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.
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…
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?