“Real estate can’t be lost or stolen, nor can it be carried away,” Franklin D. Roosevelt said. “Managed with reasonable care, it is about the safest investment in the world.”
One problem with those books, tapes and seminars about investing in real estate is that all they show you how to do is buy investment property using “creative” financing. They don’t give you the tools to make a profit on it or how to plan for its and your profit.
Buying property is far from rocket science, but you already know that since you own investment real estate. Actually treating it like a fabulous investment and opportunity is rocket science, apparently, since so many investors make the same mistakes and fall into the same traps over and over. As Brian Tracy points out, “You make your profit when you buy real estate—you realize that profit when you sell it.” The better the planning for success, the more likely that profit will be.
In this article we will look the seven biggest mistakes investors make when they buy investment real estate and how to avoid them. Those mistakes have to do with failure to set out clear goals and plans of attack.
Ernest Tew author of “How To Get Rich Helping Others,” writes, “Those who have been successful in accumulating wealth through their own efforts have more than money in common. They think and plan ‘long-term.’ They believe in the planning process, set financial goals that are carefully thought out, put their plans into writing and then into action.”
Here are those seven mistakes.
Mistake No. 1: Failure to Plan Your Exit
Whenever large corporations, and even smaller ones, buy real estate, they know exactly what they want to accomplish with it. Their plan includes their exit strategy. The cue for selling the property could be any number of events or combinations of events. It could be a specific time period, such as “we will dispose of this property after five years.”
It could be when another event takes place, such as “we will sell the property when the new shopping center begins construction across the street.”
It could be when the selling price of the property reaches a specific point, such as “we will dispose of the property when our appraiser estimates the value of the property is $5 million.”
It could also be that the company has no plans to sell the property as such, but only bought it to increase the value of the company itself. Then the exit cue would be that “we will sell our company when its value reaches $25 million that includes the value of the building in question.”
Any of these cues for disposing of the property are completely valid and reasonable. When we buy investment real estate, we need to go in knowing when we will get out. Knowing that determines what we will accept in the condition and/ or characteristics of a property.
Obviously most of us are not in the same position as a major corporation when it comes to buying property, but that doesn’t mean that we should not go into the purchase with the same way of thinking.
The first rule of real estate investing is “Set out clear goals and time lines.”
That is also the first thing that the people who teach “buy no-money-down” forget, ignore, or don’t know. Investing in real estate is like investing in anything else. We have to know what we expect from it.
What that means specifically is that we have a picture of what we want in a property. That first picture is when we will dispose of it.
There is no right or wrong answer to this activity. The only thing you can do wrong is not to have an exit strategy going in.
Here are three examples.
If our goal is to sell the property in five years and not make any capital improvements or major repairs, that means the roof must be in good condition, the heating system must be in excellent repair and have an anticipated life of at least ten years, and that the foundation must be solid.
If our goal is to sell the property in five years, but we are willing to make some capital improvements or major repairs, we are looking for a property with far different characteristics. First, it must be priced considerably under market, so that the improvements we make will not only bring it up to market value, but actually put it above market. We also must have the financial ability to make those improvements and repairs, either by borrowing the money or using our own.
If our goal with a property is to keep it for retirement income, and retirement is at least 20 years off, we will look at prospective properties far differently. Over the space of 20 years we will have to expect to put some money into a property. That means, though we don’t want to buy a new one this year, we might accept a property with a heating system that will need to be replaced in under five years, or that might require some repairs of dry rot damage or need to be re-roofed.
Because those things would need to be replaced, we would expect to buy the property at a price that is below market.
You need to decide in advance your goals and timelines for the property you intend to buy.
Mistake No. 2: Failure to Plan Your Attack
The detailed plan of action includes searching for property, doing due diligence on property, the actual purchase of the property, the maintenance of the property and finally, its disposition.
The goals and timelines are part of the plan of action, and something you need to know before you complete your plan of action.
Once you know when you will dispose of your rental property, you can create a plan for making your exit strategy happen.
Once you have the plan in place, you will know the direction for each step along the way. Without that plan in place, you buy on impulse or emotion. The only emotion we should have in real estate investing is the emotion of anticipating a fantastic return on your investment. Emotions such as “Isn’t it cute!” and “It looks just like a grandma’s house” have no place in our buying decision except as possibly a marketing tactic.
Mistake No. 3: Failure to figure out how much the repairs and updating are going to cost and if that will work for you
This investment error goes hand in hand with failure to make a plan of attack. Every investment property will need something done to it to bring it up to where we want it to be so that it will fetch the highest rents or sell for the most money.
Jumping on a rental property that seems like a great deal before we have figured out why it is such a great deal is sure to cost you money. A landlord-to-be called me the other day for some consulting on a rental property he was buying. He was to close on it the next week and was getting cold feet. I asked him to fax me the income figures and the sale price. I asked if the rents were at market now and he said they were probably a little low. He couldn’t tell from the rent figures, since every property is different and different parts of the country have markedly different rents, anywhere from $1500 a month in Los Angeles to $400 a month in South Dakota.
