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SHOW NOTES FOR EPISODE 684: MY 10 BIGGEST REAL ESTATE INVESTING MISTAKES
Every real estate investor makes mistakes. In fact, it’s an important part of the learning process. What’s important is what we learn from and do with these mistakes and how they help make us better investors. In this episode, Bill shares his personal top 10 real estate investing mistakes.
Introduction
“Failure is the key to success; each mistake teaches us something.”
Mistakes are a gift. Without them, the learning process can take so much longer. But it’s always better, when possible, to learn from the mistakes of others. That’s why I always ask my guests to share their mistakes and lessons they’ve learned – to hopefully save you the personal pain points!
In today’s podcast, I will share my own personal real estate investing mistakes over the last 6 years, (which happen to match the mistakes of many of my guests) and how you can prevent the same from happening to you.
My guests have shared many different mistakes, all of which have been very helpful for me personally in my real estate investing journey. I have avoided a lot of potential problems because of their sharing their mistakes!
To be sure, there’s a lot that can go wrong when you invest in real estate. You can overpay for a property, buy in the wrong area, use the wrong lender or loan product, or overestimate your cash flow, just to name a few. The list of mistakes is far too long to discuss in this podcast. But here are 10 big mistakes you should know about and hopefully avoid in the future.
#1 – Thinking too small
I spent approximately $150K on the cash purchase of 2 “Class C” SFRs and a “Class C” duplex which should have generated good cash flow based on my projections.
Then, after a year or 2, I borrowed against those 3 properties to get $100,000 down payment and $50K rehab to buy a 22-unit apartment
If I would have just skipped the first property purchases and taken the same $150K to buy a multifamily for $350,000 I would have made considerably more cash flow and, in a few years, instead of waiting 2 years and leveraging the 3 small properties, I could have gone straight for the 22-unit and leverage it in 2 to 3 years to buy a much larger apartment. Then, I would have established a track record as a successful commercial multifamily operator, been better positioned to attract investors and get bank funding.
I can’t tell you how many guests I’ve interview who went right for the multifamily properties first and then proceeded to scale so much faster.
#2 – Investing in Cheap Properties
When I started investing in rental properties, my first three properties (2 single family homes and one duplex) were all Class C properties. Having nearly 5 years experience with Class C properties, I have some strong opinions but I also want to now look at this class in light of current economic times and how the economy may affect these properties.
There are some real estate investors who seek out Class C properties because of the amazing potential in renovating and upgrading them. They allow real estate investors opportunities to enjoy a significant return on investment by making small improvements on the property. With proper upgrades, they can realize larger returns.
Even though a Class C property has an opportunity for strong cash flow if managed well, its potential for natural appreciation is usually very low or not to be expected due to the location. If you are looking for a capital gain, then investing in a Class C property may not be a good idea.
This type of real estate investment also carries higher risks since it will need more extensive improvements and ongoing management. One mistake many investors make when buying a Class C property is underestimating repairs and maintenance expenses. This can hugely affect their rate of return. With the type of tenants, property management will need to be more intensive. You will require greater oversight to deal with tenant problems, perform maintenance, and collect rent.
Financing can also be a problem when investing in this property class. Due to the poor condition of these properties, an investor often has fewer options for investment property financing. This can make pursuing a deal quite challenging compared to buying Class A or Class B properties. You may be forced to look for alternative sources of investment financing.
#3 – Over-Estimating Cash Flow
If you buy a rental property that brings in $2,000 in monthly rent, and your monthly mortgage payment including taxes and insurance is $1,500, it may seem like the property should produce $500 in monthly cash flow. But that’s rarely the case.
One big mistake new real estate investors make is that they fail to budget for the unexpected — specifically vacancies and repairs.
At some point, your property will be unoccupied. It may only be for a few weeks between tenants, but it’s going to happen. This is why I encourage new investors to at least purchase a duplex as a first property, or, better yet, a fourplex. That way, if you have a vacancy, it only impacts one half of your cash flow with a duplex, or one forth, if it’s a fourplex.
That’s why, as a rule of thumb, it’d a good idea to set aside 10% of the rent to cover vacancies so you don’t have to come out of pocket to pay the mortgage when your tenants move out. When a tenant moves out, you have, what I call “turnover” or “turn around” expenses (painting/fixing things, replacing things like carpet or re-keying locks, etc.)
You’re also going to need to set money aside for maintenance and repairs over time. That’s for fixing clogged sinks and toilets, repairing leaky roofs, replacing light bulbs, servicing air conditioners, heaters, changing filters, and repairing appliances, etc. – not to mention replacing costly items like water heaters, HVAC, and appliances. Plan to set aside another 10% to 15% of the rent you collect to cover maintenance and repairs.
When calculating your expected cash flow, don’t forget to consider these expenses, or your projections aren’t likely to be too realistic.
