Whenever I provide free training, a theme I return to over and over again is,
“You don’t need to hire me for your coaching, but you do need coaching. Get it from somewhere.”
Why? Because otherwise, you’ll end up making extremely expensive mistakes. Avoidable mistakes. Mistakes like the ones I made, when I was a cocky 24-year-old.
Unlike equities, which you can invest in with an extra $50, real estate requires a huge commitment of cash. You’re putting down tens of thousands of dollars, to invest in assets worth hundreds of thousands.
That means the stakes are high, and mistakes can cost you dearly.
There’s an old proverb that says, “A smart person learns from their mistakes. A wise person learns from others’ mistakes.”
Here are five mistakes I hope you’ll avoid. I’ve made every single one of these mistakes. And they cost me hundreds of thousands of dollars over my first decade of real estate investing. Hopefully, you'll learn these lessons the easy way!
Mistake 1: Trying to Time the Market
The smartest, best-informed economists on the planet can’t accurately predict how the market – any market – will turn.
And I mean no offense here, but you’re not one of them. To think that you can predict the market is pure, simple hubris.
Even when there’s strong evidence that a market is overpriced compared to historical averages (such as the stock market right now), that doesn’t mean a correction is right around the bend. The S&P 500 could rise another 40% over the next two years, before crashing down 30%.
So even if you thought you were clever, waiting for the crash before buying, not only would you have to wait two years, but even if you bought precisely at the bottom of the market (something that would be extremely unlikely), you would still be buying higher than today’s pricing.
If you try to use a crystal ball to divine the future, as the basis of your investing decisions, you’ll fail miserably.
Mistake 2: Failing to Calculate Cash Flow Accurately
You won’t make money by timing the market. So what should you do instead?
You should invest not based on tomorrow’s (alleged) returns, but on today’s cash flow…
…but only if you get the cash flow right.
Far too many investors break out their rose-colored lenses when forecasting cash flow. They either ignore or underestimate the expenses they’ll face.
What numbers do you use for repairs? Maintenance? CapEx? Vacancy rates? Property management fees?
Here’s a quick and easy example:
Linda Landlord gets excited about a rental property and puts it under contract. She says, “I’ll make $100/month cash flow from it!”
Except she’s not including the cost of property management. When pressed, she says “Well, I’ll be managing the property myself! I don’t need to pay property management fees!”
That logic unravels quickly. First, what happens if she moves out of state? Or becomes ill? Or has triplets next year and can barely see straight enough to occasionally tidy up the house, much less manage her rentals well?
She’ll be forced to hire a property manager, that’s what happens.
But even if none of that happens, and she manages the property herself, property management remains a labor expense, regardless of who's doing the labor. If she manipulates the math by not accounting for the labor of managing her properties, how can she compare her returns on real estate to her stocks or other investments that don't require labor to manage?
Or let’s say Linda budgets 10% for property management because that’s what her property manager charges on a monthly basis. What about new tenant placement fees? If the manager charges a month’s rent to place new tenants, and the property turns over every two years, then that makes the effective property management costs 14%, not 10%.
You don’t need to predict the future to accurately forecast cash flow. You just need realistic math.
Mistake 3: Failing to Set Objective Standards for Your Investments
One of the things investors love about real estate is its tangibility. It’s real, physical, and people intuitively understand it, because they’ve been living in it their whole lives.
(Unlike, say, mutual funds, which are much more abstract.)
But that very tangibility also puts investors at risk. Because they can walk up, touch it and walk through it, they all too easily develop an emotional attachment to it. They get excited about a deal, and in some cases, they fall in love with a deal (or if not love, then infatuation at least, based on their visceral experience of seeing and touching the property). They see the kitchen and think “I could replace these chewed-up counters with granite, and just imagine how beautiful this kitchen will look!”
Emotions are wonderful things, but they can be ruinous to your investing strategy.
What should you be using instead? Realistic math!
If you’re buying rental properties, set a floor for your monthly cash flow per door.
If you’re investing in flips, set a floor for your expected profit.
Also, set a floor for your return on investment. I typically set a 7% floor for cash-on-cash ROI – if a property is going to earn me less than that, I might as well invest in mutual funds or ETFs.
None of which is to say that you should buy properties that you don’t like, just because the math looks good… but if your gut warns you to stay away from a property, take that seriously.
Set objective standards for your real estate investments, and use them to counterbalance the pull and push of your emotions.
Mistake 4: Failing to Budget for the Unexpected
How often have you heard the classic horror story about the investor who bought a property, planning to pay $10,000 for repairs, only to discover the property needed $15,000?
It happens. All. The. Time.
Yes, there are some steps you can take to minimize the risk of unexpected repairs. You can have home inspections performed before buying. You can walk through the property with several contractors, getting several quotes.
And you should do these things… but at the end of the day, you’re the one who has to pay the piper (or plumber?) if an unexpected expense pops up.
Always budget extra money for unexpected expenses, and extra time for unexpected delays. They will happen. Do your best to avoid them, all while keeping a cushion in place when (not if) the worst happens.
One other word of advice – don’t tell your contractor about your cash cushion. Chances are more than likely, if they know you have extra money budgeted for the project, they’ll find an excuse to use it.
Mistake 5: Failing to Build a Network
Real estate investing is a team sport.
You need an excellent Realtor and home inspector. You need as many contractors and handymen as you can get your hands on.
And lender options? You need plenty of them, too.
They say the size of your wealth is directly proportionate to the size of your network. That means it needs to be a priority for you to build the biggest and best network you possibly can.
And while size matters, the quality of your relationships matters even more. It’s one thing to be on a local bank REO manager’s email list, and another to be happy hour buddies with them. In which scenario do you think they’d call you about the best new opportunities before they talk to any other investors?
Get to know all the other fish in your pond. You’ll learn to help each other out, and in doing so, you’ll find that profits come a’calling.
Simple, But Not Easy
None of these best practices are particularly complex. Even forecasting cash flow and returns accurately is something that can be learned in an hour.
But while these are all simple lessons, that doesn’t mean they’re easy. It takes hard work, discipline, and most of all, consistency to keep doing these best practices day after day, week after week, year after year.
Knowing that you should be networking, and even knowing how to network, is simple enough. But actually dragging yourself to a local REI club meeting on a rainy, cold Tuesday night when you’re tired from a long day of work? Actually picking up the phone and calling or emailing the people you meet, or people who you want to network with?
It’s not that investors don’t know how to do it. It’s simply that they don’t choose to do it.
If you want to be successful in anything (not just real estate investing), start getting comfortable with discomfort. Start doing the things you don’t feel like doing, but know that you should.
Because as helpful as knowledge is, it’s only as useful as how it’s acted upon. Keep reading this and other blogs for knowledge, but commit to actually using that knowledge out in the real world, where it can actually serve you and make you money!