Real Estate Investing 101
The key to any real estate investing is that you make your money on the buy and not on the sell. If you buy the wrong property or even if you buy the right property at the wrong time; you will lose money. Timing, the knowledge of market movement, and the knowledge of both monthly and annual return on investment (ROI) are three key factors to making a smart investment in real estate. I would say that many people adopt the “Shoot first and ask questions later” method of real estate investing. That is, they do make it a priority to do the proper due diligence ahead of time to ensure that they are investing in a good income stream (rental), flip potential, or new construction margins. I think it is a nod to the power of real estate as an investment tool that so many of these people are actually “right” a few times before they get burned. That is, unless we are about to see a massive market shift like we saw in 2007-2008. In times of Shift like those; people who run with the herd without doing their homework are likely to be ruined financially. This is a place where no one wants to be.
Property Due Diligence
That said, those who ask the right questions and figure out what they need to know, can make a fantastic return in a safe manner. For any property that you wish to hold and rent, it is vital to understand how much the market will bear in terms of a monthly rental rate. You must know this ahead of time (before buying) so that you can estimate your annual and monthly gross income. It is a good idea to have a trusted advisor in the local property management industry, where you invest, so that you can have a quick and easy resource to give you estimated rents. If you do not have a resource with hands-on experience, it is fairly straight forward to jump on Craigslist, Zillow, or whatever the local posting source of choice may be; in order to see what similar properties (to your subject) are collecting in rents. I have recently found a useful tool at www.rentometer.com for estimating rental rates. Once you know your income potential, you have to calculate your expenses. The most common include Taxes, Insurance, Interest on Debt/Financing, Repairs, Utilities (If owner is to pay), and a budget for Capital Improvements (or larger items not classified under a simple repair I.E. furnace goes out). The expenses can be a huge variable depending on the age and condition of the home or property. Proceed with caution.
The above dialogue pertains to residential housing purchased as a rental. That said, the same general process can and should be used for other property types including Office, Retail, Multi Family, and Land Development. Here are some important questions to ask yourself, prior to making the investment:
- What is my Annual expected gross profit? Monthly?
- What are my up-front costs of sale or acquisition (Soft Costs)?
- What are my up-front costs of improvement or development (Hard Costs)? How long is this process going to take?
- What are my on going costs of maintenance, insurance, taxes, interest, ETC?
- What is my annual expected net income? Monthly?
- If it is a development or flip… How long is this going to take? A 15% (Per Annum) return on a 3 month investment is fantastic!However, that same 15% (Per Annum) return doesn’t look so hot if it takes 3 years to come to fruition (5% Annual).
Personal Due Diligence
Successful and Profitable real estate investing is all about removing variables and reducing your risk/exposure. As outlined above, the vast majority of the work takes place (Or should take place) before you make purchase offers on prospective properties. In addition to the necessary due diligence surrounding the property itself, a smart investor will do their homework as it pertains to their specific goals and financing options, prior to making the decision to purchase real estate (these are correlated with things typically not done and mistakes made by new investors). The following questions can be very simple or very complex; depending on the type/amount of investing that is intended. They must be done ahead of time and are often left out by investors. Once you have them in line; then you can start thinking about looking at individual properties:
- Get your financing in order. Assuming that you will not be paying cash for your properties, it is imperative that your sources of financing are lined out and ready to go.It does not matter if it is private financing or conventional financing; you must have direct access to the money or a valid approval letter that your financing is set up and your lender is prepared to give you access to the funds (a letter from a credible source).
- Have a plan. This is crucial and left out by many new investors.What is your desired ROI (Return on Investment)? How long are you looking to invest? What is your budget? How many properties can you purchase at one time? Are you flipping, holding, or developing? A Combination? Where are you looking to invest (even if general)?These are all bullet points that a good agent and/or a good lender will want to cover with you when you reach out to them as a potential partner.Even if you are all-cash and do not plan to use a Realtor; you MUST know your criteria on the up front to avoid making a bad decision.A common mistake in investing is not having a written plan to refer to and getting distracted into making bad decisions.Often this is in the form of over-paying for property or buying in an area you never intended.
Gather a Team
We can all benefit from the knowledge and experience of others. I would highly recommend gathering a team of resources with you, as you move along your investment journey. It is important to have a knowledgable title and escrow contact, home inspector, contractor, property manager, and real estate agent or broker from which to draw counsel. These people should be considered partners in your success and will often help you in many small, and large, aspects of the process. For example, a qualified Realtor with Local Market Expertise can be vital to assisting you in forming an opinion of what you should pay for property. A huge component (perhaps the largest) of not getting burned investing in real estate is knowing Value. You must know several components/aspects of value; which include:
- What is the property worth in present condition and with the present market?
- What will the property be worth or could it reasonably be worth after repairs/alterations/development is completed?
- What is the long term, 3+ year, outlook of the local market and this specific property?
- Where is the market currently moving? Is it moving up or down? Is it a Buyer or Seller market?
Now, unless you are a seasoned investor in THAT particular market; you are unlikely to have the above information. You must find someone who does. Ideally, this is someone with whom you can build long-term trust and create a partnership. Investors who view Realtors as someone to “Open doors and write the contracts I tell them” often burn a ton of bridges and make things much more difficult on themselves then they need be. This is a common mistake. Another consistent error for investors is to partner with people (be they a Realtor or not) who claim to be “Experts” but are really FAR from that. A good, experienced Realtor (or local market expert) who understands your goals can save you a lot of money and time… assuming you do not already have a partner who has access to the critical data.
A good agent can help with estimates and can help you make offers that are low enough to make you money but reasonable enough to get the seller to the table. This is critical. Good negotiation brings both parties to the table and enables them to leave with something valuable to them. Investors who only throw out insultingly low offers flail and struggle to acquire property.
Find a Mentor
I cannot recommend this strongly enough, Find a Mentor. Track down someone who is already doing what you wish to do and latch on to them so as to gain as much knowledge and advice as possible. You can gain an incredible edge through their hard-learned lessons and outcomes. People are often surprised at the willingness of others to give knowledge; the key is that you be willing to do your homework and ask the questions. We can all learn the hard way and learn ourselves, however, that is a very inefficient way to operate. Often, we do not know what we do not know and time is not on our side.
Remember, Earn Going In
The interesting thing, and perhaps the most important thing, to remember about investing in real estate is this: You make, or lose, your money going IN. Once you have purchased the property, it is to late… you are stuck with it and it will either make or lose you money. If you purchase the right property at the right time, it is very difficult to lose.