There’s a certain sexiness to being able to say, “I own 100+ homes.”
I get it. It’s cool. In fact, it’s an incredible accomplishment. Most people only ever own one home at a time, and most people struggle just to pay that off. But just because you own 100 homes doesn’t mean that you are running an optimal real estate business. It doesn’t mean that this is a brilliant strategy or that it would even be helpful to others. And it shouldn’t be pushed on others.
This topic frustrates me because I was briefly sucked into this line of thinking — that I should start sourcing deals and buying as many single family homes, duplexes, triplexes, and quadplexes as I could get my hands on (good deals only, of course).
Today, I am diametrically opposed to owning 100 homes. I think it’s a foolish and dangerous path for someone like me. I think that instead of building myself a retirement, I would be building myself a tangled nightmare of management that would need a business built around it.
See, I work a full-time job and invest on the side. Every structure produces more management, paperwork, and maintenance for me, and if I pursue the “buy more deals!” approach, then every additional structure has less and less of a significant impact on my financial position.
I think that there are far better alternatives to purchasing dozens or hundreds of properties that better serve the primary objectives of most investors like me — those who want stable cash flow and a strong return on equity with relatively little active management on the part of the owner.
While there are many ways to get rich through real estate, I prefer a path that involves far fewer physical pieces of land and structure. I don’t want 100, 50, or even 10 properties. But I do believe that just one or two properties is too few.
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The Magic Number of Properties
I think the magic number is seven properties — and that investors should think in terms of buying, holding, and shedding properties with a holding period, on average, of seven years.
Let me explain.
I plan to purchase approximately one to two properties every year to 18 months, forever. I plan to purchase a larger and larger one each time, using the cash flow and/or equity of my existing holdings and any savings from my job/other investments to finance the transactions.
In November 2014, I purchased a cheap and run-down little duplex in an “up and coming” (read: not the nicest) part of town, moved in, fixed it up, rented it out, and have now moved out.
In March of this year (16 months later), I purchased a less cheap and run-down, slightly bigger duplex in an “OK” part of town, am fixing it up, plan to rent it out, and move out in a year or so.
At that point, I’ll try to buy a bigger, nicer property in an even better part of town, fix it up, rent it out, and repeat.
See where I’m going with this?
Each time I purchase, I expect to buy bigger, better, more expensive, and more profitable units, until the end of time. This obviously means that I won’t be buying duplexes in a few years and will move on instead to small commercial properties and hopefully one day, onto large ones.
At the end of these first seven purchases, I’d hope to be an owner of between $3-10M in real estate assets, with the portfolio leveraged about 3:1 across the average of the seven structures. I know that realistically speaking, some of these purchases might be months apart, while others might come with years in between. But the goal is to get to about seven properties in seven years, each larger and nicer than the last.
Why This Approach?
There are three reasons why I think that this is a fantastic approach for the part-time investor working a full-time job, and that’s what the bulk of this article will be about. Please note that I have not yet carried out this plan, and the real world will likely disrupt and alter this plan as opportunity and tragedy are wont to do. But the principles of the plan have and, I believe, will remain unchanged, even if the exact numbers play out in unexpected ways.
With that said, let’s get to the three reasons that I think that the ambitious W2 worker should consider a real estate strategy that involves purchasing just one property every year or so and selling off the older properties approximately every seven years.
Reason #1: A portfolio of seven properties gives the investor an excellent balance of both convenient management and diversified risk.
Let me tell you something about real estate. A secret. I don’t like real estate. I don’t like the physical structures of the duplexes, I don’t like doing yard work, I don’t like fixing toilets, I don’t like working with contractors, and I don’t like dealing with problems.
I think that I and another writer on this blog, Ben Leybovich, would agree on that.
Sure, I have some nostalgia for my first duplex — it was my home, I worked on it, lived it and breathed it. But no, I don’t really like the real estate itself. That said, I do like the income streams it provides. I do like collecting $1,000 per month currently. I did like living for free. I do like building equity.
And I do like the idea of SCALE.
As I mentioned, I think that when most people think about real estate investing and becoming a big player, they think about owning dozens or hundreds of properties and building an incredible management company to manage them.
If I had my way, I’d own ONE big apartment complex. Just one. Why buy 500 houses when I can buy one 500-unit apartment complex? THAT’s a massive passive income stream I can get behind. Sure, the problems are bigger, but you can solve 500 of them at once! Talk about efficiency. Talk about scale.
By the way, It’s also likely to be much easier to sell, contrary to popular belief. Sure, selling a single family residence (SFR) is easier than selling a 500-unit apartment, but selling 500 SFRs has got to be WAY more work than selling one 500-unit apartment.
