Real Estate Investing: My Biggest Mistakes Made So Far (February 12, 2014)

by FI Fighter on February 12, 2014

in Real Estate Thoughts

trail

I’ve been investing in rental properties for two years now, and made my fair share of mistakes along the way. I was very fortunate to have started in 2012, though, because I was buying near a market bottom. So, even though I did make mistakes, I was operating with a lot more margin for error than investors have in today’s market. If you are looking to get started in real estate investing this year, you must be extra careful when performing due diligence with your purchases. The returns and cash flow just aren’t as great anymore.

The good news, though, is that the deals are still out there to be had. After two years, here are my biggest blunders, looking back with the benefit of hindsight.

Blinded by Fear… Didn’t Know What a Good Deal Was

I first started looking into buying rental properties in 2012. I didn’t know it then, but that was PRIME TIME to be hunting for houses. Due to the financial crisis, housing prices were still near the bottom in almost all areas across the country, and interest rates had plummeted to historic lows. Looking back, everything is 20/20 now, but I did let one deal slip away that I almost still regret today.

It was a 4 bedroom, 3 bath townhouse located in the Bay Area. It was bank-owned and being sold as a REO. I ran the numbers and calculated that even after accounting for PITI (principal, interest, taxes, insurance), and HOA, the property still cash flowed $800/month. The real returns would be lower once you factored in vacancy and maintenance reserves, but still, there was a ton of margin to spare.

In regards to the purchase price, this property was listed for $212,000, about half of its peak value set in 2006.

bay_condo

The one that got away…

Since I was just getting started with real estate investing, naturally, I was nervous and scared. The numbers on my spreadsheet seemed to work, but I just kept seconding guessing myself. To make matters worse, I consulted with people who didn’t know the first thing about investing in real estate. All they would tell me was, “you’re making a big mistake. What if prices drop further? Aren’t you worried about going into foreclosure?”

I’ve since learned, it doesn’t matter if prices decline further! If prices drop, you buy more! Market rents at the time were $2200/month, so the cash flow more than covered PITI, HOA, and vacancy/maintenance reserves. You were cash flow positive, and the cash-on-cash returns were over 10%. In the Bay Area, of all places! Rental demand was through the roof (I knew this firsthand), so finding a quality tenant wouldn’t have been difficult at all.

In the end, I was too focused on the short-term fear. I refused to “overpay”, and ended up submitting a weak offer. The pain of not knowing what a good deal was! Returns might as well have been in the 40% range, as far as I was concerned back then. When you’re consumed with fear and don’t know how to evaluate a good deal, you’ll most likely miss out on it everytime. The property eventually sold for $240,000, and is now worth close to $420,000. Market rent is now $2450/month. The owner, whoever it turned out to be, made out like a bandit!

Used a Big Bank Lender

Another big mistake I made early on was I decide to work with one of the big name banks for my first two properties. Getting a loan and closing escrow wasn’t so bad, but as I later found out, these big banks aren’t very investor friendly.

Big banks are better suited for the first time homebuyer who wants to own their own personal residence. If you’re an investor, you would be much better served to do research and find a local bank, or portfolio lender that is investor friendly.

After closing my first rental property with a big name bank, the real estate market continued surging. After about a year, my first rental had appreciated close to $100,000. Since I wanted to buy more properties, I went back to my lender and researched into HELOC’s and cash-out refinancing options.

What I found was very disappointing. The big name bank I used was only willing to loan me 65% (loan-to-value) on a HELOC. To make matters worse, they also required that my debt-to-income levels be “within reason”. This lender refused to count any of my rental income, since each property wasn’t on my tax records for each of the last two years, so there was no way I was going to fulfill their debt-to-income requirement to qualify for the HELOC. My debt was at about $500,000 (two rentals), and they would ONLY count my W-2 income.

Suffice to say, I won’t ever use a big name bank again for buying rental properties.

Hired a Cheap Contractor

This one goes without saying, but you really do get what you pay for. After acquiring Rental Property #2, I entertained a few bids on the rehab work that needed to be done. That property was a wreck, and needed a lot of TLC. Since I was busy with work, I didn’t spend enough time trying to find the right contractor. I finally decided to just hire the cheapest guy, since he interviewed “well”.

