Getting started real estate investing and avoiding the most common mistakes comes down to four keys
No other asset has created as much family wealth as real estate. No other investment gives you the return plus the cash flow as property investing.
But that doesn't mean getting started real estate investing is easy or without risk. I jumped into real estate in my early 20s and almost bankrupted a half-million dollar portfolio of rentals because I didn't take the time to learn the biggest traps.
I've since built my portfolio back up and want to save you the time (and the heartache) by sharing what I learned. Not only will these four steps to real estate investing help get you started and avoid the most common mistakes but I've got a secret negotiating trick that will save you tens of thousands.
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Could Real Estate be the Best Investment?
I started my professional career as a commercial real estate analyst before managing my own rental properties so real estate has always had a special place in my portfolio.
Stocks crash and burn, bonds are good for safety but not much else, there’s just one investment that provides solid returns, cash flow and safety – and that’s real estate.
In a stocks vs real estate battle, property wins hands-down.
Of the 50 richest people in the world, 11 of them are there because of real estate investments and you can bet every single one owns property.
But that doesn’t mean getting started in real estate investing is easy or that it’s the easy path to riches like you hear in those 3am infomercials. Here’s a trivia question for you, who was the only person to get rich with those Carleton Sheets infomercials in the 80s?
Don’t get me wrong, I love real estate investing and have made my own respectable little fortune in it but it’s not without its tricks and traps.
I turned $30,000 saved while in the Marine Corps into a portfolio of rentals worth nearly half a million in my early 20s…and then lost most of it because I rushed into property investing before I knew how it worked.
Here's what I learned and the four keys to real estate I've used to build that portfolio back up.
Don't Expect Real Estate Investing to be Easy
First, real estate investing is not passive income. Yes, I’m sorry to crush your dream and the idea that you can just buy rentals with no money down and watch the money come in.
There are property managers that will help you run your rentals for you but there are two huge problems with this, especially for beginner real estate investors.
First is that you might have a tough time finding a property manager willing to take on your portfolio. Most managers only want to run larger, multi-family units and aren’t going to give your two or three rental units a second look.
Second is just the cost of property management. You’re looking at around 10% to 15% off your gross rents, minimum. If you’re using debt to buy your properties, there isn’t going to be much cash flow left after paying the mortgage, repairs, county and legal fees, taxes and marketing.
Of course, you can out-of-pocket for management but you better have deep pockets to cover these costs.
When I got into real estate, I was blinded by this passive income myth.
I thought I could just sit back, watch tenants pay my mortgage and would soon be sipping Pina Coladas on some sandy beach.
I bought my first single-family rental for $33,000 from another investor that was facing foreclosure on it. I fixed it up, cashed out with a refinance and bought two more places. Did the same to them and within two years, I had six rental properties including a duplex.
But having more than a couple of properties means something is always breaking, someone is always late on their rent and you’re spending weekends cleaning a place up to get it back on the market. I was spending 10 to 15 hours a week minimum on my properties besides the 60 hours at my corporate job.
The moral here is to start slow. Buy just one or two properties for that first year to see what kind of work goes into managing them. Better yet, buy a duplex or triplex and live in one of the units.
Not only are you going to slowly work into the time it takes but you’ll learn all the repair skills you can use when you really get going.
I’m not trying to burst your bubble or talk you out of becoming a real estate investor because it really is an amazing investment. I just want to give you the facts. The only people talking about real estate as a passive income investment are the ones trying to sell you their course.
One way I've found to make real estate investing a little more passive is through real estate crowdfunding. You still have to analyze the properties and the investment but you get professional management and solid returns. In fact, a survey of real estate crowdfunding returns estimates debt investments at 9% annually and equity investments up to 20% a year.
Real Estate Investing is Still All About Location
The second key to getting started real estate investing, and this is easily the most important, is buy quality over price.
I know what you’re thinking, “But Joe, I can buy a house in the less than perfect side of town for about half the price and still get solid rents. That means higher returns on my money.”
Price is important and we’re going to be getting to how to get a better price on any home in a minute, but quality neighborhood is so much more important.