On the other hand, having my entire real estate portfolio in one giant apartment complex is a bit of a risk. What if the holding company that owns it gets sued? What if it burns down? What if something goes wrong with that specific location?
I understand that having all your eggs in one basket is a risky endeavor, and that’s why I want to get to this magic number of seven properties.
The best part is that once I get to seven properties, I can still continue scaling, contrary to popular belief. I will do so by selling either the first property I acquired — or the one that is the least productive or the biggest pain to manage.
I’ll take any equity I get from that sale and simply exchange it for a larger, nicer property, simultaneously plowing any excess cash I might have lying around into the next, seventh investment.
Back to seven properties — just with one that is bigger, nicer, and (hopefully) less of a pain than the one I just sold.
I can rinse and repeat this forever, with the end goal of owning seven incredible 500+ unit complexes in excellent locations.
How does that sound? Sounds like a pretty good goal to me.
If I ever achieve that end goal with a controlling ownership interest, I’ll probably be an old, old man. But that’s the great thing about this process — there’s always a next step, from the slightly-less-beat-up-duplex to the $1B skyscraper downtown. I can stop whenever I want to, or never, and even if I stop in just 10 years, I’ll have a huge net worth and a real estate business that is way less of a pain to manage than 100s or even 1,000s of scattered SFRs.
Reason #2: Real estate investors should expect to releverage every seven or so years to maximize the benefits of both appreciation and stable cash flow
This is an analysis for the math whizzes out there. Earlier, I mentioned that you can scale by selling off early purchases in exchange for larger, nicer, and newer ones. Here, I’ll tell you why you should do that, or at least why the math suggests that you should.
When you invest in real estate, you benefit from two things:
Now, when you leverage (buy real estate with a loan) with 20% down, you can purchase a property roughly 5 times larger than you otherwise would. The effect that this has is that it immediately compounds the rewards and risks of real estate fivefold.
Think about it. If you have $100K and buy a property for all cash and it appreciates 5%, you’ve made $5K. If you have $100K, get a loan for $400K, and buy a property for $500K that appreciates 5%, you’ve made $25K.
Now check this out — this is an analysis I put together analyzing the effects of leverage on real estate returns and how they compare to the stock market. I use historical averages — in the real world the returns would jump and dive all over the place rather than produce the smooth curves in the model, but this is useful in terms of looking at how an average real estate investor might plan his strategy over the very long term. You can download the model yourself for free if you want to challenge or tweak my numbers.
In this analysis, we talk about a $62,500 property purchased with $12,500 down and a $50,000 loan (leveraged at 4:1). But the math works with everything from this tiny purchase to real estate into the hundreds of millions. Let’s look at two graphs produced by the model:
- Notice, first of all, that unleveraged real estate (the blue line) performs worse than the stock market (the red line) over time, on average. Leveraged real estate, on the other hand, typically performs much better than the stock market over the first decade, and then produces lower than average returns after that as the portfolio de-leverages.
- Notice, second of all, that leveraged real estate produces less cash flow than unleveraged real estate at first, and indeed, less cash flow than the dividends typically disbursed by stocks in the S&P 500 index on an equivalent investment. In fact, it’s about halfway through that seven year timeframe we talked about before a leveraged property will, on average, generate cash flow in excess of the two alternatives shown here.
One thing that is important to note with leveraged real estate is that with every passing year, you deleverage. As you deleverage, increase rents, and operate more smoothly, your cash flow increases and soon surpasses the cash flow of the unleveraged purchase, while your return on equity decreases.
I suspect that many moderately wealthy real estate investors suffer from this paradox. On the one hand, they are paying off their notes and getting some great passive cash flow from their investments. On the other hand, they’d actually be better off from a return perspective if they just sold their de-leveraging properties and invested in the stock market, or better yet, re-leveraged. I can imagine that in real life, that can be a tough decision if you hadn’t planned it out like this and done the math ahead of time. Still, less-than-optimal cash flow on a high net worth isn’t the worst thing in the world! But I digress.
The key points here are these:
- Leveraged real estate produces greater returns on average than unleveraged RE.
- Leveraged RE produces less initial cash flow than unleveraged RE.
- Every year, the effects of loan amortization and appreciation cause you to deleverage.
The conclusion I draw from all of this can be summarized thusly:
I want to get the highest total return I can, while stably and somewhat passively managing my investments. Therefore, according to the math and common sense that are most apparent to me, I must commit to continually re-leveraging my holistic real estate position, have relatively few structures, and manage my portfolio such that I have comfortable cash flow at all times.