Boy, what a mistake that turned out to be. The guy was sloppy, unprofessional, and quite frankly, didn’t do a very good job with the rehab. Within the first week of renting out the place, the upstairs bathroom was leaking. Water was pouring out of the recessed lights in the living room! Luckily, I didn’t panic the second time around, and hired an expensive repairman who had a very good reputation. He did an excellent job with the repairs, and fixed it right the first time. So, in the future, I’ve learned to just pay more for quality. Even more important, it is necessary to put in the research to find the right person for the job. Whether through Yelp, or word of mouth, or through an internet search, it’s worth the effort. Things could have ended up much worse for me, and I don’t want to go through this experience again!

Partnered with a Turnkey Marketer

If you thought I was nervous and scared buying my first two local properties, you should have seen the look on my face when I was trying to buy my first out-of-state investment! I first researched into turnkey properties in the middle of 2013, after the local real estate well dried up and cash flow numbers stopped making sense.

A turnkey company is one that does all the work for you (in theory). They acquire the property, rehab them, find the tenants, and run the property management. They make their money “flipping” the houses to you, the investor. The key selling point to investors is that the turnkey company will do all the work for you, and manage your property after you purchase. If you find the right company, this can be a perfect business partnership. They make their money off the flips, and you pocket the monthly cash flow. For busy professionals who work in an expensive real estate market (Bay Area, SoCal, Seattle, NYC, etc.) this makes absolute sense. For other investors who live in areas where cash flow is flowing aplenty, it’s probably a better idea to just do it yourself, so that you can maximize your returns.

The mistake I made wasn’t buying a turnkey property through a turnkey seller. No, the mistake I made was that I used a turnkey marketer to introduce me to a turnkey seller. I didn’t know any better! I was again, nervous and scared, and got caught up with the wrong people. I have nothing personal against turnkey marketers, but I now realize how unnecessary they are in the process of buying turnkey properties. They hardly do anything, and will take a huge cut of the sales proceeds in the form of commissions. If you use a turnkey marketer, you will have very little wiggle room to negotiate a better deal for yourself.

And the worst part? Once you become their “client”, they lock you down for all future purchases as well. Granted, not all turnkey marketers will do this, but the especially greedy ones will (the one I worked with did). So, even if your first turnkey experience goes well, if you decide to buy more properties using sellers in their network, they will again take a big bite out of the pie. It’ll feel like paying royalty fees to someone who doesn’t do ANYTHING.

Set the Bar Too Low and was NOT Creative Enough

Connecting back to the first big mistake I made above, there’s an old saying dividend investors love to use, “when others are greedy, be fearful. When others are fearful, be greedy.” Back in 2012, it was the perfect time to be GREEDY. Honestly, when I reflect back, I’m grateful that I was able to lock-down two rental properties in the Bay Area at near market bottom prices. However, since I was still a newbie starting out, another mistake I made was that I had no clue how high the bar should be set.

Although I lucked out with two properties, there were plenty of those around me who had enough conviction (and smarts) to pick up even more. Recently, I had dinner with a local investor who bought FIFTEEN properties in the downturn from 2009-2013. He knew that the deals were a “once in a lifetime” opportunity, so he put his brain to good use and discovered clever ways to finance deals. He borrowed money from everyone: family, friends, neighbors, co-workers, banks, private money, etc. and even figured out how to win properties at the courthouse auctions. So, he was able to swoop up $400,000 townhouses/condos at a fraction of their peak values. In many instances he picked them up for as low as $120,000. The cash-on-cash numbers were out of this world (20%+ returns), so he knew he was in a no-lose situation. If prices dropped further, he would either buy more properties, or just hold the ones he had and collect the cash flow. This investor has since retired from his 9-5 job and now does real estate investing full time. He estimated that he made close to $3 million during the downturn. That would be $200,000 on each of the fifteen properties. Seems kind of high, but not altogether unrealistic if he was indeed able to buy each one at the courthouse steps…

Summary

Investing in real estate can be highly lucrative. When first starting out, it’s easy to make a lot of mistakes, so it’s important to do your research and to network with others who have done it, so you can avoid making the same errors. In two years, I’ve made my share of mistakes, and these were some of the more painful ones. I’ve now realized that there’s a never ending list of things to learn, which makes the real estate game a journey of lifelong learning. In other words, the sky’s the limit!