I did a quick calculation of the capitalization rate and came up with 9.9 percent. Wow! That is terrific! If you get a 7 percent cap rate on an apartment building you are doing well. That ran up a red flag. Why was it so cheap?
I immediately thought of rotting roofs, heating and cooling systems ready to explode, cracked foundations and immediate need of window replacement. But this landlord-to-be said he had inspected the property, though “maybe not as thoroughly as I should have.”
I asked him why the sellers were selling. He said they were in their 80s and lived 2,000 miles away. That explained everything. These were people who may not have known the value of the property or when they heard a $1.5 million market value thought they had already died and gone to heaven. This was indeed a good deal. This man, who is now an official landlord, will net about $17,000 a year, even without raising rents. Pretty good for putting almost no money down.
But what if the property had required major repairs? He should have run from the deal, especially since he knew that the owners may not have paid as close attention to it as they might have and the current management company was far from as attentive as it should have been.
Mistake No. 4: Neglect to re-evaluate their investment plan periodically
Nothing is forever. Life happens and life interferes. Even with the most thought-out and diligent plan, our needs and wants change. You might have decided you were going to keep that property for your retirement income, but two years later a 90-unit property came available at a price you couldn’t pass up and with income potential beyond your wildest dreams when you began your real estate investing career.
But you have a plan! You worked hard on it. You thought it out carefully. You have followed it diligently and it has worked wonders so far. Throw it out, or at least amend it.
If the investment is that good it would be government thinking not to buy it. Obviously you would check it out thoroughly and apply your exit plan and plan of attack to it, but if it checks out, throw out your old plan and create a new one with this property in it.
Mistake No. 5: Think that planning is only for the large real estate investors
Large real estate investors didn’t get that way by hit and miss investing. Meet Joe Weston. “When The [Portland, Oregon] Business Journal asked him how he’d spend $30 million on Portland-area real estate, he said, ‘I’d hold onto it, because I believe there are better buys yet to come.’ Weston anticipates REITs—or real estate investment trusts—will soon unload properties purchased years ago, because many REITs are nearing the end of the optimal seven-year holding period.”
Weston bought his first piece of real estate, a duplex, as a teenager from his earnings in a part-time job and built an empire in concentric circles around his boyhood home. He had a vision of being far wealthier than his parents were; his father sold encyclopedias and Niagara Chairs on commission.
He remembers his parents buying “bones at the butcher to boil for soup when they could not afford meat. He remembers saving Halloween candy and doling it out over months.” That was not for Joe. As a young man he made a plan. Part of that plan was to watch the market and see what the best investments would be, then buy the best he could. Today, at 68, he is one of Oregon’s “most fortunate” men, he doesn’t like the word wealthiest.
He wasn’t a large investor when he started out in real estate investing, but he is now. Just the other day he announced he is building 32-story apartment tower in downtown Portland. You don’t do that selling encyclopedias and Niagara Chairs on commission. He got from small to large by planning his success.
Mistake No. 6: Expect unrealistic returns on investments
Holly Hunter, writing in Seacoastonline.com, observes: “Wise financial planners will tell you that earning the highest possible return should not be the real goal of investing. Rather, the main purpose of investing is – in conjunction with other components of your financial life – to help you realize major life goals: a comfortable retirement, a dream job or business, a college education for your children, funding for your favorite charities, or accumulating assets to pass on to your heirs.”
She further points out “Investors shooting for the highest returns also are more vulnerable to investment scams offering returns that ‘are too good to be true.’” The old adage “You can’t make a good deal with a bad guy” comes into focus here.
If you are promised, or it seems as if, the real estate investment you are looking at will earn you returns far above what the rest of the market is earning, poke it with a stick. If a lot of hot air and nothing else comes out, if the history of other investors is two months’ glorious returns and there are no older ones to be found, if the whole thing flunks the smell test, run for your life.
I know, it happened once. Somebody won the $240 Powerball recently, too. Great returns happen fairly often, if you keep your eyes open; good returns happen more often. Getting taken happens to people who think they can beat the system and get returns in the stratosphere.
Mistake No. 7: Think that using a consultant or coach means losing control
If you aren’t sure, call somebody who will give you objective advice. You can’t lose control if you never had control to begin with. With a plan in place and you follow it, your control is assured. All getting objective advice will do is tell you the facts.
Will your real estate agent give you objective advice? Absolutely not. He or she doesn’t get paid unless you buy something. As I point out to prospective consulting customers,
• I will give you a straight, reasoned answer and analysis.
• If you should buy, I will tell you;
• If you shouldn’t, I will tell you that, too.
• If you should rent to that tenant, I will tell you;
• If you shouldn’t, I will tell you.
That is the same with any real estate and rental property consultant. He or she can tell you will make a good decision or tell you to bail before you make a bad one. You keep control as long as you have a concrete end in mind.
Many of this nation’s greatest fortunes have been made in real estate. They were made because of intelligent investing and knowing what the end was. They didn’t have to be detailed, etched in stone plans, but plans that allowed them the flexibility to invest intelligently while keeping an eye on the market around them, ready to take advantage of what fit their needs, wants and investing abilities.