The next decision is to determine which type of property you are interested in. Do you want to focus on residential or commercial properties? Do you want to invest in land instead of buildings? The choices you make depend on your goals and the length of time you plan to hold your investment.

Another factor is the amount of time you have or are willing to spend. If you are investing on the side and have very little time, look for opportunities that are relatively maintenance free. Another option if you are short on time is to turn your properties over to a property management firm, but they charge for their services so you need to account for their costs in your analysis.

Unless you have a lot of money, I would wait on the management company until after you have a little experience under your belt. If you do choose to use one, make sure you have checked with other property owners and the company comes highly recommended.  Many are not worth their fee and do little more than collect rent and make money on their service calls.

As we discuss the different property types, you will get a feel for the time commitment involved in their ownership.

RESIDENTIAL PROPERTY

For most beginning investors (and many experienced ones) we recommend working with residential property. The reason for this is familiarity. You already know what makes a good home, you live in one. As with all investing, it is best to work with something you know about.

There are many types of residential property. You can focus on one or two types, or just keep your eyes open for good opportunities. A good mix doesn’t hurt, as long as it matches your goals and over-all strategy. Some types of residential property for consideration are:


 Each property type has its advantages and disadvantages.

Single-family Residence (SFR). Single-family residences are great, if you have the right tenant. You can become very wealthy investing in these types of properties. One of the most powerful investing aspects of SFRs is annual appreciation in good markets. Plus, when the market is hot SFRs are easy to sell if you want to cash out.  But with a bad tenant, SFRs can be a real pain.  The advantage is that you only have to find one renter per property. The disadvantage is that all your rent is from one renter. With a single renter, you have to be more careful with your rental rates.  Too high and you lose renters, too low and you don’t cover your costs. In addition, if they leave, you have no income until you rent the house again. If you have enough of a buffer in your cash flow, that is fine, but if you are relying on the rent to make the mortgage payment, a move-out can cause a lot of stress, perhaps even jeopardizing your owner-ship.

Another strategy for single-family homes is to find an older home for sale in an area that is zoned for high-density housing, or will be zoned appropriately in the near future (do your homework here). If the property is in a good location, it will increase in value over time. In the mean time, you let the rent pay down the mortgage. Eventually, you will have a good development site for an apartment building.

 I used this strategy with a property in Pismo Beach, California. It was a single-family house with 2 small, detached rentals on 2 city lots. The zoning was such that it allowed for an 8-unit condo project. The old house and 2 small rentals were able to carry the property for several years until we were able to get plans approved. The project ended up taking several more years than we had originally anticipated, but since it produced some income we were able to hold it until we ultimately sold it to a developer for a tidy profit.

 The most common way to determine the value of these types of properties is with a market approach to value. Have your real estate agent pull some comps or do what they call a (BPO) or brokers opinion of value. They typically won’t charge for this, but some may ask for a small fee. An even better way to determine value is to order an E appraisal from the 4RealEstateSuccess website. It will cost from $10-40, depending on the type of comparable sales data you request. You will get a detailed report, complete with comps, sales data, assessed value, etc. It is a great way to get valuations for just a few bucks.

Condominiums and Town Homes: Condominiums

have many of the same considerations as a single-family home. However, you generally don’t have to worry about yard work and upkeep. Generally, out-side work is handled by the homeowner association. In addition, if a complex has an on-site manager, they may handle all the renting for you, making it a very hassle-free investment. The disadvantage here is the homeowner fees. If the association decides to raise the fees (for whatever reason), you don’t really have any choice but to pay them.  As long as your rents cover your expenses, you should be in good shape.

 In my experience Condos and Town homes are not as liquid as SFRs, nor are they as desirable. Of course, this varies by market and project. Check with your local Realtors on appreciation rates and liquidity if you go this route. Even though the SFRs may be appreciating, condos and town homes may be flat.

‘Plexes: Duplexes, triplexes and four-plexes are often the easiest entrance into the buy and hold strategy. In many cases, you can live in one of the units as you rent out the others, building equity and income without the hassle of two mortgages. If you can handle living in an apartment for a while, this is a great way to get started. If you live there, you are close at hand to resolve any problems before they get out of hand. It also helps you establish a better relationship with your other tenants.

 Another advantage of 1-4 unit ‘plexs is financing.  Owner occupied rates and loan programs are readily available. You may virtually be able to live rent-free if you live in a four-plex and three of the units cover your monthly mortgage obligation. Also when one tenant moves out you still have some income to cover the monthly mortgage payment. This is not the case when you have a SFR with only one tenant.

Apartments: This final option, apartments, can be a great source of income, but it typically requires a much larger investment up front. If this is your goal, great! Just be careful with your analysis and make sure you buy the right property. If you find a good location and a good situation, you can do wonders with it over the long term.  We purchased a 21 unit building in 1988 that we still own today. When we bought it, rents were $450/month per unit. The total purchase price was $1,380,000. At the time we clearly paid too much. Now, 15 years latter, it has appreciated to approximately $2,700,000. Rents are $975/ mo per unit, and it produces a solid monthly cash flow.  I lamented when we bought it because I felt we overpaid by $150,000 or more. But with time it has become a great buy and hold investment. I am currently in the process of refinancing it. We will probably pull out $500,000 or so, tax-free, and not even increase the payment because I am get-ting a loan from an insurance company at a much lower rate.


