How To Buy Your First Investment Property by Anna Seidel
After the panel discussion on “How to buy your first investment property” found such great interest among the community, I hope to share a few key insights and helpful reference points for your research as you get started on your own real estate investment journey.
To provide a brief background, my name is Anna Seidel. I am an investment professional based in London and worked for €650bn AUM private equity investor Blackstone over the past years. During my time with Blackstone, I’ve worked on numerous Pan-European investment deals as well as the build-out of the firm’s €8bn last-mile logistics platform. While studying at Harvard and the University of St.Gallen, I had the opportunity to work as an investment scout for European VC fund Global Founders Capital and the family office of tech-entrepreneur Marc Samwer, where I led real estate investments exceeding €60m across Germany. Now, I am working with a Brazilian long-term equity investor, leading investments in the global B2B SaaS & MedTech industries (also with some exposure to PropTech), yet the passion for real estate remained and I started buying a few investment properties myself.
In this article I will provide a brief guiding outline on the most relevant factors to begin with. I’d be happy to connect with fellow Business & Dreams members that might want to reach out to exchange further or discuss any questions.
1. Finding your investment approach
As a first step, start with “WHY”- understand your personal ambition with real estate; it could be that you want to find a high-quality asset as a long-term investment, learn about real estate by investing in the public market or even real estate asset adjacent companies (i.e., PropTech), build a buy-to-let portfolio or develop assets to resell them post improvements. Depending on your “WHY” you can define clear commitment targets in terms of time and money you’re willing and able to invest for the buildup of your portfolio.
2. Exploring your options: from buying rental properties to REITS
a) Rental Properties: Owning rental properties can be a great opportunity for individuals with relevant real estate knowledge, and the ability to manage tenants or budget for a property manager to monitor ongoing property maintenance, payments and rent reviews. Most importantly, aspiring real estate owners can maximize capital through leverage, paying off the balance and interest over time with the regular rental property income received. In some cases, the required down payment may only equal 5% of the total asset value (usually you find yourself paying 15-20% of the total asset value upfront to the bank to receive a mortgage for the remaining part of the asset price). Consequently, this means that you could for instance buy an apartment worth EUR 500,000 (i.e., SEK 5.1m) with just EUR 75,000 (i.e., 761k) of your own money (note – there might be additional closing costs as later discussed in this article) and have the rest of the balance paid off ideally by your tenant.
b) Investment Groups: Real estate investment groups include multiple partners or private shareholders; with these multiple sources for capital investments, one has a greater pool of capital available and a greater ability to invest more broadly vs. in one focused market. Real estate investment groups focus the majority of their business on real estate but do not necessarily have a specific real estate entity status / are not obliged to any specific type of operations. Usually, these types of groups require a significant upfront investment ticket to participate and may require an additional management fee. Therefore, this option might only make sense if you wish to commit a substantial amount of your personal savings portfolio to this type of investment vehicle and can afford to lock capital for an extended time period. However, there are still quite a few small investment groups that might be a viable investment option for your circumstances that will allow participation with tickets of c. EUR 100,000 (you can find investment groups via LinkedIn or exchange with brokers in your local community).
c) Development Projects: Finding rental properties at a good price and potentially investing some budget in renovations to allow you to increase rent might be the most common approach in real estate ownership and is likely also best suitable for beginning real estate investors. Yet, should you already have substantial real estate knowledge of a specific market and an understanding of development and renovation costs, you might want to actively look for significantly BMW (below market value) properties to develop or modernize apartment buildings (i.e., adding elevators, internal refurbishments, changing out heating / energy systems) to unlock value uplift opportunities.
d) Online Real Estate Platforms & REITS: If you don’t immediately want to lock up meaningful amounts of capital and have the ability to “correct” decisions fairly quickly, investing in online platforms or REITS and publicly traded funds might be the best option
Online Real Estate Platforms: crowd-funding platforms may be a way to start understanding the real estate world and building exposure without locking-up too much of your personal funds. Usually, these platforms require fairly small buy in tickets, however, it is important still that you do understand the underlying asset portfolio well (what assets / locations the fund is buying), check the “lock-up” periods and management fees these platforms require. Fellow panelist Lovisa Löwenborg from WIRE Invest is likely the best person to ask here as a starting point.
