Why Having an Investment Philosophy is Critical & How to Create One
There are plenty of ways to make money in real estate. Oftentimes, people become overwhelmed once they begin researching these various options because of just how many exist. They start asking themselves “Which of these is right for me?”
In reality, the answer may be that there are multiple paths that could work well for you; But to even get to that short list it’s vital to have a clear investment philosophy to guide you down this decision path. Each real estate investment avenue has trade offs and the “right” one will depend largely on your financial goals, lifestyle, timelines, risk tolerance, and personal values. That’s where an investment philosophy comes into play.
According to Investopedia, “an investment philosophy is a set of beliefs and principles that guide an investor's decision-making process.” Think of it as a set of guidelines that you can always refer back to when faced with investment opportunities. While it can be used to guide any kind of investment decision, this article will focus on how to create your very own philosophy for investing in real estate, how to use it, and why it’s important.
Components of an Investment Philosophy
Before we discuss how to build your personal philosophy, it’s important to outline the components that make up a philosophy. Think of each of these components as a spectrum and it’s up to you to decide where you fall.
Financial Goals - this includes both short and long term goals, if you’re working towards financial independence and how much money you need for that, what amount of income you need monthly to sustain your lifestyle or reach your desired lifestyle, and whether you’re looking to build wealth or generate monthly income.
Lifestyle Factors - this should take into consideration factors such as how much time you have, how much time you want to spend in this particular area, how interested you are in the investment subject, and what other components you need to consider in your current lifestyle such as work or family obligations.
Risk Tolerance - this may depend on how many years you have to invest in your timeline, how much wealth you currently have, your experience level, and what else you are investing in.
Timelines - this refers to the amount of time you have available to reach your goals.
Values - this could include moral values, ethical values, and/or what you value in relationships with others.
Let’s explore a couple of concrete examples of investment philosophies looking at the world of real estate:
Example 1: Kim’s investment philosophy is to focus on passive investments that generate high returns over long periods of time via equity positions. She is trying to reach financial independence in 10 years so she can quit her corporate job and travel. She values time freedom, location freedom, directness, honesty, and concise communication. This is based on factors such as she has a full time job and isn’t super interested in being hands-on in real estate. She doesn’t need cash flow right now because she has a job but she does want to eventually leave corporate life. She values travel and doesn’t want to be tied to a business where she needs to be on call on weekends. She is also passionate about providing quality yet affordable housing to people. She has quite a bit of savings so would like to spread that into a couple of investments but still generate a higher return than her 401K in the stock market to help her reach her financial independence goals.
Example 2: Mark’s investment philosophy is focused on both short term rental properties and being a general partner on larger multifamily deals. He has a family and a full time job but it isn’t time intensive so he has availability to spend on other activities. He enjoys learning about how to operate Airbnbs efficiently and is passionate about helping others learn about real estate investing. This is why he focuses on raising money and being part of the operations for larger deals while also getting hands-on operating knowledge from his short term rental investments. He wants to generate multiple sources of income so he can save for his children’s college and also have income when he retires in the future. He values respect, human connection, and being part of a team.
Why Having a Philosophy is Important
Establishing an investment philosophy can help in many ways regardless of whether you are a new or experienced investor. If you’re new, it can help you focus your learning and give you talking points when meeting people in the industry. If you’re experienced, it can help you decide what to do more of and optimize your investments as you build wealth.
Regardless of your experience level, having an investment philosophy can help you avoid the frustrating state of analysis paralysis; This is where you end up taking no action because you can’t decide which action is best. Should you invest in a REIT or as a limited partner in a multifamily syndication? Should you buy a property to operate as a vacation rental or a long term rental? Education is still important. We always advocate taking the time to learn about several different avenues at a high level, but only spend your time going deep in the ones that align with your philosophy.