So, given that objective, when is the best time to re-leverage, on average?
If you’ve noticed a theme of seven in this post, you got it.
On average, I should expect to re-leverage my real estate position every seven years to maximize the benefits of both return and cash flow.
When it comes to re-leveraging I have two choices. I can either refinance the property and take cash out, or I can sell a de-leveraging property, take the entire net proceeds, and use it to buy a larger property with a larger loan.
I believe that given my goals, the smart thing to do in my case is to sell the deleveraging property and buy a bigger, better, newer one with the proceeds (tax-free, too — but that’s another story). I can then repeat the process roughly once per year and continuously sustain a favorable leverage position for my portfolio in the process.
Reason #3: Owning seven properties and purchasing/refinancing real estate once per year is an excellent blend of cyclical activity and gradually increasing challenges for the part-time investor.
Remember how I mentioned that I don’t like real estate? Well, that’s only partially true. I like solving problems, I like learning, and I like being able to say that I produced something. I like seeing the results of my hard work. But I don’t like solving the same problems over and over again. I don’t want to keep screening tenants for years and years.
I want to train someone else to solve problems that I’ve already solved. Then, I want to train him/her to train others. That way, I can go on to solve new problems every day.
See where I’m going? Let me put it another way:
Every property purchase involves hard work, discipline, and tests a variety of traits. I have to be analytical, good with people, a marketer, a salesman, a legal team, a CPA, and everything else all at once.
I like that.
What I don’t like is having to do that year round. Some people do, and that’s why they build huge portfolios involving hundreds of properties. They like pouncing on every good deal as it becomes available and making it work. But that’s not me.
I’m investing in real estate to build passive, massive wealth, on the side, and in my spare time.
I’m happy to give a couple weekends and weeknights per year directly to this cause and to read and learn and network and plan my next move year round. But I’m going to build my wealth through my career and by following my passions, the proceeds of which will then be invested in real estate.
One transaction per year is plenty to satisfy my hunger to build my business, but not so much that it will overwhelm me and become a second full-time job.
Lastly, let me note another advantage to this “seven properties” approach from a cyclical management side of things. That advantage is that I can pick and choose which properties to keep and sell.
Perhaps one property is slightly less leveraged and therefore performing slightly suboptimally, but I’ve got great tenants in there. Or suppose I have a potential awesome exit in a few years where I could knock the property down and build a bigger building. Or maybe the property is in the way of eminent domain and the government might buy me out.
In any event, I can just sell the next property, the one that has terrible tenants and is a constant pain in my side, but is technically performing better, or is next to the big factory that’s being built, or is just a painfully long drive away.
Rather than just having one property, I now have choice, and I can use that choice, coupled with the stable cash flows from the other properties, to make a decision that makes sense given my portfolio and personal situation.
Will this path work for everyone? Of course not. It probably won’t even work for most. But I think it might work very well for those of us who work full-time W2 jobs that we love, but want to build a scalable and minimally invasive real estate business.
Seven properties. Seven years. One property purchase per year. Bigger, better, and more scalable each time.
I want to point out that I believe that this works best when I am making sure to purchase these properties during times when I am well capitalized and in a stable life position. It’s when you have tens of thousands in the bank set aside for your next purchase, are pre-approved or extremely well-qualified for financing, or have other sources of money ready to go for your purchase and few other life or business distractions that you are most prepared to purchase investment real estate.
With my approach, I’m actually NOT interested in other deals, even great deals, at the current moment, and had to turn down a great deal recently on a duplex right in my hot zone. I turned it down because I’m currently in the middle of stabilizing my second duplex. I’m giving that my total attention, and my next purchase is at least six months out, and that’s only if I stick with the small multifamily stuff. There is ALWAYS another deal down the road, and I am following what I believe to be a smart, yet intentionally boring seven-year plan to building wealth through real estate.
An incredible, exciting deal at the wrong time is not a good deal for me.
I hope that this is a sustainable, long-term approach to building real estate wealth with stabilized businesses that will both grow and help me grow over time. It’s not for the aggressive entrepreneur, the man who is close to losing everything and needs to provide for his family TODAY — or for those who do not intend to scale over time.
But if you are looking for a passive approach that rewards limited hustle, lots of networking, a commitment to self-education, and financial discipline, this might be great for you as well. I believe that an approach like this scales over time and allows one to consistently reach for slightly larger challenges with each passing year.
Personally, I can’t think of a better way to invest my money and my time.
- What do you think of this strategy?
- Are more properties always better?
- Is this something you think could work for you?
Leave your thoughts below.