Let me tell you what happens when you buy real estate in the cheap seats. Your tenants destroy the house, then the county gets after you for rental code like they don’t know you had screens on all the windows just last week. The tenants pay a few months then start testing you to see how late they can get before you evict.
When you do evict tenants, and it’s going to happen more than once a year, they leave a dumpster full of trash for you to clean up.
That’s not an exaggeration. I used to rent a 17-foot Uhaul when tenants moved out and I’d fill it up with furniture, carpet and everything else you can imagine before unloading at the dump at 5am before work on Monday.
I’m not going to sugar coat this and I’ll probably piss some people off but, buy in the hood and you’re going to get hood tenants.
Now I’m not saying you have to buy in the priciest neighborhood in town but there’s a happy medium here. Buy in stable, family communities.
Learn how to negotiate for a good price which we’ll talk about and you’re return is going to be higher. You’re not going to have the vacancy or the repairs and more importantly you’ll keep your sanity.
Learn How to Use Debt as a Tool to Buy Property
Our third secret to real estate investing and this is another controversial one, one that some investors are going to disagree with but screw it.
Debt is not a four-letter word in real estate investing. I know everyone is talking about paying cash right now, everyone wants to do their debt free scream, but real estate investing without debt just isn’t worth it.
Real estate investing without debt might get you a 5% return after all the costs, and we’re talking about rentals here so including the cash flow and appreciation. But with financing even 65% of that property, you can boost your return to double-digits when you include the tax deduction on interest.
I’m not talking about these bullshit strategies buying real estate with no money down or financing 90% of the property. You have to be smart about how much debt you use. Like any tool, if you start swinging it around and use it incorrectly you’re going to start smashing things up.
That was another one of the mistakes I made. In my fever to buy more and more properties, I leveraged them all to 80% or more. When you do this, there just isn’t going to be much cash flow left after the mortgage payment.
Any unexpected expenses or higher vacancies or anything is going to have you dipping into savings to pay the debt and that can’t go on for long.
The best thing you can do here is to estimate your cash flow before buying a property. This is going to show you exactly how much cash flow you can expect to make that mortgage payment and also give you an idea of how much to pay for the property.
So let’s look through a quick estimate for real estate rental cash flow. First get an average for rents in the area, how much you can charge and take 10% off for vacancy. Some years might be less and some years might be more.
This is called your gross rent but from it you still need to take out an estimation for all your expenses. You can call the public utilities; water, gas, electric to get an average if you plan on paying that in the rent. Property taxes are usually paid twice a year but break it down into a monthly amount. You can get that number from your county assessor.
You’re going to need insurance so call your agent to get a quote. I usually estimate another 2% of the rent to go to marketing when the house is vacant. Again, you won’t have this every month but when you do it can be a decent size bill. If you’re going to use a property manager, get quotes or estimate 10% of the rent.
Maintenance is going to be a big question mark but a good rule of thumb is to estimate about 15% each month. That’s going to cover not only the small jobs but also repairing roofs, heating and cooling and all those huge projects that cost thousands.
Finally I usually estimate about 5% for legal and permits. Legal will be higher if you have to evict often and you can find the cost of rental permits from the county.
You can see that all this adds up fast. Just these bottom four items can cost you a third of the rent. Even if you’re going to manage the rentals yourself, you’re still looking at probably a third of your rent or more going to expenses.
Now you have a better idea of how much you’ll have left over each month for the mortgage payment and you can decide how much to borrow based on that.
Of course, all of these expenses won’t come every month. You’ll build up a savings but that savings is going to go to when the big expenses do hit and make sure that you don’t come up short on cash and can’t pay the mortgage.
How to Negotiate in Real Estate Investing
Finally here, our last key to success in real estate investing is learning how to negotiate and knowing how much a property is worth.
This is the part that takes so many real estate investors so long to figure out and it will literally save you tens of thousands of dollars on a single property.
First let’s look at how to know exactly how much an investment is worth and then we’ll look at how to get it for less than that so stick around because I have a cool negotiating trick that is going to get you properties for big discounts off the fair price.
