If only I had a time machine to go back and tell my younger, dumber self everything I know now. Among other things, I could save myself hundreds of thousands in losses on bad deals I made.
Today, I consider those losses “tuition” for my real estate education. But they caused me plenty of sleepless nights in my younger years.
You can learn in two ways: the hard way, by making mistakes firsthand. Or the easy way, learning from people who have gone before you and made those mistakes themselves. The easy way is a lot cheaper financially, but it does require swallowing your ego and admitting that you don’t know nearly as much as you should before investing your hard-earned money.
If I could go back and whisper ten real estate investing lessons in the ear of my younger self, here’s what I’d say.
1. Focus on the Fundamentals First
Novice investors ask me all the time about cute moves like the BRRR strategy or tax tricks like 1031 exchanges. They’re fixating on the wrong things.
Instead, they should be focusing on the core skills needed to make money in real estate. Those include finding great deals, calculating returns accurately, screening and managing contractors, and screening and managing tenants, among others. They’re not glamorous or exciting. They take hard work and a lot of it. More on many of these skills shortly.
Don’t get cute, trying to flip houses with no money or create the perfect asset protection scheme on your first few deals. Focus on not losing money first and foremost—minimizing your risk while maximizing your odds of earning a decent return.
2. Invest for Profits, Not Tax Perks
Too many novice investors get hung up on the tax advantages of real estate investments. Some go so far as to buy rental properties with negative tax flow, assuming that they’ll earn a big payday on appreciation and that the tax writeoff will be worth it in the meantime.
That’s a losing game, investing in liabilities rather than assets.
Yes, real estate comes with plenty of tax benefits, from sweeping deductions to depreciation to ways to avoid capital gains taxes. But they are a side order, not the main course. Whether you fix and flip houses, invest in rentals, land, or any other real estate strategy, invest for profits and avoid any deal that doesn’t meet your minimum profit standards.
This, in turn, means you need to know how to calculate those returns in advance before investing.
3. Learn to Calculate Returns Accurately
Whatever your investing strategy, dig into the details of how to forecast returns.
For rental properties, that means learning how to calculate cash flow. In particular, you need to know how to forecast expenses such as vacancy rate, repairs, and maintenance, property management fees, property taxes, insurance, etc. And yes, even if you plan to self-manage, you still need to include property management as a labor cost to compare your returns to other passive investments.
If you plan to use financing, you need to know how to calculate cash-on-cash returns.
Psst: they’re not always higher than the returns if you buy properties in cash. They amplify your returns in either direction, making good returns great and mediocre returns terrible.
For flipping houses, forecasting returns involves not just knowing ARVs but, again, getting your expenses right. Those include carrying costs, in addition to rehab costs, closing costs, and more. And you’re deluding yourself if you don’t include a 25-50% buffer for unexpected rehab costs and a timeline buffer for carrying costs as well.
4. The Best Deals Take the Most Work to Find
Sure, you can hop on the MLS or Roofstock and find a turnkey rental property, either already rented or ready for showing. But don’t expect stellar returns on it—everyone on the planet is competing for those same deals.
If you want a great deal on a property, you need to create it yourself. And that means going out and finding motivated sellers who haven’t publicly listed their property for sale to the masses.
You can do that in many ways, from driving for dollars to contacting owners in foreclosure to advertising yourself as a local “We Buy Ugly Houses Fast” type of buyer. But they all take work on your part.
For your trouble, you can potentially score huge returns well into the double or even triple digits. But you won’t score those returns on publicly listed properties that everyone and their mother can see.
5. Constantly Improve Your Network
Real estate investing is a team sport. You need a huge team with a deep bench to do it right.
To begin with, you need contractors. You need plumbers, electricians, HVAC specialists, roofers, foundation experts, and all-around handymen—and several of each. When your property’s furnace kicks the bucket in January, your first six calls to HVAC guys might all end in “We’re booked up and can’t get to it for a few weeks.” This is why you need the seventh in the lineup.
But your real estate network doesn’t end with contractors. You need to know local real estate agents, home inspectors, appraisers, lenders, title companies, and more.
