just wasting your time and scarce investment dollars.

When an existing property owner is trying to sell a rental property, he or she typically prepares a financial “pro forma.” Pro formas contain both income and expense items. Usually, income results largely from rents, and so you want to make sure that projected rents are realistic. For instance, if rents have recently been increasing in surrounding areas by 3% per year, they’re unlikely to suddenly jump by 10% per year for the property you’re thinking of buying. Or if only half of the apartments or offices within the property you’re considering have been leased for the past few years, occupancy rates are unlikely to hit 80% or 90% in the foreseeable future.

Likewise, you’ll want to take account of all of the costs involved in purchasing and maintaining the property in question. Typically, costs on a rental property consist mainly of operating expenses (what it costs to manage and maintain the property) and debt servicing costs (the interest expense on any loans that you obtained to pay for the property).

But there also may be other hidden costs. Do you need to replace the furnishings or flooring in the units? Are there new government regulations that you need to comply with, or new permits you need to secure? How long are the typical delays between when one occupant moves out and another moves in? And so on.

Making an honest assessment of the full range of income and cost factors will strike a great many properties off your “potentials” list, and that can be frustrating. But look at it this way: eliminating high-risk or low-return properties will significantly increase the probability that the properties that do make the cut will have a very strong chance of generating a handsome cash flow for many years to come.

Strategy 6. Serve Your Tenants Well

It’s commonplace for new real estate investors to focus solely on the bottom line. That’s to be expected—after all, as noted, your main purpose as a real estate investor is to make money. But you have to be careful not to take this emphasis on money too far, because you want to protect not just your near-term cash flow, but your long-term income as well.

Indeed, as a real estate investor (particularly if you’re renting or leasing your properties), you’re in a customer-facing business just like the local car-repair shop or the electronics store down the street. And like them, you have to take care of your customers and make sure they’re happy, or else you won’t be in business very long.

This doesn’t mean being extravagant, fitting your apartments with gold-plated faucets or your offices with granite floors. But it does mean providing clean, neat, and well-maintained housing or commercial space. And it also means regularly inspecting your rental units so that you can prevent problems beforehand—and then responding quickly and courteously when such problems do occur.

Going to all of this trouble may seem like a lot of unnecessary work and expense, but it’s a cost you’ll need to plan for if you want your properties to remain fully rented or leased. Otherwise, not only will your tenants tell other potential renters about any negative experiences—and even may move out if the situation gets bad enough—but with the proliferation these days of online review sites for nearly every type of property, one tenant’s unpleasant dealings with you can be paraded across the computer screen for every prospective new tenant to read.

And if these unpleasant dealings start to mount, well…you don’t even want to think about that.

Strategy 7. Trade Up in Value

When I played the board game Monopoly as a child, I learned one very important principle that has greatly increased my success in real estate investing: four, four green houses lead to one red hotel.

Most real estate investors who remain in the profession for even a short time realize that the bountiful profits that so many of their colleagues earn come only with larger and larger properties. It’s difficult, for instance, to generate sizable earnings when your sole investment property is a $150,000 duplex or a starter home in a marginal neighborhood. The solution: trading up.

Trading up, of course, involves selling a smaller or less-profitable property, “cashing out,” and then purchasing a larger and more lucrative piece of real estate with the proceeds. There’s just one catch. Every time you “cash out,” you receive what’s called a “capital gain.” And capital gains are taxed (albeit at a lower rate than ordinary personal income) by both the federal government and many state governments. How can you get ahead when you’re giving up so much of your gain in taxes?

The answer is: you don’t give the money up. It’s not a matter of hiding income or doing anything illegal. In fact, the government actually wants you to purchase larger and larger properties because that means more, and usually better, housing and commercial space is being created. And they give you some powerful incentives for doing just that.

The most important of these incentives is something known as a “1031 exchange.” The number “1031” is the section of the Internal Revenue Service Code that governs a certain class of real estate transactions. In simplest terms, 1031 exchanges allow you to roll over the capital gains from one investment property into another.

If you want to be phenomenally successful as a real estate investor, 1031 exchanges (and other tax-friendly ways of trading up) are tools that you’ll want to use more and more frequently as your investing business expands.

Act and Learn

The ideas outlined here are the real secrets to becoming financially comfortable—even fabulously wealthy—through real estate investing. But, as written, they’re just that: ideas. The only way for these ideas to transform you into a successful real estate investor is if you put them into practice. At the same time, you also need to keep learning—because what we’ve described here barely scratches the surface of the knowledge you need in order to make successful real estate investing a lifelong career. I like to say, “Act now—and keep learning throughout your life.” As you do, you’ll find that real estate investing can provide you with the wonderful foundation of wealth and happiness that you’ve long desired.