As stakeholders of Amplend, we found it necessary to provide our clients, current and future, with advice on how to grow and diversify a portfolio. This advice stems from our meetings with clients, underwriting deals, and measuring risk.
Our goal is for successful clients to solidify their confidence in Amplend. Your success is ours.
This article focuses on the difference between growing versus scaling a portfolio and the factors important to a lender when underwriting a client’s plan and vision so here is our best advice to real estate investors.
Key Takeaways
- There are fundamental differences between growing and scaling a portfolio
- When an investor expands their holdings to another product type, this model needs a new business plan
- The proper delegation of tasks will eliminate sunk costs
- The concept of leverage applies to borrowed funds and the talent of team members
- The process of scaling is internal to the portfolio
Defined Terms
- Growth – investing in a new asset class and market
- Scaling – increasing holdings in the current asset class and market of the portfolio
- Sunk Costs – costs of a lost opportunity and the value of an investor’s time that cannot be recouped
Growing a Portfolio vs. Scaling a Portfolio
There are fundamental differences in growth and scale. Everyone in this business works hard. Unfortunately, some investors define work as offering several contracts with no-risk deposits and then “seeing what sticks.” There is no plan, team, or process. This is hard work without comparable results.
Scaling a portfolio involves work, but the difference is working smart. An investor’s financial position can increase tenfold without the investor doing 10x the work.
Components of a Scaled Portfolio
The seven components of a scaled investment business are:
- Know your niche,
- Create a team,
- Delegate,
- Measure and verify,
- Standardize,
- Use leverage wisely, and
- Hire a property management company
These seven components are listed and described below. Before we begin, let’s set the context in which our advice is given. We target residential real estate investors with either the fix-and-flip or the buy-and-hold objectives.
When diversity is mentioned, it is given in the context of these objectives for cash flow or the recapitalization of funds but maintained within the asset class of residential real estate. The diversity of the products can be single-family attached or detached units in different markets. The asset class remains residential.
Best Advice to Real Estate Investors in 2023
As you embark on your journey, it’s essential to understand that success isn’t just about working hard; it’s about working smart. That’s why we’re here to share the best advice to real estate investors to help you make the most of your real estate ventures this year.
Whether you’re passionate about fix-and-flip projects or prefer the stability of long-term buy-and-hold strategies, we’ve got you covered.
So, get ready to dive into the seven essential tips for real estate investors in 2023. From discovering your niche and building a dream team to delegating tasks and leveraging your talents, we’ll guide you every step of the way.
Let’s get started
1. Know Your Niche
When investors experience success, they naturally want to venture into something new. If an investor experience success in building wealth in the niche of renting homes in middle-class neighborhoods, then a new focus on luxury homes or vacation rentals will need a new business plan.
In this instance, investors must learn about a new market and ways to measure risk and value potential. This decision must be strategic and well-planned.
The planned expansion of investing in a current product type is scaling; investing in a new market is growing.
2. Create a Team
The secret to success in any business is to surround yourself with people smarter than you. So you should build a real estate team around you. The team members must be comprised of those offering advice and services in the niche and assigned specific project tasks. These professionals are Realtors, contractors, and lenders.
If growing your holdings involves a new product type, then chances are very good that the team members should also be changed. A Realtor may not know the luxury home or the vacation rental market if their expertise is in the markets for middle-class buyers or tenants. The contractor, and possibly the lender, may need to change because of price points or their business model.
Another critical point may be identifying new mentors or a different group of investors for your network to seek advice for a new product type.
3. Delegate
Delegation is essential. As a portfolio grows, an investor needs a team of trusted members to delegate tasks within their field of expertise.
An important aspect of delegation is opportunity cost. An investor will miss an opportunity when their time is spent on tasks that should have been delegated. The loss of an opportunity cannot be recovered. Delegation is the basis of the analogy: “Time is money.”
The loss of an opportunity and the value of an investor’s time handling a task that should have been delegated are also known as “sunk costs.” This means they are not legitimate costs to allocate to a project. These costs cannot be recovered, nor can a profit be generated from them.
