TL;DR: Most investing mistakes are the result of unforced errors driven by greed and fear. To help avoid these errors, develop a set of investing rules to follow religiously. When it comes to real estate, I focus on knowing the market and current investing environment, knowing intimately what I’m investing in, and having the discipline to walk away from a deal that doesn’t meet my bar. Figure out your own and live by them!
Investing your money well is simple, but it’s not easy. The challenge often lies within. We let our emotions (greed and fear) cloud our judgment. For this reason, I try to define and follow investment rules when putting my money to work. I have a set of general investing rules that I think everyone should follow. When it comes to real estate, I’ve refined a more specific set of rules, or perhaps guidelines, to follow before pulling the trigger on an investment. Take a spin through, and adapt what works for you!
Before you get excited about a specific property, get excited about a particular market (and even sub-market). As the saying goes, a rising tide lifts all boats. The reverse is also true. It will be hard to make money if the market deteriorates around you. Therefore, before you start looking at properties, spend time looking at markets, and figuring out which ones will suit your investment goals. Then, when you have the right market picked out, go deep on that market and become an expert.
Most real estate gurus will tell you to invest within a 10 minute drive of where you live because you should already be a relative expert. That would be nice, but that’s not always practical for folks living in high cost locations like California. Fortunately, you don’t need to live somewhere to become deeply familiar with the market and sub-market. You just need to put in the time and effort to go deep.
Of course, the reality is you can only become an expert on at most a few markets at a time, so you need to choose them wisely. Once you make that choice, focus. Stay within your lanes, and block out all the other inbound opportunities that come your way. Maintaining this focus will also save you a ton of time chasing random opportunities that will come your way.
Is it 2007 or 2012?
Is this a time to be greedy, or time to be fearful? Nobody can predict the future, but we can all take a look at where things are at today and assess what kind of investing environment we’re operating in. You want to be greedy when there is blood in the streets – when everyone thinks the world is ending will probably be one of the best times to buy. Conversely, one of the riskiest times to buy is often when everyone is optimistic and euphoric. In early 2007 the world economy was on a tear, and real estate in particular was going crazy. Everyone was making money. In hindsight, that would have been the worst time to invest in real estate for the last 20 years. On the other hand, early 2012 felt pretty rough. The economy was weak and real estate had been tumbling for the last five years. There was talk of a double dip recession / depression to follow the 2008/2009 fiasco. It turns out early 2012 was the perfect time to get back into the market, at the depths of investor sentiment and with a huge tailwind of government led monetary easing.
The point here, is that you need to know what environment you’re in. Are you in a buyers market or a sellers market? Are properties languishing on the market for 100+ days, or getting scooped up in a few weeks? Are properties going for over asking, or selling at a 10-20% discount to ask? Knowing what environment you’re in will help you figure out your stance – aggressive of defensive. Just because it’s a sellers market doesn’t mean you stop investing… it just means proceed with caution. Underwrite with a healthy focus on capital preservation. Stress test everything. Know the worst case scenario and plan for it… and if you can’t get offers accepted, that’s okay. Wait. If you find a deal where the numbers work for you, then make it happen, but don’t go on a spending spree when it’s obviously not an attractive time to be buying.
There will always be another deal
Tied to the previous point, don’t chase deals. There will always be another one, at some place or some time in the future. Take a page from Warren Buffett’s book – in early 2018, his cash hoard at Berkshire Hathaway has grown to $115B. He can’t find any good deals with the right price, so he waits. If you look at his past behavior, you’ll note he often spends heavily during downturns – notice the dip back in 2013, and early 2016 – both times of uncertainty in the markets. Also, if you look back to 2007, you’ll see his cash hoard reach a peak of $47B, only to be drawn down to $24B by mid-2009 – the best time in the last 20 years to invest.
Riches are in the niches
When it comes to real estate, you really need to focus. There are so many different areas of real estate you can invest in, and someone is making money in all of them, but to be one of those people making money, you only have time to go deep in just one or two of them. Try to focus the investment strategy, market and property focus as much as possible to the point where you become the ‘big fish in the small pond’, and are able to scoop up the best deals in your particular niche.
It’s okay to stick your head up every once in a while and check out what is happening in other niches, but do that very selectively.