#4 – Avoid “Class C” Properties
One of my personal mistakes is that I purchased a bunch of “Class C” properties when I first started in real estate investing because they were cheap.
Class C properties are usually older buildings that are more than 30 years old with minimal amenities and outdated systems. In fact, they may have most of their original appliances and systems. Many of these investment properties show visible deterioration and often have deferred maintenance issues. Due to their poor condition, they tend to have lower upfront costs compared to the other property classes. However, they will often require more ongoing repairs and hands-on maintenance. As a real estate investor, you must invest some money in repairing the structure and mechanical systems. Some properties will require more than others and some will require significant renovation work before they can be expected to provide steady cash flows.
With all the negative characteristics of Class C properties, you may be wondering why an investor would want to invest in a Class C property. One aspect that makes a Class C property a good real estate investment is the low acquisition cost. They are cheaper than Class A and Class B properties and the rental rate is usually more than 1% of the acquisition cost. Therefore, the return on investment when investing in these properties is higher in terms of cash flow and cap rates. Out of all multifamily asset classes, these properties offer the highest potential for bigger cash flow. Since areas with this type of rental property tend to have lower-wage tenants, home ownership is usually a big challenge. Therefore, you will have a deep pool of renters if you decide to buy Class C properties for investment. If your real estate investment strategy focuses on cash flow, then Class C properties may be a good investment. With the right strategy, it can still very lucrative.
#5 – Not Vetting Property Managers More Carefully
I just accepted that the property management that came with my turn-key properties was OK without checking them out first
Turn-key property managers should be carefully checked out in the same way you would screen non-turn-key situations
#6 – Not Checking Out the Market Better
You should always collect and analyze data on any potential market you are considering for investment. Ideally, seek out an “emerging market.”
- What are real estate prices doing in the area?
- Going up
- Declining
- Stagnant
- What is the local job situation?
- Job growth percentages up or down
- Are new employers coming to the area
- Is the market dependent on a single employer or industry
- Get unemployment stats and trends
- What is the overall local economy?
- Are businesses closing or moving out of the area?
- Are commercial real estate values and office occupancy rates increasing
- Are there “redevelopment plans?”
- Does the city have a major “growth initiative?”
#7 – Wasting Time with the Wrong Funding Source
- This was one of my first big mistakes.
- Don’t think because it is a big name bank that that it will be your best source of money
- Know their funding requirements before applying
- Have good back-up sources before you are approved
- Make sure the lender is compatible with you and your plan
- Get a pre-approval before you start your search for a property
#8 – Not having sufficient operational reserves
Have a 6 month reserve, or back-up funding source, to cover maintenance and repairs expenses – especially if you are investing in “C Class” properties. This is not the same money you set aside for your value-add rehab or upgrade funds.
This can be costly as you struggle to cover expenses by creating additional debt
#9 – Don’t Just Buy Only for Cash Flow
In the beginning, I only looked at cash flow. After all, my motto is “Cash Flow is King”
However, halfway through my investing efforts, I sought to build in the “equity factor,” buying properties that had “built-in” equity the day I signed the escrow papers.
In addition, I searched out “emerging markets” that further ensured a strong equity play
However, when I came to the end of my 6-year goal, it was the equity that allowed me to truly retire with confidence.
#10 – Not Having a Mentor
- I had done much research (reading books, listening to podcasts, attending boot camps, etc.) and felt I didn’t need a mentor and that I was ready to just get started
- Looking back, I see most of my mistakes could have been avoided if I had, first, sought out a good mentor to bounce things off before I purchased a property
- I trusted that my first “turn-key” properties were OK and skipped much of the normal due diligence. If I had a mentor, I could have run it my mentor first
Here Are a Couple of Bonus Mistakes
Here are two BONUS biggest mistakes, according to Old Dawg/Long-Time Investors:
- Not buying more
- Selling
Not buying more real estate! My most seasoned real estate investor guests all said the same thing! And, in an interview with Samuel K. Freshman, a Stanford Law grad who wrote the book on real estate syndication, and who has been investing in real estate for over 60 plus years said the same thing… My only regret is selling! He bragged to many of how he made a quick million selling an office building in downtown Los Angeles – he bought it for $1 million and sold it for $2 million. But he isn’t bragging today because, if he would have held on to the building today, it’s worth over $100 million!
Listen to his answer about his biggest mistake: 091: Real Estate Syndication for Dummies
In Conclusion
These are my “Big 10!” And, I’m sure, if you don’t already some of your own, you certainly will. It’s not a bad thing! Don’t consider mistakes a curse but a blessing! A free education, if you will!
Either way, it doesn’t mean you shouldn’t try to avoid mistakes as best you can –but understand — mistakes will happen. And when they do, learn from those mistakes, and chock it up to experience!
The bottom line! Learn from other people’s mistakes when you can. And when you do slip up, consider it homework, learn what needs to change, reengineer, do it better and reap the rewards!
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