An ideal real estate investment is one that generates enough rental income to pay for the operating expenses and mortgage payment, and still leaves you with money in the bank at the end of each month.
There are several ways for real estate investors to reach the goal of positive cash flow. The path to financial freedom begins with choosing the right real estate investing strategy.
Main Types of Real Estate Investing Strategies
There are three main strategies for investing in real estate:
- Core
- Value Add
- Opportunistic
Each strategy works a different way to help you achieve success as a real estate investor.
The balance between risk and reward is different, and they are also a key tool you can use to narrow down your options when choosing what, where, when, and how to invest in real estate.
Core
Core investments generate predictable returns from newer property leased to qualified tenants. Core real estate has the lowest level of risk but also the lowest returns, in exchange for the reduced amount of uncertainty. Property is rated as Class A and is found in neighborhoods and school districts with the highest ratings.
Value Add
Value Add property allows investors to increase cash flow or market value by doing strategic updating, adding square footage, or creating incremental revenue streams in small multi-family property. Risk and reward are evenly balanced in value add investments due to the potential for increasing returns.
Class B real estate is found in neighborhoods and school districts with average to above-average ratings. When located on the fringes of Class A areas, investing in Class B property may become Class B+ or greater as the surrounding areas continue to grow and gentrify.
Opportunistic
Property purchased using an opportunistic real estate investing strategy includes wholesale and fix-and-flip property and ‘cash cow’ rental property.
The first two opportunistic types of real estate require a lot of capital and a high level of risk in exchange for a potentially big reward if the market timing is right.
Cash cow property is usually Class C real estate that is older construction with an acceptable level of maintenance. Although tenant turnover may be higher, rental incomes normally remain consistent due to renter demand. But, because of the below-average neighborhoods and school districts, cash cow property normally offers little possibility for appreciation.
12 Popular Types of Real Estate Investments
Your real estate investment strategy acts as a guide to ‘how’ you’d like to invest. After selecting your strategy, the next step is to determine what type of real estate you want to invest in.
Here’s a quick look at some of the most popular ways to invest in real estate:
Residential Real Estate
- Single-family houses: There are about 95 million single-family homes in the U.S. It’s easy to find houses to invest in and in many real estate markets they’re the type of rental property many tenants want.
- Multi-family property: Small multi-family properties such as duplexes, triplexes, and fourplexes (2, 3, and 4-unit properties) are a great way to multiply the cash flow in your portfolio by investing in rental ‘units’ rather than houses.
- Wholesaling: Real estate wholesalers locate motivated sellers, put the property under contract and estimate the cost of needed repairs, then assign the contract to a real estate investor in exchange for a wholesale fee. Teaming up with a wholesaler you can trust can be a great way to find deals with instant equity, although you’ll also need to locate a tenant.
- Fix-and-flip: Similar to wholesaling, except the fix-and-flipper closes escrow, performs the needed rehab, then resells the property as quickly as possible. This type of real estate investment focuses on short-term gain instead of recurring cash flow. Fixing-and-flipping may sound good on paper but requires a lot of time and capital and a very high tolerance for risk if the deal doesn’t work out as planned.
Commercial Real Estate
- Apartment buildings: Larger apartment buildings such as low-rise, mid-rise and high-rise; garden-style communities, mixed-use projects (usually with office or retail property on the same site); and special-use multi-family development such as student housing, senior housing, and affordable and subsidized housing.
- Office: Divided into urban and suburban properties and classified into Class A, B, and C office buildings. Office property types include single-tenant, multi-tenant, medical, coworking, and build-to-suit.
- Retail: Includes small storefronts in downtown or suburban business districts, and individual suites in small strip centers, neighborhood shopping centers, outlet stores, regional malls, and power centers.
- Industrial: Usually located near major transportation routes in suburban areas of the market. Common types of industrial property include distribution for ‘last mile’ deliveries, bulk warehouse, light assembly, heavy manufacturing, flex industrial (combination of office and warehouse), and telecom/data hosting centers.
- Land: Often purchased as a speculative investment while the surrounding area develops. Farm and ranch land, raw land, undeveloped land, subdivided lots in a subdivision, urban infill plots in the inner city, and brownfield land that has undergone an environmental clean-up and is ready for re-development.