 

What are some mistakes you’ve made in your real estate investing career? What would you change or do differently for next time?

{ 29 comments… read them below or add one }

1 Fast WeeklyNo Gravatar February 12, 2014 at 3:51 am

Thanks for your list FI. Those are some very helpful tips. You’ve come a long way in two years…..and 5 properties. In hindsight I just wish I had my sh@# together already. Have a great day
-Bryan

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2 FI FighterNo Gravatar February 12, 2014 at 11:17 pm

Bryan,

Yeah, a lot has happened in two years. With the benefit of hindsight, I think a lot of us would do things differently. But what’s happened has happened. Just gotta keep moving forward and making progress. I think you’re on the right track my friend!

All the best!

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3 writing2realityNo Gravatar February 12, 2014 at 7:52 am

Wow, what a fascinating group of stories and some valuable lessons for beginner investors. Your fears and concerns are definitely quite common as you hear people talk about analysis-paralysis when waiting to pull the trigger on their first property.

Keep cranking out these posts sir, they are looking good!

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4 FI FighterNo Gravatar February 12, 2014 at 11:19 pm

writing2reality,

Thanks! Appreciate the support.

Yeah, fear can be paralyzing at times… especially when it’s unjustified. This is something I needed to experience and learn. Hopefully I’ll be better prepared next time, whenever the market decides to correct again. I’m very grateful for how things worked out, but will keep on working on getting better.

Take care!

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5 EricNo Gravatar February 12, 2014 at 9:07 am

Good post. Know your market. When a great deal comes up, there will be multiple offers. You want your offer accepted, before the other offers even come in.

Most of my properties were foreclosures. Most of the deals were sealed before they hit the MLS. I have purchased them as short sales, REO properties, at the sheriff’s sale, redeemed as a junior lien holder, bought mortgages directly from the bank. I have purchased a 4-plex every year in 2008 to 2012, 5 total. Most purchased for about fifty cents on the dollar from the peak.

Understand the foreclosure process for the area you are buying in if you want the best deals. Get the deals where the “turn-key” sellers are getting them, or even before they do. You do know they make money too? Why not pick up their profit while you are at it.

Get a RE license. It’s generally easy and will not only save money, it will give you additional knowledge. Take a few RE seminars, even if they are over the web. Buy the ‘kits’, study them, and return them for a full refund. Make sure your RE agent gives you a cut of their commission. You are a buying in bulk; you should get 25% of the agent’s commission, that’s what I did.

Join a local RE investment club. Lots of great deals are passed around there. There are ‘bird doggers’ who find deals, but do not have the capital to execute them. They get $5K or so, you get the deal. Make sure you know about liens and title transfers, or have a great RE attorney. With any deal, there will be some risk, you need to understand it and mitigate it.

You will have cash to bring if you want the best deals. You cannot get a mortgage when you buy a mortgage… There are still deals to be had, but you need to work for them, or pay someone else. I just did a flip last month with a partner and picked up $26K in a deal that took 3 months and only ~80 hours of work.

I do much of my own maintenance, but I do hire guys to work with me at times. Why pay someone if I am just watching TV otherwise. If someone is going to make $50 per hour, I want it to be me. Learning the maintenance goes a long way to understanding if your handyman is doing it correctly. You should know how to do a few things on your own house anyway. If you do not know how to do something, someone has already dedicated their life trying to teach you and has posted a YouTube video on the subject.

A 4-plex costs $4000 per month sitting vacant in lost opportunity, plus the hard expenses. So it is imperative to get it up and running as soon as possible. Hire someone to help. With only one vacant, it’s only $1,000. You can do the work and save $2,000.

Put in decent quality fixtures. “Industrial strength, but cheap” is a good mode to be in. I use Moen faucets; laminate counter tops, RTA cabinets (100% real wood, no particle board). Not Taj Mahal, but not slum lord either.

