Real estate portfolio: What is it and how do you build one?

Have you ever thought of putting together a real estate portfolio? Real estate investments can be a great way to grow wealth. When you invest in a collection of investment properties, you’ve systematically built a real estate portfolio.

Let's go over some strategies for building a real estate portfolio. A strong portfolio can build a solid financial foundation that can weather the ups and downs of the housing market.

What is a real estate portfolio?

Put simply, a real estate portfolio is a collection of real estate investment assets. A typical portfolio can include rental properties, flipped homes and real estate investment trusts (REITs).

How to build a real estate portfolio: Strategies for savvy investors

Ready to start? Take a look at the following tips and strategies to build your real estate portfolio.

Outline your objectives and goals

Consider your long-term investment goals before you start building a portfolio. Knowing where you’re going can help you determine the best strategies to get there.

Think about how much time and labor you’re willing to put into building a portfolio. If you want to offload active management of a property, you’ll need to hire a property manager. What’s your risk tolerance? To build a portfolio that can handle the ups and downs of the market, you’ll need to invest in a mix of commercial and residential properties around the country.

Choose a starting point

Consider starting small. For some investors, this may mean house hacking. With this strategy, you live in a property while renting out the remaining space. Securing financing for a house hack is significantly easier because the home qualifies as a primary residence. And loans with more relaxed down payment and credit requirements, such as Federal Housing Administration (FHA) loans, are only available if you live in the property most of the year.

Consider starting with simpler property types before diving into complex real estate. Residential properties are typically easier to finance and manage than commercial real estate.

Knowing how to buy an investment property can help you avoid costly mistakes and getting in over your head. If you’ve never owned a property with tenants, consider the upfront and long-term costs of managing that type of property – not just how the property’s value may increase over time.

Consider exponential rather than linear increases to your portfolio

Exponential growth refers to a pattern of data that shows greater increases over time.

Let’s say you grow your portfolio by investing in a new rental property of similar value every 3 years. This approach would likely result in gradual linear growth of your portfolio’s value. However, you can set your portfolio on an exponential growth trajectory when you leverage your rental income and the accumulated equity from your first property after 3 years to finance two new properties. In 3 more years, you may be able to finance four additional properties or move on to more complex and lucrative property types, like commercial property.

Many experts encourage exponential growth because it can help boost profits. Ultimately, you’ll need to craft the investment strategy that works best for your situation. The added complexities and risks with exponential growth aren’t for every investor.

Learn your local market

Knowing your local market gives you a real estate edge. When you’re considering a property that’s far away, you don't always know what's happening with a rental home or much about the neighborhood it’s in.

In an area you know well, you’re likely tapped into a community’s opportunities and liabilities. For example, you may know which neighborhood a new highway will route behind. You’ll likely know where the good schools are in your area or whether a particular neighborhood has started to pick up in popularity.

Keeping tabs on your local market helps you find potentially lucrative deals and can provide insight into the offers you’re contemplating.

Research your financing options

It can be challenging to finance multiple investment properties. But you must know your financing options to successfully carve out your real estate niche. The two most popular financing options are hard money loans and conventional loans.

• Hard money loans: A hard money loan is a short-term loan investors can get from individuals or private companies that accept property or other assets as collateral. You may need a hard money loan if a traditional lender denies your loan or mortgage application.
• Conventional loans: A conventional mortgage conforms to Fannie Mae or Freddie Mac guidelines. Investors with high credit scores who can make large down payments can avoid paying mortgage insurance. A conventional loan is a type of loan the federal government doesn’t back. If you’re using a conventional loan to finance an investment property, you’ll likely need to make a significant down payment and pay a high interest rate. However, the rate on a conventional loan will be lower than a hard money loan rate.

Understand the 1% rule and other financial benchmarks

You must know your numbers. Track every expense, identify which numbers rise to the top – and know the numbers you need to work on. The 1% rule measures the price of an investment property against the gross income it generates. You can use it to quickly determine how the property should generate cash or decide what you should charge in monthly rent.

