5 Lessons I Wish I’d Known When I Started Investing in Real Estate
Overestimating Cash Flow.
In the beginning, I was afraid. Later, I was greedy and reckless. Neither worked out for me very well.
Then I met a solid mentor, bought my first buy-and-hold deal, and it worked out pretty well. After that, I became a vacuum cleaner, sucking up every deal I could find.
I wish I had a time machine, so I could go back and slap some sense into my younger self. Here are the five lessons I’d use my time machine to teach myself. Learn from my mistakes, so you don’t have to suffer the results like I did and lose remotely as much money as I did.
Learn how to forecast cash flow accurately
The first lesson of cash flow is that it’s a long-term average, not what happens in a “typical” month.
Cash flow works like this: For nine months, you’ll be sitting pretty, banking the (hopefully wide) margin between your rent and your mortgage. Then you’ll be slapped with a $3,000 furnace repair.
Or your tenants will decide to stop paying. Or they’ll sue you because the neighbor’s dog looked at them funny. Or whatever. Novice landlords say to themselves, “What bad luck! Oh well, this was a freak one-time expense, next year will be better!” Which is, of course, crap. People are typically nice until they start to have financial issues, then you will start to hear every excuse in the book. Its a reality. I have faith in people, but people have also been trying to take advantage of me for decades. Some are good, some are not.
By contrast, experienced landlords say to themselves, “Good thing I budgeted for these expenses in my cash flow calculations.”
You need to include repairs, maintenance, CapEx, vacancy rate, property management fees, accounting costs, administrative costs, property taxes, insurance, HOA fees (if applicable), and maybe even your shrink’s bill.
Sound like it’s difficult to find deals that will still cash flow properly after all those expenses? It is! Finding good deals is work — they’re not just strewn all over the MLS. Often the best deals are known only to the very connected agents within the industry.
But if you learn to forecast these expenses accurately and you only invest in properties that still cash flow well, you are virtually guaranteed to make money. If you get cash flow forecasting wrong, prepare to lose money. The good news is that it’s not hard to get right, once you know what questions to ask.
House hacking is an ideal way to get started
What’s better than living for free? Not much.
If you aren’t deeply familiar with house hacking, there is a lot of information available on the internet. In summary, house hacking is essentially living for free.
When your neighboring renters pay your mortgage and other housing expenses for you, you can throw your savings into hyperdrive. For most people, their highest expense is housing. Remove that, and suddenly they can devote all the money they would have spent on rent or a mortgage toward savings and investment. At $2000 per month in rent savings, thats $24,000 per year in after tax dollars!
Lower expenses, higher savings rate: This is the formula for reaching financial independence very, very quickly. The really ambitious set a goal of living on half their income and investing the rest! This is a very efficient way to save up the required downpayments.
The trade off? You wont be able to live in that giant house. In the short term you would be living in an apartment sized place. Comfort vs getting ahead will always be your trade off to future success.
The perfect deal is a myth; look for a good deal
New investors sometimes wind themselves up looking for the “perfect” deal. It doesn’t exist.
In personal development circles, there’s an adage that “perfect is the enemy of progress.” It’s true: If you refuse to act until conditions are “perfect,” you’ll never act. No, today’s housing markets are not as advantageous to buyers as housing markets six years ago. Get over it. That market is gone, and this is the market available to you now.
This is not to say you should buy indiscriminately. Quite the opposite—set targets for ROI and for cash flow, and commit to yourself that you will not buy any properties that don’t meet those standards.
Choose a few neighborhoods to target with care, and then focus on finding good deals within those neighborhoods. Don’t be afraid to negotiate hard to drop a property’s price to meet your standards.
Most importantly, keep at it. There are good deals out there, finding them is just a matter of tenacity.
After purchasing, properties’ ROI comes from strong management
You can score a great deal on a property and then still lose a boatload of money on it. How? Bad property management. When you buy a property, you’ve forecasted its cash flow, but those forecasts are purely theoretical. They exist only on paper.
How well do you screen out bad tenants? How well do you retain good tenants? Does your preventative maintenance extend the lifespans of your mechanical systems? How well do you add value to remain competitive with other nearby properties?
Your returns on rental properties will be based on two things: whether you bought a good deal initially and whether you manage the property effectively. Success depends on doing both right.
The best acquisition in the world will lose money if you lease to a deadbeat who doesn’t pay the rent and then fights you in rent court. Invest time and effort in tenant screening and tenant retention when you’re first starting out—these are the backbone of good property management.
Focus on the fundamentals (and forget the rest!)
I can’t tell you how often I see questions from new investors asking about corporate structures versus Ltds, or about exchanges, or some other distraction far over their head. This is imporatnt, but not if you don't know the fundamentals as second nature.
When you’re a multimillionaire, you can worry about protecting your assets with legal entities or trusts or Harry Potter’s invisibility cloak. When you’re starting out, focus on accruing assets that are actually worth protecting.
And don’t get me started on all the armchair economists who go on about trying to time the market. If housing experts and real economists with actual PhDs behind their names can’t accurately predict market timing, you can’t.
Forget all that nonsense. Stick to the basic fundamentals and adjust your cash reserves based on the potential timeline risk.
In the beginning, there are only two things new investors should focus on: finding good deals and managing them effectively. If that sounds oversimplified, it’s because both of those tasks involve plenty of sub-skills to master.
-Chris Kotscha, Commercial Realtor