Investors can properly manage project costs only if tasks are appropriately delegated to team members with contracts in place. Delegation also builds mutual trust between the team members and their principal.
4. Measure and Verify
The catch to delegation is the measurement of performance and the verification of it. In this instance, measurement means the forward progress with allegiance to the budget. Each team member must know the budget number that applies to their scope. The investor’s responsibility is the total budget.
Actual expenses should always be compared to the budget, and all variances must be explained. These explanations will aid the team members in knowing of any delays, issues, and the plan to rectify them. The scope of one team member subject to a delay will affect the scope of the others.
While team members are autonomous in their respective scope of work, all team members depend upon the scope of others for a successful project. An investor’s relationship with the team is never autonomous.
The measurement of the path forward, and the verification of it, will produce a successful project and a plan of action for future projects.
5. Standardize
A team that works well achieves success and profit for all members. The projected profit is based on product type, comparable sales, market analysis, work scope, and ROI. These standards can be applied to future projects.
This standardization can also apply to the types of appliances, paint brands, color schemes, and fixtures.
While the business plan for a fix-and-flip and buy-and-hold objectives could be similar, the procedures differ. For example, under a buy-and-hold objective, there must be policies for retaining a Realtor experienced with securing tenants and a property management company to handle the rents, maintenance issues, and accounting.
The fix-and-flip objective needs procedures for when tasks are started. Some tasks can begin during the contract’s due diligence period, and some cannot begin until after the closing. The timing of when the property should be listed for sale and determining the asking price must also be procedures in the plan.
The achievement of standardization takes time, and nothing is set. The plan to move forward must be known to the team, and the agility for dealing with any delay should also be a standard.
6. Use Leverage Wisely
All investors must know the proper use of leverage. The concept is applied to debt and talent.
Let’s start with debt.
The riskiest part of an investment is when investors do not fully understand their financial position and do not know the proper use of leverage. No one should take on more debt than can be handled comfortably.
A common mistake we see in our underwriting is using short-term money over a long-term hold and vice versa. The loan structures must match the investor’s objective.
Hard-money loans should be considered for a fix-and-flip or the buy-and-hold objective until the renovation is complete. These short-term loans must either be satisfied with sale proceeds or refinanced with long-term money when the property stabilizes.
All proformas must account for the short-term loan to cover a portion of the acquisition and the renovation scope. The remaining amount and the debt service during the renovation must be funded with the investor’s equity. This means cash.
The most significant mistakes seen in underwriting are the miscalculation of the loan term and the available cash to service the debt.
Leverage also applies to the talent within the team. Let’s look at some examples.
The Realtor’s knowledge of the market in identifying a property for acquisition can also be used to position the improved property for sale. The Realtor can also advise on whether the sale should target a homeowner or another investor.
The report prepared by the home inspector, typically referred by the Realtor, can be the basis of a preliminary budget and work scope for the contractor to verify, bid, and finalize. The Realtor can use this report to determine the market value of the renovations and the offered sale price.
The expertise of a property manager could also locate and qualify a tenant.
Some of these tasks can be performed by leveraging talent early in the investment stage. After the closing, all the tasks can then proceed concurrently to save time.
7. The Property Management Company
The hiring of a property management company makes sense for the investment portfolio. A full-service company will handle the screening and qualifying of tenants, maintenance issues, and preparing accounting reports.
The hiring of a management company supports the concepts of delegation and the leveraging of talent. It is common for investors to take the position of saving money by performing management tasks themselves. The professional management fee, usually between 8%-10% of rents, must be interpreted as an operating cost and a value-add investment.
The management fee is deductible as an expense. A well-maintained property with a qualified tenant and continuous cash flow will increase the market value more than the management cost.
Final Thoughts
We cannot emphasize enough the importance of scaling. The scaling process is integral to the investment portfolio.
When the scaling concepts are implemented, the investor’s financial strength will grow faster with less effort and time.
We are not here to say there will be less work, but the work will be done smartly. Your efforts and talents need to be leveraged like those of the team members. Your liquidity must be leveraged with the same diligence and considerations as those extended to borrowed money.
This is our best advice to real estate investors.