And in many cases, your network is how you find deals. Some investors build a vast local network of bird dogs, who call up the investor whenever they hear about someone in the neighborhood who’s behind on their payments, or looking to sell their home quickly, or inherited a property they don’t want. The investor pays them a finder’s fee whenever they close on one of these properties.
The better relationships you have with all of these people, the more likely they are to go out of their way to help you. As the saying goes, “Your net worth equals your network.”
6. Avoid Unfriendly Markets
I initially invested in Baltimore rental properties when I first started investing. After a decade of misery, I finally unloaded them all and vowed never to invest in tenant-friendly markets again.
Every law in Baltimore’s landlord-tenant code is designed to prop up tenants and defend against “evil” landlords. It once took me 11 months to evict a professional tenant because there were so many loopholes for him to take advantage of and draw out the process.
Cities with rent control, rent stabilization, slow evictions, “no-fault eviction” bans, and other anti-landlord laws might be nice places to live, but they’re terrible places to invest. Some don’t even let you pull eviction history reports, consider criminal history in your tenant screening, or force you to accept Section 8 tenants even if you prefer a cash tenant.
If you don’t want to go from idealistic to jaded—losing plenty of money in the bargain—dismiss this warning at your own risk.
7. Avoid Lower-End Neighborhoods
The better the neighborhood, the worse the cap rates. And vice versa: lower-end neighborhoods tend to have high cap rates, at least on paper.
Why? Because they come with exponentially more headaches than their better-heeled counterparts. Think higher rent default rates, higher eviction rates, higher turnover rates, higher crime rates, and higher-impact tenants.
I know firsthand—I’ve owned properties in slums and neighborhoods catering to polished professionals. And despite the better cap rates on paper, I earned far better returns at the end of the year in the better neighborhoods, with far fewer headaches. All without the resentment, spite, and people constantly accusing you of being a slumlord for trying to offer a needed service.
Consider aiming for a happy medium in neighborhoods serving solid working- and middle-class residents. You can earn decent cap rates without all the social problems.
8. Screen Tenants Aggressively
The quality of your renters determines the quality of your returns. It’s one of the many reasons to avoid bad neighborhoods.
Once you’ve bought a rental property, the most important action you take as a landlord is screening tenants. Invest more time and effort here than you do on anything else.
Screening tenants might start with collecting rental applications and running credit, criminal, and eviction reports, but it certainly doesn’t end there. Call references, verify income and employment, and speak with the applicant’s supervisor about what kind of person they are. Call up not just the applicant’s current landlord to ask about their rental history but also their former landlord. They’ll tell it to you straight, while current landlords might say anything to get rid of a nightmare tenant.
Drop by their current home if you can to see how they treat it. That’s exactly how they’ll treat your investment property, too.
9. Start by House Hacking
Don’t have a ton of cash to invest? Start by buying a multifamily property and moving into one of the units. You can use the rents from the other units to help you qualify for the mortgage, and you can take out a conventional mortgage loan with a low down payment and interest rate.
Do it right, and the rents from your neighboring tenants cover your entire mortgage payment, ideally with some extra money for repairs and maintenance.
You must live in the property for at least one year; then you’re free to repeat the process and buy another property with up to four units. Most conventional loan programs allow you to have up to four properties reporting on your credit before they stop lending to you.
I knew one young couple that reached financial independence in their 30s by repeating this process a few times. It’s cheap, easy, and gives you an up-close-and-personal introduction to managing rental properties.
10. Find an Experienced Partner for Your First Deals
If you don’t like the idea of house hacking for your first few deals, consider partnering with a veteran real estate investor.
Sure, you’ll have to do most of the grunt work and perhaps come up with more than your share of the down payment. Call it tuition or paying your dues, but in exchange, you get a first-class education on investing strategy, mistakes to avoid, local lenders and support personnel, and tricks of the trade.
Swallow your pride, acknowledge that you don’t know everything, and learn these lessons the easy way. I wish I had.
I made every mistake in the book when I was younger, and they cost me dearly.
Even so, the lessons I learned led me to where I am today. I unwittingly paid that tuition, but at least I got a top-notch education out of it.
They say a smart person learns from their mistakes, but a wise person learns from others’ mistakes. Which are you?