Posted On 05 Jan 2012
Real estate investing can be very lucrative. It can be a great way either to store or increase your wealth.
However, it’s such a vast and tempting topic that it’s easy to get started before you really understand what you are doing.
I’ve been a small-time real estate investor for over 30 years. Naturally, my experience has taught me a few lessons. I thought it worth passing along the five most important ones.
First, don’t lie. Lying to others is bad, but it’s actually easier to avoid doing that than it is to avoid lying to yourself.
Hope for the best, but plan for the worst.
I doubt that I’m the only one doing real estate investing who likes to think well of his investments. I practice being positive, even optimistic. Caution: don’t take that mindset too far.
For example, suppose you consider your house an investment (as opposed to just a shelter). Let’s say that you purchased it for $100,000 at the end of 2010 and that it appraises for $110,000 at the end of 2011. You may think: excellent! I made 10% on my investment.
No you didn’t. Measured against gold, the U.S. dollar declined 10% in value during 2011. If you figure in the diluted dollars, your house hasn’t at all changed in value.
My point is not that you shouldn’t have purchased it. My point is that it’s a bad idea to lie to yourself when doing real estate investing.
If you believe the falsehood that real estate always appreciates in value, you are deluded. The problem comes when you apprehend the world in terms of your deluded thoughts. You “see” what isn’t real. Then you make decisions based on what you “see.”
A single poor decision in real estate investing can cost you tens of thousands of dollars. To decrease your chances of making mistakes, don’t lie to yourself.
It’s especially important not to lie to yourself by thinking that you understand what you are doing when you don’t.
The way to avoid that is to select what kind of real estate investing you want to do. Specialize. Then ignore all other kinds of real estate investing while you focus on mastering that single area. Do not learn a little about it, do it once successfully, and go on to something more interesting! (That’s my tendency!) Instead, do it over and over and over again until you really have it down cold. Let your winning formula run.
Always remember: success in one kind of real estate investing does not necessarily transfer to other areas of real estate investing.
When you enter a new domain, admit that you are just a newbie and act accordingly.
Second, don’t underestimate expenses. Inflation isn’t just driving up property valuations. Those valuations drive up taxes.
Furthermore, the dollar cost of maintenance is also increasing steadily as the dollar declines in value. So it keeps getting more expensive to replace roofs or furnaces or appliances or carpeting. Do you purchase landscaping service? Do you purchase property management? Even if you do it all yourself, the price of supplies such as paint and cleaners steadily increases.
Major repairs are easy to underestimate. For example, as oil rises from $100 a barrel to $200 a barrel, the cost to replace the siding on a building increases because oil is used to make plastic.
Yes, rents, too, increase. Let’s hope that the demand for your property remains constant or increases sufficiently so that you can raise them enough to cover rising expenses.
Always do this before closing a deal: double the actual expenses that you have calculated. If the deal doesn’t work with doubled expenses, walk away from it.
Real estate investing is a way to obtain tax advantages as well as cash flow. Take full advantage of both. A good introductory book is Kiyosaki & Lechter’s Real Estate Loopholes.
Third, focus on cash flow. Do not get sidetracked focusing on the supposedly ever increasing valuation of your property.
Keep counterparty risk in mind. For example, suppose you have purchased a single family home as an investment. You rent it to a family and its breadwinner loses his or her employment. Uh oh! This is a major reason why, for example, counterparty risk is lower when you do real estate investing by purchasing large apartment buildings rather than single family homes.
It does not follow that it is better for you to purchase large apartment buildings rather than single family homes. The point is to keep your eye on your cash flow from real estate investing by, for example, factoring in counterparty risk.
Fourth, buy right or don’t buy.
This is what distinguishes the pros from the amateurs. Pros make money buying, not selling.
To buy right, focus relentlessly on cash flow. This involves two factors: terms and price.
Terms are critical. If you are unable to obtain favorable terms from the seller, walk away from the deal.
This is where due diligence pays off. For every one hundred properties you look at, perhaps only three will yield the kind of favorable terms you require. If you make an offer on those three, you may eventually purchase one.
If you are not willing to do that kind of work, avoid real estate investing. If you don’t understand how to do that kind of work, learn.
Getting the right price means understanding the real estate cycle and knowing what phase of the cycle applies to the real estate you are thinking about purchasing.
Fortunately, there’s an excellent book about this that I recommend if this topic interests you, namely, C. Hall’s Timing the Real Estate Market. I don’t recommend buying any real estate until you read and understand that book.
(If you are interested in large apartment buildings, you might also look at D. Lindahl’s Emerging Real Estate Markets or take his course.)
Fifth, think long term.
By itself, this will foster your taking care of the interests of others. If you practice only thinking in terms of your short term advantage, you may cut corners or proceed without taking the interests of others into account. This tends to create enemies.
If you approach all others as if they were potential, long term business partners, you will automatically begin looking for win/win outcomes. If someone else would sooner or later suffer from your doing a deal, walk away from it.
This really means always using high standards when doing business. There are a number of good books on this, including John C. Bogle’s Enough.
If you do real estate investing and enter the marketplace with goal of getting value for yourself, you may indeed get value. Even if you gained great monetary wealth, however, that would only be another sad instance of winning the world at the cost of your true self.
Instead, if you enter the marketplace with the goal of giving value to others, you are not only more likely to succeed in enriching yourself, but doing it by serving others will also enrich them as well. That’s the only kind of worldly success that involves well-being.