Consolidate colors and fixtures. I use the same color paint in all my apartments, Ceiling and trim is white. Walls are interactive cream. Most have the same appliances. Lowes is great for getting 10% off appliances with free delivery, even off sale prices. Use the Home Depot paint program, or get Sherwin Williams to give you a deal on paints. I get SW ProMar 200 for $19.97 a gal in semi-gloss, which is about half-price. Use sheepskin roller covers and Purdy brushes. HD’s $37 carpet install is a great deal. For rentals, use laminate flooring instead of carpet in all rooms except bedrooms. Sam’s club has great flooring for a small price.

Keep your properties maintained, do not mistake deferred maintenance for profit.

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6 FI FighterNo Gravatar February 12, 2014 at 11:24 pm

Eric,

That’s some awesome advice you are offering. Lots of excellent points, so I’m going to copy and paste your message into a file to refer to.

It definitely gives the beginner investor something to aspire to. It’s amazing how lucrative REI can be… even when you don’t know what you are doing. For guys like yourself, the possibilities are even more endless.

Yes sir, slowly working on networking and building up networks and teams. It’s a slow process, but I’m enjoying the journey.

Cheers!

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7 SandyNo Gravatar February 14, 2014 at 7:53 pm

I follow the “Not Taj Mahal but not slum lord” rule as well. Durability is the most important to me at this point.

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8 Retire Before DadNo Gravatar February 12, 2014 at 9:08 am

FIF,
Thanks for sharing this list. The one that stands out for me is talking to the big banks. I spoke to one about a HELOC and they gave me some 65-75 percentage loan to value too. Meaning, I couldn’t take money out. Need to find someone else to lend to me.

-RBD

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9 FI FighterNo Gravatar February 12, 2014 at 11:25 pm

RBD,

Definitely, I learned this the hard way as well. 65% doesn’t get you very far LTV. Wish I knew this before hand…

Best of luck!

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10 J. MoneyNo Gravatar February 12, 2014 at 9:43 am

Great article! 😉

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11 FI FighterNo Gravatar February 12, 2014 at 9:58 am

LOL! But not as great as the “other” one, right? 😉

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12 MarvinNo Gravatar February 12, 2014 at 1:55 pm

These posts are gold nuggets FI! I love reading them, this one particularly drove home because it talked about fear at first. Thanks for opening up about your mistakes, most real estate investing “gurus” paint a rosy picture about how nothing can go wrong.

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13 FI FighterNo Gravatar February 12, 2014 at 11:27 pm

Marvin,

Thanks! Glad the posts are helpful. Yeah, I figured since it’s been about two years, enough time has passed for me to reflect back on my mistakes. I’m sure in another year, I’ll have another list of mistakes to add onto the list.

It’ll probably be never ending, but that’s ok. Learning is a good. Next, I need to come up with an action plan on things to implement improvements on for this year.

Cheers!

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14 Dave @ The New York BudgetNo Gravatar February 12, 2014 at 2:41 pm

Thanks FI – I’ll try to learn from your mistakes! Although, I am sure I will make plenty of my own along the way.

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15 FI FighterNo Gravatar February 12, 2014 at 11:29 pm

Dave,

Yeah, I wish you the best and hopefully you can avoid the mistakes that I made.

We will all make mistakes, that’s part of the learning process. But when you can, learn from others… it’ll be cheaper that way! 🙂

All the best on your journey!

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16 The First Million is the HardestNo Gravatar February 12, 2014 at 6:58 pm

I’m glad I had the wherewithal to buy my primary residence near the absolute bottom of the housing market, but I really wish I was prepared to jump into investment properties at that time. I recognized the opportunity, but didn’t do anything about it!

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17 FI FighterNo Gravatar February 12, 2014 at 11:30 pm

Jay,

Great move on your part. You are reaping the rewards of a smart decision now. Yeah, I wish I bought more as well, but am still really grateful for getting what I did.

Let’s aim to do better next time!

Cheers!

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18 Fig @ Figuring Money OutNo Gravatar February 13, 2014 at 8:54 am

I feel like I just learned so much in the last five minutes! I’m incredibly obsessed with buying a house in the near future so right now I’m trying to learn everything I possibly can so I’ll be ready! I’d love to start with a duplex so I’m focusing on that. 🙂

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19 FI FighterNo Gravatar February 15, 2014 at 10:06 am

Fig,

Glad you are excited to get started! Buying a duplex sounds like a great idea, whether it’s to live in one side and rent out the other, or to just own as an investment property.