REITS & Public companies: A real estate investment trust is best suited if you want portfolio exposure to real estate but don’t want to commit significant capital upfront or go through the traditional real estate transaction. A REIT is created when a corporation (or trust) uses investors’ money to buy and operate income properties and like any other stock most of the major REITS can be bought across global stock exchanges. It also allows you to invest in real estate portfolios across various countries usually or asset classes (i.e., commercial properties like offices, logistics assets or hospitality asset that you could otherwise not access as an individual investor). Moreover, in case you need to pull out your funds, the public investment approach – just like with stocks – allows you to sell fairly quickly whereas buying rental properties with a loan might trigger penalty fees upon early termination or there might also be additional taxes (i.e., in Germany you are taxed for opportunistically buying and selling assets with less than 10-year holding periods etc.)
PropTech investing: Not only can real estate assets themselves produce great returns and value appreciation, but there are also various stellar companies supporting the global real estate market such as software solutions for asset management (both private early-stage companies as well as publicly traded software solution businesses) that you can invest in. To invest in publicly traded PropTech stocks, you can start building an understanding of great opportunities by screening reports by major banks, investment platforms and forums online and narrowing down a target list of companies that you want to learn in depth about. Once you have set a watchlist of companies, you can review their annual reports, earnings calls and look into real estate broker market reports to further firm up your investment decisions.
3. Building market understanding
Assuming you want to pursue a buy-to-let investment strategy, develop assets or buy and hold for own use, your next step will be focused on building market understanding.
There are numerous ways to build knowledge about your respective investment market in terms of country, region, asset class you want to buy into, but to give you a cohesive starting point the most relevant sources are summarized below: very high level – there are a few core dynamics you want to understand to frame the respective market that you want to buy into
a) vacancy rates (what % of apartments are occupied in the market / neighborhood you want to invest in and what was the occupancy dynamic historically? You want to understand how attractive your chosen area is and how quickly empty apartments are usually taken up again),
b) net new supply (how many new developments are built each year in your chosen investment area? If there is new supply in the direct vicinity of your property then why would a tenant rent your existing, older property and how can you argue “location” value over time upon a potential sale – so, you ideally want to ensure that you find a continuously attractive location where people want to / have to live for their jobs and families and where no new development can quickly compete with your property (i.e., either you already buy in a fairly urban area that is constraint for new developments or you ensure to understand as well the pipeline of permits and potential future developments via your broker and publicly accessible records) ,
c) take up dynamics (you also want to understand what kind of properties where rented in your chosen market / area i.e., what size, what tenant profile, what lease length to understand what is desired and will provide a fairly consistent and secured cash flow),
d) rental and asset value growth (what are the current avg. rents paid in your chosen area? At what rate have they grown over the past years and likewise how have underlying asset values developed, what value growth per year has been experienced for your chosen asset area and for comparable assets?)
Where to find this information:
To first settle on an attractive market potentially even and also develop an “investment mindset” or key themes you believe in, you can read the annual reports of REITs online. In their annual reports they will not only track above mentioned metrics but also provide guidance on their valuation approaches, believes in specific themes and trends. To start I’ve listed a few notable Swedish real estate investment companies that you can read up on to get a good sense of their business models and investment approaches: Corem, Humlegarden Fastigheter AB, Akelius, Castellum, Heimstaden, Klövern, Atrium Ljungnerg, Hufvudstaden, D Carnegie, to name just a few.
Next, to understand the core criteria outlined above you can read publicly available market reports by key brokers such as JLL, CBRE or Cushman & Wakefield, among others. They will usually all provide color on past transactions in the market, growth dynamics, new supply and occupancy rates. Likewise, there will be quite a few large-cap banks holding real estate assets or running real estate funds that will offer regular market updates. Also, some private equity style investors are publicly listed (i.e., this is also true for Blackstone) and they will publish filings and annual reports that reflect their investment strategies and views on the market.
