Why should I become a real estate investor? This was a question my wife and I asked ourselves in 2005 as we were building the plan for our real estate investing business. Our children were ages six and three at the time and we wanted to build a real estate portfolio that not only would take care of us in our retirement, but also assets to pass on to our children. To achieve this, we had to accumulate enough passive income and assets to offset inflation and the taxes that erode wealth over time. And for that purpose, real estate is an excellent investment vehicle for minimizing your taxes while accumulating wealth through monthly cash flow and asset appreciation.
The great thing about real estate is that even in a bad economy, it will usually fare better than stocks. Land, after all, is a finite resource. People need a place to live, work, shop, and play — so real estate is really just a matter of supply and demand. Over the long term, real estate will continue to appreciate despite occasional slow-downs in the economy. In fact, it’s proven to be one of the best way to create wealth, and an investor need not be a genius or a millionaire to get started. As Andrew Carnegie said best, “90% of all millionaires become so by owning real estate.”
I wanted to share my learnings and top Do’s and Don’ts for investors getting started and succeeding in real estate:
1. Do — plan your financial goals.
Before you buy that first property, or do your first analysis, determine what you expect from your investments and your business as a real estate entrepreneur. What are your financial goals? For us, each property had to be positive cash flow from day one with the goal of improving cash flow over time. We did this through strong property management in a growth market. You shouldn’t shy away from taking the time to understand your goals and make sure each investment property is a step towards achieving them. If you are unsure exactly how to create real estate financial goals, meeting with a real estate coach or someone that’s done it.
2. Don’t — spend a fortune on books, tapes, & seminars, to sit on a shelf.
You absolutely do need to learn some basics before venturing into real estate investing and building your business as a real estate entrepreneur. So, be sure to do some studying, but don’t let “buying and collecting” information become your endgame. Again, having goals in mind and a coach will make the process much more straightforward. It’s easy to get so caught up in the “research” phase that you never actually take action to get into the wealth building phase. Instead, write down specific questions you want answered or goals you want to meet before delving into the latest book/seminar/etc. Look for a real estate coach that can actually help you execute your plan, not just put a plan on paper or sell you a book.
3. Do — look at plenty of properties.
Don’t just grab the first property you look at. Too many investors buy properties because they “look nice,” or they don’t want to spend the time looking for an opportunity. Remember, you won’t be living in the home, so don’t make your investment decision based on your personal tastes. Your decision should be based on your investment goals and objectives. While you shouldn’t fall into the trap of analysis paralysis, make sure you are thorough in looking at properties. Give yourself a wide range of options, then narrow them down based on the criteria (goals) you set for yourself (cash flow, cap rate, flip, etc.).
4. Don’t — wait for that perfect “unicorn” deal to get started.
That’s the flip side to number 3, of course. A lot of beginning investors I talk to, suffer from “a-better-deal-may-be-just-around-the-corner” syndrome. This can backfire in a big way, and you could potentially let a great deal slip just because you’re holding out for something better. Your task may feel difficult if this is your first property, but you must realize that the “perfect deal” rarely (if ever) exists. Better to execute on a deal that meets your criteria/goals than wait for another that may never come. Get in the game and you will learn faster and gain invaluable knowledge towards your second property, and third property, etc.
5. Do — a thorough financial analysis.
Be realistic. Look at different alternatives to determine which makes the most financial sense. And never buy property at a higher price or on less attractive terms than your analysis says makes sense. Be wary of sellers that try to over-estimate the value of the property through pro-forma (estimated) data. While you can certainly use a pro-forma to start the conversation, make sure you know the real numbers before closing. Look at previous years’ tax returns, property-tax bills, maintenance records, etc. to get a good idea of the real income and expenses during your due diligence period.
The most important figures you should know are:
- Net income (income/expenses)
- Cash flow (net income/debt financing payments)
- Return on investment (cash flow/investment)
- Cap rate (net income/property price)
- Total ROI (total return/investment)
In each case, “investment” refers to how much you invest in the property. “Debt financing” refers to any loans you may have to take out to buy the property. And “total return” refers to cash flow, equity accrual (i.e., equity gained from your tenants paying their rents and your debt payment), appreciation and depreciation to reduce your taxes. Remember, it’s not what you make, but rather what you keep that matters.
Once you understand these figures, you should have enough information to determine whether or not acquiring the property fits with your financial goals.
6. Don’t — try to buy property that the seller is not motivated to sell.
If the seller is motivated to sell, you’re likely to get the price best aligned with your financial goals. So, how do you know if a seller is motivated? Look at the asking price. For example, if the property has been on the market for 6 months at $200,000, with little-to-no price reduction, the seller is clearly not very motivated to move the property. However, if that same property has been on the market for 6 months and has had its price moved down considerably multiple times, the seller most likely wants to do whatever it takes to sell the property. Of course, this raises the question of how to find motivated sellers. There are many approaches, and not all of these will work for you each time. But a few trusted methods include:
- Attending open houses to understand why they are selling or have your Real Estate coach engage with the selling agent to uncover motivation and opportunity.
- Looking for vacant/unattractive properties that are for sale and can be improved with cosmetic updates, ie., paint, flooring, fixtures, etc….unless you have the capacity for a full blown renovation.
- Communicating with your real estate coach about what properties you are looking for and working with him/her to identify them.
- Going the old-fashioned route and looking in the foreclosure section of loopnet, realtytrac, and other aggregate real estate search engines.
These are just a few ways to find sellers, but there are potentially dozens of other methods, depending on what type of property you’re looking for. If you’re not full-time in the real estate market, it’s always good to have a real estate coach who knows the ins-outs of the market to help you.
7. Do — know the difference between real estate investor and the business of real estate.
As a real estate entrepreneur, you already have a business, and real estate investing is best used to support that business, not replace it — unless that’s your intention. In other words, don’t get so caught up in executing transactions that your core business metrics (cash flow, tax savings, appreciation, etc.) falter. If that happens, you’ll be facing a bumpy road to get back to stability and achieving your overall wealth goals. Unless your business is itself real estate (ie,. your a contractor, real estate agent, etc.), or you’re looking to get into the business full-time, always remember that pursuing these deals is a means to an end, not an end unto itself. If a deal doesn’t meet your investing business metrics, don’t be afraid to walk away and look for the next one.
So, if you’re interested in staying ahead of taxes and inflation while building wealth for the future and possibly the next generation, becoming a real estate investor is a great way to achieve this. After 10+ years, my wife and I now have over 45 rental units and continue to build a business we plan to pass on to our children.
The first step to success is getting started. What’s keeping you from achieving wealth through real estate?