I own one duplex, and am closing on a second one next week.

All the best!

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20 Mel @ brokeGIRLrichNo Gravatar February 13, 2014 at 2:34 pm

This is maybe the first article I’ve ever read that made me feel like real estate investing was actually do-able… even with you writing about your mistakes.

Also – “when others are greedy, be fearful. When others are fearful, be greedy” – I’m going to remember that.

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21 FI FighterNo Gravatar February 15, 2014 at 10:07 am

Mel,

Yes, real estate investing is very doable. By no means is it easy, so the important thing is to get educated first, but it also isn’t impossible as so many “experts” would like you to believe.

Do your homework, research, and buy right. Years later, you’ll be glad you did and reaping the benefits.

Cheers!

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22 theFIREstarterNo Gravatar February 14, 2014 at 12:32 am

I guess my biggest REI mistake so far has been to NOT DO ANY during that ever so lucrative sounding downturn. Arrrgh! Like you mentioned in a comment above though it’s not so important dwelling on mistakes like those. I had no time, money, nor inclination to do such a thing anyway at that time, it wasn’t even on my radar.

Thanks as always for the insights, I’ll be referring back to this in the months to come!

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23 FI FighterNo Gravatar February 15, 2014 at 10:17 am

theFIREstarter,

Yeah, if everyone knew, then we would have all done it… Hindsight is always 20/20, so no use dwelling over it any. I just wanted to do a post like this to kind of remind myself on what to do next time… because there always is a next time. Real estate is cyclical, just like stocks… and the economy 😉

In the future, if I ever see 20,30,40% returns, I have no excuses to miss out! Can’t say I didn’t know better the next time around.

Cheers!

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24 IntegratorNo Gravatar February 14, 2014 at 12:58 pm

This was a great summary. I had a very similar experience with buying equities in the downturn of 2009 as far as being fearful on some great deals. I guess the issue I had there was I was buying on margin and I didn’t know how much lower we were likely to go, everyday just brought more pain. At least you don’t mark to market with real estate on a daily basis! You’ve still done really well. Congratulations!

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25 FI FighterNo Gravatar February 15, 2014 at 10:19 am

Integrator,

Yeah, definitely the downturn impacted not only REI, but also stocks. Lots and lots of great bargains in early 2009.

Congrats to you on making some shrewd moves. Those decisions are paying off big time for you today.

It’s difficult buying in a downmarket, and even though everyone says they will, it takes extra conviction to keep doing it, even as prices continue falling.

All the best!

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26 SandyNo Gravatar February 14, 2014 at 7:51 pm

I have to say, I know these mistakes so well. I make the same mistake on price and let a 5 unit building slip through my hands. It BURNS me to this day every time I think about it.

Fear can be a paralyzing thing but we have this sense of fear for a reason. We have to be cautious because we can potentially lose our shirts.

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27 FI FighterNo Gravatar February 15, 2014 at 10:22 am

Sandy,

I can relate to how you are feeling. Yeah, missing out on a great deal is something that sticks in your head for awhile…

I guess the best way to move on is to learn from our mistakes and try and make sure we capitalize next time around.

Yeah, fear is not a bad thing. It can save your skin, actually. Just need to be able to filter it out and know when it is justified and when it is overblown. I should have known that 10%+ cash on cash in the Bay Area was a good deal… Also, the property was selling for half of its peak value… The risk was low, so the fear was definitely overblown and unjustified.

All the best!

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28 The StoicNo Gravatar February 16, 2014 at 3:45 pm

Great lessons and thanks for sharing!! Looks like you done well over the last few years and have a solid foundation to build from. Congrats!

I’ve been away from the blogosphere for awhile but I’m looking forward to catching up on your progress.

Cheers

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29 FI FighterNo Gravatar February 21, 2014 at 11:45 pm

Stoic,

Glad to see you back online buddy! Love the rehab work you’ve done on the place, and looking forward to seeing more pics.

Cheers!

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