4. Finding investment opportunities
After you’ve built up your “knowledge portfolio” and feel comfortable with the “screening framework” set up, along above guidelines, you want to start searching for investment opportunities. Likely, the first search will be on one of the leading marketplaces yet be mindful that this is where everyone searches for properties and most likely for own use vs. investment purposes. You’ll often have a premium priced in and most likely you’ll face higher competition bidding on these deals, driving up prices even further. A few alternative strategies might be the following:
Follow small property developers via LinkedIn and see what projects they’ve developed over the past years, potentially some recent projects might come to market or they know the first buyers that potentially want to resell (i.e., I found one of my assets via building contacts to local developers and tracking buyers of these new-built projects. A family-office investor wanted to dispose of some assets from a recent development purchase and that way I was able to access an opportunity without broker, marketplace platform or competition and had a better negotiation position).
Build relationships with local brokers, that way they might be able to flag new opportunities coming to market or show you additional stock that is not listed on marketplace platforms.
Build relationships with small local real estate investors and managers (i.e., you could either connect on LinkedIn to asset managers and find out via that relationship whose properties they manage and whether these owners might be sellers in the near term, or you could also find fellow small investors that might have a different return requirement, liquidity needs or investment horizon and want to sell individual assets in their portfolio to you.
You can sign up for auctions – this might not necessarily be the source for an investment for most, unless you want to spend time on a comparatively riskier re-development or value-uplift project, yet sometimes there might still be some hidden gems or you might connect to experienced real estate developers that may want to sell a “stabilized” (meaning, refurbished and re-let) asset.
Bottom line here is, be creative! Actively build your contact network via LinkedIn, virtual and local events. Being close to the market and having access to opportunities beyond the marketplace listings everyone sees is definitely possible with a reasonable time investment and really pays off in the long-term.
5. Evaluating an investment opportunity
Once you’ve found an asset that you like; you’ll want to have an understanding of how to approximate a fair value for the asset and have an understanding of whether something is “expensive” or “overvalued”.
The approaches for analyzing the value of real estate investments function analogous to those used for the fundamental analysis of stocks. As real estate is usually not a short-term trade, analyzing cash flows and the ensuing rate of return is critical to achieving your investment goals of profitability. You must develop an understanding / be able to make an educated guess on how much profit each asset will make, whether through property appreciation, rental income growth, or both. One of the most important assumptions to make when performing real estate valuations is to choose an appropriate cap rate: the cap rate or capitalization rate is used in commercial real estate to indicate the rate of return that is expected to be generated on a real estate investment property. This metric is computed based on the net income a respective property is expected to generate and calculated by dividing net operating income by the given asset value. While the cap rate can be useful to quickly compare the relative value of similar asset investments in the market, it shouldn’t be used as the sole indicator of investment strength as it does not take leverage into account, the time value of money and future cash flows from property improvements, among other factors. Cap rates largely depend on the context of the property and the market, so see this as a proxy / starting point for understanding whether you found “a good investment”.
To summarize, in order to determine the present value of a property, you apply your determined cap rate to the property’s NOI (net operating income). For example, you have a property generating an expected NOI of EUR 200,000 over 10-years and discount at a cap rate of 10%, the market value of the property would be EUR 200,000 / 0.10 = EUR 2m. Accordingly, if the example property is up for sale above the EUR 2m mark it is not a great deal.
There are several methods you can use to find an appropriate capitalization rate, including the following: One common approach to calculating the cap rate is the build-up method. Start with the interest rate and add the following:
A liquidity premium —arises due to the illiquid nature of real estate. In general, investors who choose to invest in illiquid investments need to be rewarded for the added risk that a lack of liquidity poses.
Recapture premium—accounts for net land appreciation: every year you as an investor lose a % of the invested capital, which was represented in the full value of the property at the time of purchase, due to the aging of the property. Therefore, you want to incl. a recapture premium which can be estimated by dividing 1/ “useful life (in years) of your property, so if you think your property is functional for 40-years your recapture premium would be 1/40 or 2.5% p.a.