Go with what you know
Do you really know the market you’re buying in? Have you driven the neighborhoods? Can you picture the type of people living there? Would you want to live there? Would you want to roll through there at 10PM at night? With your wife? Your Daughter? You should be able to answer those types of questions before you buy.
If you’re investing directly, I would advise you to choose one market and focus. Get to know the key players (agents, brokers, lenders, property managers, contractors etc.). If you need diversification, get that through a number of syndicates operating in different parts of the country, but for direct ownership buy-and-hold, you need to know what you’re talking about. You need to be able to see a property (even just pictures and a google search) and know exactly what the market price is for that property, so you can bid effectively and get a better-than-market price. You make your money when you buy.
Know why you’re buying
What is your thesis on the market and the specific property? What do you need to believe for things to work out according to your plans? Are you expecting major appreciation in prices to drive your return? Do you just need the local rents to remain flat to slightly positive? What are the implicit bets you’re making, and why do you believe they’ll come true? Write this down for every deal, and then review all your deals at least once a year to see how your plans are playing out.
Know what you’re buying
Are you buying what you think you’re buying? Are you sure there will be no surprises? Do your diligence. Spend the money up front to make sure you’re getting what you think you’re getting. Inspectors, realtors and other industry collaborators will be your friends. An ounce of prevention is worth a pound of cure – especially if your timeline for ownership is forever.
It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.
Buy below replacement cost
When you buy, you want to understand how the property price compares to other comps on the market. But the ultimate ‘comparable’ is the cost of constructing something new that is similar to your property. You should know the land costs and construction costs for something similar to what you will be buying. You want to purchase properties for a healthy discount to the cost of new construction. Otherwise, you run the risk of a developer coming in, building and undercutting your prices on rent. With a 20-30% cushion, you’ll have the lowest cost base in the area and be able to weather any onslaughts of new supply.
Don’t be afraid to walk away
At every step in the journey toward closing a deal, you cross hurdles that make it increasingly difficult to walk away. Not only will you have invested your time and money, but you’ll also have a number of advisors who often only get paid if the deal happens. This means they’ll all be pushing to make it happen. But it’s your money on the line, so it’s on you to protect it. If you learn something new that changes your outlook on the deal, don’t be afraid to renegotiate or walk away. Much better to take the small hit and live to fight another day, rather than ending up with a shitty deal. Perhaps the hardest thing will be disappointing all the folks you’ve been working with and having those difficult conversations… but don’t worry about them. Put yourself first. Don’t be afraid to walk away.
Whenever there is any doubt, there is no doubt.
Don’t let yourself get attached to anything you are not willing to walk out on in 30 seconds flat if you feel the heat around the corner.
Never become a forced seller
We can’t control when the markets will go down, but we can control whether we have to sell at those depressed prices. If you’re able to hold on through market declines, by and large, your investments will recover in the end, but if you sell at the bottom, you lock in those losses. Therefore, do the proper stress tests for each property you buy, and for your portfolio as a whole. Model out what will happen to your property if vacancies increase, or rents decline, or both. At what point will you stop making money and have to start putting money back into the property just to float it? Do the same thing for your entire portfolio – model out declines across all your properties at once. What would things look like if we saw a repeat of 2007-2012? Could you hold on? What sort of financial stress would that put on you? Underwrite each property conservatively – which might mean using less debt, and make sure your portfolio is equally resilient. Then you can sleep well at night, knowing that you’ve done your diligence and left yourself a nice cushion to fall back on should the unpredictable happen.
If you want to become a property manager, quit your day job and open a property management business. If you want to invest your money, then invest your money and expect to pay a modest amount for someone to manage it for you. This will free up your time to focus on things that matter, whether that be higher value tasks or just enjoying life. People who decide to self-manage properties end up resenting them and selling at a loss. If you underwrite the property with management expenses built in, then you’ll be happy with your return and happy with your life.
So that’s it, 11 real estate investment rules to live by. Use these. Develop your own. Whatever you do, create the discipline up front so it is easy to follow when you’re in the heat of the moment with a deal. Before you pull the trigger, revisit your list and make sure you’re living up to it. The first principle is that you must not fool yourself and you are the easiest person to fool. (Feynman)
To your health and wealth!