So an investment that produces $100,000 a year in rent, with a purchase price of $1,000,000 has a GRM of 10. If the annual rental income is $50,000, the GRM is 20. When buying, you want a lower GRM, when selling, higher.  A better way to compare investments is to use a cap rate. GRM’s don’t take into consideration the operating expenses of an investment and are therefore not as accurate. A cap rate is computed from net operating income (NOI), after expenses.
Cap rate = NOI/purchase price

So a property that produces $100,000 NOI with a 6.5 cap rate would sell for $1,538,461.00. That same investment property with an 8.5 cap rate would sell for $1,176,470. With cape rates, you want them lower when you sell and higher when you buy.

One of the nice things about commercial and multi-family property vs. single family residence is that price is based less on subjective emotional variables and more on the actual numbers an asset produces. While it is true some trophy properties have an emotional pride of ownership in the valuation, most investments are valued on the numbers.
COMMERCIAL PROPERTY

Commercial property is much more difficult to select properly. There are many more factors that can effect the long-term value of commercial property.  Many of these factors are difficult to predict, including:


The investment required in commercial property is generally greater than residential. The expenses are also greater, so it is even more critical to know how to attract and keep tenants. If you plan to invest in commercial property, it is best to work with an experienced investor to help you get started, understand the risks, and minimize those risks.

Some common commercial property types are:

Office Buildings: Office space is probably the first thought people have when considering commercial property. Whether it is a small office complex that holds a few businesses, or a large office building for many businesses and large tenants, office space can be a difficult and risky investment.  The key to successful office building ownership is adequate income. As you evaluate potential properties, be sure to do a thorough tenant demand analysis. Be aware of the going prices for office space in that area, and also the amount of vacant space available. Most business districts have an overabundance of office space, so just make sure you can cover your costs.

Shopping Centers: There are two main types of shopping centers, strip malls and anchored shop-ping centers. Strip malls are generally a collection of smaller, unrelated businesses, all with street frontage. Anchored shopping centers can be indoor malls or outdoor centers, but are generally anchored by a large tenant or tenants.

There are many factors that affect the success of shopping properties. Some cities are friendlier than others in terms of appearance, parking, construction, and other regulations. You need to be aware of retail trends, nationally, regionally, and locally. Also, as with office space, demand and availability are important. If there is currently a large oversupply of commercial space available, it might not be a good time to get into the market.  As always, do your homework.

 Industrial Buildings: Industrial buildings are frequently single-purpose buildings, constructed for a specific use and process. In most cases, the ten-ants are long-term leases that plan to remain there. There are some exceptions (always) in the case of warehouse or open space that can be easily reconfigured for different uses.

Industry knowledge, and an awareness of long-range trends are important when deciding to purchase or build industrial infrastructure. If you are targeting a specific industry, how stable has it been historically, and what are the prospects for the future? What kinds of infrastructure are required for different types of manufacturers? All these questions and more are important as you analyze profitability and potential.

Storage Facilities and Mini-Warehouses: Mini storage

facilities are increasingly common in many areas of the country. You can see them in many neighborhoods, industrial areas, commercial locations, and even out in the countryside. The key to these facilities is demand and retention. You have to be able to attract customers to your location over others, and you need to be able to keep customers.

Building a storage facility requires a significant investment, so make sure you have enough demand to cover your costs.

I know several owners who have done extremely well with these over the years. As always do your homework to determine demand and competition in your market.

LAND

There is a third type of investment property, land.  In general, when you purchase land, it is either with the intent of building one of the two property types above, or you will hold it. When you consider buying land, you need to evaluate the highest and best use to  which it can be applied. If the best use is a four-plex or apartment building, do it. If the best use is an office or other commercial building, do it.  Just make sure you factor your holding costs into your profit scenario. If a property does not have entitlements, you may be sitting on it for a while before it can be built out.

If there isn’t a clear best use, then perhaps it is best to sit on the property for a while until the

potential use clarifies and the value increases. As in the example at the beginning of this section, the best use changes over time. So does the value.  You can also take a more proactive approach and hire a good engineer and real estate attorney to help sway the city planners. This can be costly but can also prove very profitable.

One of the down sides of owning land can be that empty land doesn’t generate income during the holding period. However, I also know first-hand how profitable land holdings can be. If you want to hold raw land try to find some way to make it a producing asset.

I know a gentleman who purchased land under power poles for deep discount, and then leased it out to nursery growers to grow nursery stock. My family has farmland that they farm. They grow lemons and other row crops on land that will one day be sub dividable into building lots of some type.  The key to all these investment types, as we men-tioned at the beginning of this section, is to find the right property for your situation and long-term plan. If you do your research, you know that over time the real estate you purchase will increase in value. Even if you only cover your costs, you are building long-term wealth as your tenants buy your property for you. In the end, the property will be paid for, with very little money from your own pock-et, and it will be yours to use as you please, whether for retirement, or pass on to the next generation.
 
Summary

The most powerful investors I know primarily use the buy and hold strategy for long-term investment.  In the beginning, you may need to buy and sell to assist in paying bills and creating a lifestyle for yourself. However, if you buy and hold just one additional property every six months, in five years you will have accumulated a dozen properties that will pay you the rest of your life. Those properties will finance your retirement and provide you with a mil-lion dollars plus in wealth. Not bad for a part-time job.