Having a set of guidelines to reference can also help lower the chances that you regret a decision you made later. Investing in real estate usually involves larger sums of money than other areas, which means making mistakes can be costly. A set philosophy won’t guarantee you’ll avoid all risk and won’t have any regrets, but it can help you feel confident that you are making the best decision you can with the information you have available at the time versus a random choice. It encourages you to ask the right questions, gather data, think through the opportunity, and know why it would or would not work for you. There is less likelihood of having “buyer’s remorse” after the fact knowing why you invested in this opportunity and how it’s helping progress your goals.
How to Build a Real Estate Investment Philosophy
As you may have noticed by now, these guidelines are quite personal. The philosophy that holds true to one person may feel completely off base to another person. That is why it is important to take the time to document your own set of guidelines. Start by answering these questions that are relevant to you under each category:
Financial Goals
What big financial goals are you working towards this year and in 10 years?
Are you looking to retire early or reach financial freedom and if so what amount do you need to do that?
Do you have multiple streams of income monthly?
Do you want to focus on building wealth for later or generating cash flow for the now?
Lifestyle Factors
What are your current work obligations?
What are your family obligations or desires?
Do you have spare time? If so, how much and what do you want to spend it on?
What interests you in real estate or are you not interested?
Are you mobile or are you tied to a specific location?
Do you have a desire to travel?
Risk Tolerance
How much of your money will be going into a certain investment/asset class and how do you feel about it?
What is your current net worth?
How much do you have in savings?
How much do you have to invest?
How old are you?
What other investments do you have in your portfolio and how risky are they?
How in control/hands on do you want to be in your investments? If you have a partner you trust, how hands off are you willing to be?
Timelines
When are you planning on retiring?
When are you trying to reach financial freedom by (if applicable)?
What is the timing of other major financial events in your life you need to plan for (college, baby, etc)?
When will you need additional streams of income or when are you planning on losing a certain source of income?
Values
What qualities do you value in professional and personal relationships?
What characteristics of investments are important to you (i.e. control, visibility, etc)
What are some of your personal values that guide your life currently?
What are you morally opposed to and in favor of?
What are you ethically opposed to and in favor of?
Once you have the answers to these questions, you can put them all together to articulate your personal investing philosophy. Having this documented will allow you to easily share or review it when you find a new investment opportunity or partner. Having this information written down will help you be more clear on what you want out of an investment and why.
Remember, this is a fluid document that should evolve as you evolve. Check in on your philosophy each year and see if it still rings true to you and where you are in your life. Don’t be afraid to adjust components as you progress along your investment journey.
Using Your Philosophy
Use these guidelines each time you are presented with a new investment opportunity or are considering diving deeper into an area of real estate. This criteria can help you to find partners and/or operators that align with your personal philosophy. It will also allow you to know what questions to ask to vet them.
If you’re an active investor, you can use this to decide what area of real estate you want to get involved in, such as being a wholesaler, flipping houses, buying storage units, or partnering with others to invest. If you’re considering a partnership, be sure to ask questions like what their financial and lifestyle goals are in the short and long term, what personal values are important to them, what involvement they want a partner to have in the project and in future projects, how long they envision a specific project to last, and what their long term vision is for partnering.
If you’re a passive investor, you can use this to decide what asset types you want to invest in, such as REITs, ATMs, funds, or apartment syndications. When vetting sponsors or other partners, be sure to ask them what their investment strategy is, what their values are, how they communicate with investors, what kind of analysis they have done (to determine if their assumptions are conservative or aggressive), how long the project will last for, and what the expected returns are for different investment options.
In both cases, you want to ensure that whoever you’re partnering with lines up with your goals and values. For instance, if an investor asked about our multifamily syndication company’s philosophy, we would say we believe in buying cash producing assets while focusing on creating value by improving/renovating to generate profits. We also believe in transparency, establishing personal connections with each investor to build long term relationships, and providing constant education to help investors grow in their journey.
Having an investment philosophy won’t guarantee you’ll make higher returns, but it enables you to make faster decisions that you feel more confident in because you know why you are making them.