When starting the journey to become a real estate investor, one of the first questions you may ask yourself is “where will I get the money?”. You can work hard at your day job and attempt to save money paycheck after paycheck, but really exciting real estate investment opportunities will pass you by with this approach. A more effective strategy is to form a real estate investment club, which allows you to gather a group of investors to create a larger pool of available funding and be able to move opportunistically on properties.
Clubs are typically formed within a specific location with like-minded people interested in pooling resources to gain financial leverage. Anyone can form a club, however you would be wise to clearly articulate the investment levels and cash return expectations with the club when you meet to make sure everyone is operating on the same page. You will also need to identify a set of common guiding principles for the club, such as a exit strategy for an investment and the ability to ‘buy out’ investors when individuals want to leave the club. Clubs overall are an exciting way to invest without a large personal outlay of investment dollars.
As an example, lets say you find a residential property for sale with a listing price of $100,000. If you find 20 potential investors with an investment of $5,000 each, you can make a cash offer for the property which may times will allow you to successfully bid below listing price. If for example your club made a cash bid of $95,000 and it was accepted, you could keep $5,000 in reserve for vacancy and repairs and begin renting the property immediately. If you are able to rent the property for $1200 a month, and you deducted expenses such as taxes, property management and other maintenance reserves you may be able to see a positive cash flow of somewhere between $800-$1000 per month. Annualized this return would amount to $9,600 – $12,000, giving a cash-on-cash return of up to 12%. This is just an example and you must carefully analyze expenses and rental income opportunity prior to any investment decisions.
Using the power of an investment club, you can see from the example above you effectively serve as the ‘bank’ and therefore eliminate many of the expenses typically incurred. Some cautions exist however, you must carefully select your investment group so that you have common expectations for cash flow on a property. You will also need to determine what type of legal entity you will form to protect you from litigation should there become an issue on or with the property. Understanding the difference in entities such as corporations and LLCs are critical in protecting you personally, as your personal assets may be exposed if the entity selected does not affort you the proper protections. Finally, you will need to agree to regular meetings to review the cashflow of the property and continually review your exit criteria.
Investment clubs may not have the phenomenal financial return potential of small cap stocks and IPOs, but they allow you to limit downside and risk while returning higher than average returns on investment. They also are a great vehicle for learning the details of managing a property for the time when you want to ‘strike it out’ on your own.