Risk premium—reveals the overall risk exposure of the real estate market
One other approach is a market-led method or -extraction method which assumes current, readily available NOI and sale price information on comparable income-generating properties. Assume an investor might buy a house expected to generate EUR 500,000 in NOI. In the area, there are three existing comparable income-producing houses:
House A with NOI of EUR 250,000 and a sale price of EUR 3m (Cap rate % is EUR 250k divided by EUR 3m)
House B with NOI of EUR 300,000 and a sales price of EUR 4m (same approach here for cap rate calc.)
House C with NOI of EUR 200,000 and a sale price of EUR 2m (same approach here for cap rate calc.)
Taking the avg. of all these cap rates for comparable investment assets will lead to a cap rate that can be viewed as a reasonable representation of the market. Using this avg. capitalization rate applied to the expected net operating income for your investment property will give you a fair estimate of the market value for your property.
6. Setting your real estate business plan
Once you’ve settled on an investment property, you want to set out clear goals, so a strategic plan tracking the value development of your property; what you will “change” about your asset and what returns you expect to achieve over a set time period with your invested capital. For the purpose of this article, I will only touch briefly on the components that your spreadsheet might include to keep this outline straight-forward. Should you wish to go through an excel template or case study, feel free to let Vendela and Camilla know, and I’d be happy to set up a webinar.
To name just a few core points of “value improvement” or ways of “making your business plan work”: a) you buy below market value property (i.e., see point above on finding a good deal, b) you have a value-add plan such as refurbishment improvements that will allow you to increase rent, c) you studied the market dynamics for your respective asset and can benefit from both strong rental growth and asset value appreciation over time. Usually, your business plan for your respective asset will be a combination of these factors and can be broken down into measurable components with a spreadsheet tracker / simple model.
Your spreadsheet, similar to a company P&L, will track the asset value appreciation, top line revenue, operating costs, investment costs for refurb, debt payments and eventually net operating income over time, so that you can track the free cash flow your property is generating and approximate the value development effects due to rental growth and other value uplift drivers discussed above. For those readers with a background in accounting and / or finance, this exercise will resemble the dynamics of building a DCF. Even if you intend to hold your investment property for own purposes and don’t necessarily aim for an active business plan development, this tracker is still useful to have in terms of cost development, keeping up to date on key lease dates and rental uplifts.
7. Securing Financing & Closing an Investment
In parallel to your property hunt, there are a few points to tick off your checklist in parallel, so that you can act timely once an opportunity comes up that you want to invest in. Therefore, start speaking to banks early! Schedule appointments with different local banks to see what terms you can actually get from your bank and what your monthly repayment and interest fees will amount to. Also, come prepared with a value range in mind i.e., how much own equity can you put up / what kind of asset you want to invest in. Make sure to understand what risks the bank is looking at to also understand how you might be able to get a higher leverage component on your asset. Usually, a bank wants to understand a) do you have existing assets that can act as collateral, b) do you have regular income so that you could cover the mortgage payments if your tenant leaves, c) what kind of property are you buying – they will make their offer dependent on the quality of the asset and the risk associated with it. Make sure to keep that in mind – there might be additional finance opportunities or subsidies for energy efficient homes etc. d) what are you planning to do with the asset – for instance, you may have EUR 100k available as a 15% down payment and budgeted an additional amount to refurbish the property, now you could go back to your bank for a re-evaluation and re-finance your mortgage with better terms, given the risk / attractiveness profile of your asset improved.
Overall, this exercise of speaking with banks early is super helpful as they will be able to provide you with “guiding” repayment plans and terms that let you anticipate your costs and available funds better.
Once you’ve secured financing and actually are about to close a deal, make sure to budget for additional fees and costs that might amount. There might be an additional 10-15% of your asset value due upon closing for broker fees, notary fees, registration and technical reports to check the property does not have any substantial defects. To get a better sense of what % you’re looking at for your respective market you can find guiding tables outlining closing costs for instance on online marketplaces. The final checklist point should be ongoing costs, both for operating your property and potential management fee costs, should you wish to outsource the property maintenance and liaison with your tenants.
If you want to go into further details, discuss any questions you might have or bounce ideas – feel free to reach out! You can find me on LinkedIn, or Instagram (@annacasophie). I look forward to meeting many more Business & Dreams members online!