Also, make sure you know the financials associated with the following items:

• Economic occupancy: This is the percentage of potential gross income a property can generate during a given period. For example, let's say the total potential rental revenue for a collection of properties in January is $100,000, but you only earn $43,000. In that case, the economic occupancy for January equals 43%.
• Return on investment: Measure all return on investment (ROI) in real estate. Define your investment priorities and goals. Will you invest for cash flow or appreciation? What return on investment will you feel comfortable with? Many investors aim to beat stock market returns, which have hovered around 10% over the last century.
• Improvement costs: What improvements do you need to make on a property? Renovations should increase property value or improve a property’s usefulness for tenants and should follow the 1% rule.
• Monthly operating costs: How much does it cost to maintain the property? Calculate your expenses versus your income. Let's say you collect $1,200 in rent, and your expenses equal $200 each month. You can use your income and expenses to help measure your results against the 1% rule.

Understand the BRRRR method and its pros and cons

The Buy, Rehab, Rent, Refinance, Repeat (BRRRR) method involves flipping a distressed property, rehabbing it, renting it out and then refinancing it with a cash-out refinance to repeat the process and fund more rental property investments. It’s a steady pattern of turning out more rental properties.

This method can aggressively expand your real estate portfolio – but it’s risky. Flipping a property isn’t always a successful venture. If you overinvested in making the property attractive, you may not make a significant return on investment when you rent the property. If the market goes down and the property’s value decreases, you may not have enough equity for the cash-out refinance.

Real estate portfolio pros and cons

Building a real estate portfolio has its advantages and disadvantages. Let’s review both to help you decide whether to start investing in real estate.

Pros

Building a real estate portfolio can help you build long-term wealth, but there are many other reasons to start investing and build a real estate portfolio, such as:

• Passive income: You can generate passive income from certain real estate investments. You can watch your cash flow grow with technically less effort.
• Tax benefits: When you invest in real estate, you receive certain tax benefits, which is why investors like to go this route.
• Builds equity: If you invest in a house, make renovations and boost the home’s value, your ROI and equity will continue to grow.
• Can combine with homeownership: When you house hack, you can combine the benefits of homeownership with the profit potential of real estate investing.

Cons

One real estate portfolio disadvantage can be the time and effort you must invest. Let’s take a look at a few other disadvantages:

• Long-term investment: Because properties take time to grow in value, you might not see any ROI for a You must be patient when investing in real estate.
• Requires maintenance: If you’re renting out properties or working on a fix-and-flip, you’ll need to know how to make repairs or who to hire to make them for you.
• Value can decline: The housing market is unpredictable. Home values constantly go up and down.
• Costs can be high: Real estate investing isn’t cheap. Whether you’re renovating or replacing a broken appliance in a tenant’s property, you must cover these
• Lack of diversification: While you can diversify your real estate portfolio, it’s typically easier to diversify a stock portfolio because real estate requires a significant upfront investment.

How to diversify a real estate portfolio

Experts always suggest diversifying your financial investments or asset classes. For example, a financial advisor may encourage you to invest in more than stocks or different types of stocks. Savvy investors typically buy stocks across diverse industries.

To diversify your real estate portfolio, consider investing in multiple real estate types, such as vacation rental properties, fix-and-flip properties, raw land, multifamily properties, commercial properties and REITs.

It’s highly recommended to start investing with the least volatile and complex real estate – REITs and residential properties are popular choices – and then branch into riskier types as your experience and wealth grow.

Consider all your options before you choose. Avoid pigeonholing yourself into one investment type when you may have multiple options available to potentially boost your portfolio even more.

The bottom line

Building a portfolio requires careful planning and research at every stage of the process and constant reflection and analysis.

If you’re ready to buy your first investment property, start an application with Rocket Mortgage^® today.