Indirect Ownership
- Joint ventures (JVs) and partnerships: Forming an LLC to invest in real estate is a good way to share risk and reward and invest in projects you don’t have expertise in. Managing partner oversees the project management, while passive partners contribute capital, contacts, or experience in exchange for a percentage of the profits or tax benefits.
- REITs: Real estate investment trusts may be public or private and concentrate on a specific real estate asset class or serve as a broad-based fund. Three of the largest publicly held residential REITs are Invitation Homes, Essex Property Trust, and American Homes 4 Rent.
- Crowdfunding: Real estate crowdfunding companies pool large amounts of money together from groups of investors to invest in commercial and residential property that is out of the reach of most investors. Many crowdfunding investments are new development or value add projects and pay a quarterly return to each investor plus a share of the profits when the property is sold.
How Each Strategy Works
Now let’s take a look at how each of the three real estate investing strategies – core, value add, and opportunistic – work in the real world.
We’ll use the Roofstock Cloudhouse Calculator to analyze the potential returns of three single-family houses by entering the address of each property:
Core: 3624 Huntsman Road, Edmond, OK
- Property: 4 bedroom, 3 bath, built 1999
- Initial investment: $294,350
- Monthly rent: $1,675
- Cap rate: 4.0%
- Appreciation: 3.6%
- Gross yield: 6.9%
- Neighborhood: 5 stars
Value Add: 3054 Yanlee Lane, Jacksonville, FL
- Property: 4 bedroom, 2 bath, built 1958
- Initial investment $184,335
- Monthly rent: $1,399
- Cap rate: 5.1%
- Appreciation: 3.6%
- Gross yield: 9.3%
- Neighborhood: 3 stars
Opportunistic: 3527 Shemwell Avenue, Memphis, TN
- Property: 3 bedroom, 1 bath, built 1973
- Initial investment: $64,126
- Monthly rent: $650
- Cap rate: 7.8%
- Appreciation: 1.8%
- Gross yield: 12.5%
- Neighborhood: 1.5 stars
Choosing the Right Real Estate Investing Strategy
Here’s a good tip to follow when you’re deciding which real estate investing strategy is right for you.
First, draw a line and write the word ‘risk’ at one end of the line and the word ‘reward’ at the other end of the line. Then, put ‘Core’ above ‘reward’, ‘Opportunistic’ above ‘risk’, and ‘Value add’ in the middle.
You should have a risk and reward line that looks something like this:
Core Value Add Opportunistic
__________________________________________________________________
Reward Risk
Now, as you analyze different investment opportunities, you can plot them along your line of risk and reward.
Core real estate investing
- Turnkey rental property fully updated and already rent to a tenant
- Class A real estate in the best neighborhoods and school districts
- Similar to investing in a government bond or a large-cap stock
- Provides a lower level of risk in exchange for a lower return
Value Add real estate investing
- Rental property that may need some minor repairs to increase rents to market value or add incremental revenue streams in multi-family property
- Class B real estate in average and above-average neighborhoods and school districts
- Similar to investing in a growth stock or a higher risk bond
- Provides a balanced blend of risk and return
Opportunistic real estate investing
- Cash cow rental property where additional updating will not result in increased rental income
- Class C real estate in average or below-average neighborhoods and school districts
- Similar to investing in shares of a brand new IPO
- Risk of tenant turnover is greater balanced with the reward of solid and predictable cash flows
Diversify with Different Investing Strategies
You can also grow your real estate business by diversifying your rental property portfolio by using different investing strategies. This is similar to what people who still invest in the stock market do when they buy direct shares of companies, ETFs and REITs, and government bonds.
For example, let’s say your preferred real estate investing strategy lies between Core and Value Add. You like buying Class B single-family houses in above-average neighborhoods and school districts that return a balanced blend of net monthly income and market value appreciation over the long term.
You’ve found a market where the economy is strong and rents are rising, but all you can find is a Class C ‘cash cow’ multi-family duplex.
The property is in a below-average neighborhood and the investment promises to deliver plenty of net income but little to no appreciation. Based on your research and analysis, the deal makes good financial sense but doesn’t fit the profile of the type of property you like to invest in.
One option is to allocate a small percentage of your portfolio – say 10% or 20% – to investments that may be slightly riskier but also have a higher potential pay off. Or, partner with another investor or family member so that you’re deploying less personal investment capital while still benefiting from a higher possible payoff.