There are a couple of ways to value real estate but the best is called the comparable sales approach. This is where you find the price of similar properties and use that to value the one you’re looking to buy.
Your county assessor is responsible for recording real estate sales. If your assessor is on point, they’ll have a website that is easily searchable for sales data. So we go to the assessor’s page and find the information for the house we want to buy, we’re looking for district or neighborhood as well as year built, living area, and we can take down some other features like whether it has AC or a garage.
So here we have this house is in neighborhood DM89, it was built in 1900 and remodeled in 2010. It’s 1,460 square feet, two stories and no garage.
Oh look, someone bought this house for $25,000 in 2010 and sold it for $104,000 in 2013 – that was a pretty good deal huh?
Then we do a sales search and put in the neighborhood and ranges for some of these other points. Basically, you’re looking for houses that were sold in that neighborhood within the last year and that are similar to your house. So maybe your property was built in 1950 and you look for houses that were built between 1925 and 1975 or within a hundred square feet of the size of the house you’re looking at.
You might have to play around with it a little if there weren’t many houses sold matching your description. Maybe expand your search to nearby neighborhoods or other factors.
This is going to take a little time but it’s less than an hour and is that too much to spend if you’re going to be paying a few hundred thousand for an investment?
Once you have a list of at least five to ten houses sold, divide the sales price by the total living area in square feet. So we can go through this list and look to make sure the houses are similar. Make sure you look for different types of sales. A house sold on contract isn’t going to be comparable because it will be a little higher. So you want houses that are similar and sales that are for the deed.
If I divide the price for each by the square footage, so let’s say $93,000 divided by 1,265 square feet for this first one, I get a price of $73.53 per square foot. If I go through this list for all the houses that are comparable and get an average of those, then I get an average of $78 per square foot.
Now this is the average of what houses are selling for in that neighborhood. Remember the house we were looking at was 1,460 square foot so that times $78 per square foot gives us a fair price of about $114,000 for the house.
Let’s say you’re not lucky enough to have a county assessor with an easy website search. You can do this same thing with houses that are for sale. So you go to a site like Realtor.com or Zillow and you find all the houses for sale in the neighborhood. Understand though that these prices are offer prices so maybe you take 5% off of that to estimate a fair sales price.
This research might take you an hour but it is hugely important. You can take the cash flow you estimated from the rent to find a return on the property, so that annual cash flow plus the principal part of your mortgage plus maybe 2% of appreciation add that all up and divide it by the how much you think the house is worth and that’s your annual return.
More importantly though, this research is going to give you ammunition in negotiating with the sellers. You know exactly how much the house is worth and can prove it.
A Real Estate Negotiating Trick for Big Discounts
In fact, and this is a little trick to get investments for thousands less than the market price, after doing this research so you know how much the house is worth, run through the search again. Find those other houses sold in the neighborhood but cherry-pick the sales. Find five or ten sales that were at lower price-per-square foot than the others.
We’re not talking foreclosures that were sold for pennies but houses that were sold for maybe a 10% or 15% discount. You’re going to print out this list and use that as ammunition in negotiating with the seller. You can say, “I understand you want this price and I want to give you a fair price but look, these other houses in this neighborhood were sold for this much. This is a fair price for the house.”
You can get an easy 10% discount on a house this way. I’ve done it many times and it works.
Besides value, you also want to have different things you can ask for in negotiation. You want to demand some things like closing costs and paid property taxes (not just pro-rated) and repairs. It’s not necessarily that you’re going to get all these things but they just give you a place to start in negotiating. Being able to negotiate on more things means you can drop a few without increasing your price.
One last negotiating tip here, you must have a walk-away price. Anything can be a good investment at the right price but so many investments have turned to shit because the investor got pulled in and paid too much. You might have to negotiate and probably won’t get your initial offer price but know what’s the max price you will pay for it to still be a good investment and don’t go above that.
These four keys are a lot to take in at once but master these and you will be successful as a real estate investor. I made a lot of mistakes as a new investor but learned from them and was able to bounce back fast. Follow these four tips to getting started in real estate and you can avoid the biggest mistakes.