I’ve been investing in real estate for many years. It has been the single best investment strategy I’ve ever used to build wealth and passive income. Today, however, I was musing on how it could have been better over the years. Unfortunately, I’m like most people in that I have the unfortunate tendency to learn things the hard way. This gritty experience has codified in my mind several things over the years. Although I know there are more, here are 7 things I wish I would have known before I started investing in real estate.
Being a Landlord Is Tough!
My first rental property was a home that I had lived in for 4.5 years as my personal residence. It was the home I purchased when I first moved to Austin, Texas. The kids were getting older and we needed more living space. Our school needs changed and so we were looking to move into a bigger home, closer to our new school. We decided that since the Austin market was so strong that we’d keep our first home as a rental. It turned into a great rental, but there were several things about being a landlord that were more difficult than I expected.
I realized that it was harder to take care of a property I wasn’t occupying, especially when the renter doesn’t care about the home the way I do. In order to overcome this, I had to develop various systems to keep the rental running smoothly. I needed a communication system with my tenant for reminders about things such as lawn maintenance, rent payment schedules, and lease renewals. I also needed a system to keep up to date on maintenance items I was responsible for on a regular basis. There are things that need to be done monthly, other things quarterly, and there are a few things that should be done on the property once or twice per year. Since I wasn’t living on the property, I would forget all of these things if I didn’t have a system in place.
Additionally, I needed plans in place for contingencies like a broken water heater, and even small things that fail to function like door knobs and fixtures. I discovered that many of my tenants expected immediate action when these small items began to malfunction.
Learning systems from someone more experienced, or a book would have been very helpful to me. But I learned on-the-go. Thankfully, it all worked out pretty well in the end.
Cash Flow Is Elusive
How many times have you heard a fellow real estate investor say, “I have a property that is cash flow positive.” The reality is that there are very few properties that are actually “cash-flow positive”, in my experience. I have always been careful to do the math on all of my long-term rental projects to make sure that project income exceeds expenses. But what I discovered was that even if my rental was producing $500-$600 per month, the capital expenditures can wipe all of that out in an instant. The installation of a water heater can cost $1100-$2000. An HVAC system could cost $5,000-$7,000 for one system. A roof replacement can cost up to $10,000. You get the point. These are costs most people don’t work into the numbers, but should! Over time, I found myself getting less and less excited about this cash flow from my properties because I knew that the large capital expenses were waiting for me down the road. The cash flow should cover all expenses, not just the interest, insurance and taxes.
Price Appreciation Is Where You Really Make Money in Real Estate
The elusive nature of the cash flow is a reality check that can be depressing. But, all is not lost. The debt you owe to the bank for the home is paid by your tenants, and if you’re in a growing market, your home is gaining value with each passing year. This difference between the debt and the value of the home is your equity. This is where the real money is made in real estate. I held my first rental home for almost 5 years before I sold it. I had refinanced it twice and it held almost no positive cash flow by the time I sold it. But, the equity in the property had delivered a 30% annual return. Not too shabby!
Knowing this ahead of time is very important. It changes the way you look for properties. Instead of hunting down opportunities that promise a large delta between income and expenses, I started examining the potential for appreciation. That made all the difference.
Location, Location, Location Is Not Just a Cliché
We’ve all heard this phrase, and we certainly use it when searching for the homes we want to live in. So then why do we abandon this wisdom when searching for rentals? I think it’s because we’re lured in by the cash flow.
I bought a triplex once that had stellar cash flow. It was located in a nearby city that I didn’t know too well at the time. The triplex, as it turned out was not in a great location. All of the growth was happening in other submarkets. I purchased a poor location with good cash flow. This meant that I had very little appreciation to look forward to, and that much of my cash flow, as I’ve referred to above, would be siphoned off by capital expenses, turnovers, and lost rent.
We do well to listen to the voices of the past in real estate. Location is everything in real estate investing. It’s a law that is ignored at your peril. You owe it to yourself to know as much as you can about the location you’re considering investing in.
You need to focus on a niche
When I started out I was learning about wholesaling, flipping, and long term investing. While I majored in long term holds, I romanticized about flipping houses and wholesaling. I can’t tell you how much time I spent listening to podcasts and reading about these strategies. While I don’t think I did myself any harm in learning about these methods, I did waste a lot of time looking at properties and actually pursuing these types of deals when all along, I knew I was a buy and hold investor.
There may be some different opinions on this, but for me, I’ve learned that it’s best to choose a niche and focus on it. The competition for flipping in most U.S. markets is so tough, that you really need to put all your energy into it if you want to do well. I just don’t see how you can dabble in a variety of strategies and hope to do well with the competition being what it is.
I bid on a flip property near my personal residence once and realized everyone else was offering cash for the property. There was really no way to compete unless I was willing to offer an all-cash purchase. The only way I could do this is if I focused on flipping as my sole strategy. And since I view flipping as a higher risk, less profitable approach to investing over the long term, I just avoid it altogether.
It takes maturity and discipline to say no to good opportunities, in order to free yourself and your resources so you can say yes to the best opportunities. And those opportunities are unique to your strengths and abilities in real estate investing.
Get mentoring sooner rather than later
What made a huge difference in my ability to scale my investing business was meeting a another more experienced investor in my city who became a mentor. At the time I was beginning to learn about buying apartments and had a few attempts at purchasing them alone. Commercial real estate, if you haven’t learned already, requires professional expertise and it’s a completely different animal than residential real estate investing. Having a mentor changed everything.
Having a real estate ‘yoda’ who has mastered the niche you are wanting to learn is essential. The investment of money, time and effort is well worth it. In life you can learn things the hard, slow way, or you can fast track your learning by pursuing the community of real estate investors around you. Mentorship can take lots of different forms. It might be an individual who is a mentor to you, or a mastermind group. Whatever the form, it is the key to growing your knowledge and ability to scale.
Team is everything when you want to scale
Finally, I knew this principle before I started real estate investing, but it’s a conviction that cannot be overstated. If you’re investing in residential properties, you need to take the time to build the very best team you can. These may not be people on your payroll, but professionals you rely upon for expertise and service. They are real estate agents, bankers, plumbers and contractors. For commercial real estate they are syndicators, mentors, brokers, partners, sponsors and employees.
Building great teams leads to great success! You should treat this as a serious endeavor. You are the coach and you need to build a winning team if you want to win in the game of real estate.
There are a great many more things I wish I had known before I started investing in real estate. To list all of those would result in quite an annoying article. But these are just a few. I hope it was helpful to you. What do you wish you had known before you started investing in real estate?