There are a lot of rules when it comes to real estate but there are ten that should never be broken. These are 10 real estate investor commandments.
This is real estate month so we want to cover some of the most important rules to follow if you want to become a successful real estate investor.
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1. Have a Strategy
Jack of all trades and master of none applies to real estate investing too. There are lots of niches in real estate investing, house flippers, buy and hold, cash flow investors, type of property (we had a guest who invested solely in trailer parks), types of tenets (our contributor Allison likes to rent turnkey properties to grad students), certain areas of the country.
If you are trying your hand at a lot of different niches, you are never going to learn enough about any of them to be an expert and optimize your investments. Choose one niche, learn everything you can about it, and stick to it.
2. Know Your Requirements
You have a relatively short list of requirements to meet when you are shopping for a home to live in compared to shopping for an investment property.
When you are buying rental property you have to consider price, what the cash flow needs to be, the average appreciation for the area, the age of the home, how much work it needs, how much reserve you need to have, the vacancy rate, what the property taxes are, is there an HOA, the quality of the neighborhood, your you’re going to rent to. Gah!
There are a lot of factors to consider and everyone will have their own requirements but the point is, once those requirements are set, you must stick to them.
Don’t be tempted by a place that meets most of them or comes close to the numbers you set. You set these requirements for a reason and they’re called requirements for a reason.
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3. Do Your Own Research
You can use a company like Roofstock to handle the whole process of finding, buying, owning, and managing a rental property for you but you still must do your own research.
Because no one will ever care more about your money than you. Nearly all of the research you need to do to choose an investment property can be done online. You can do a lot of it through the tool Andrew created, Simple Wealth.
4. Be Skeptical
Do you know who got a really good deal on a house? The Lutz family. A super cheap price for a fully furnished home right on the water. What was the catch?
It was where some months previous, Ronald DeFeo had murdered his entire family. The house, of course, is the house the Amityville Horror book and movies were based on. (The whole thing was a hoax but the point stands).
There is no such thing as a good deal. Everyone is in real estate to make money so who is selling you such a good deal? Is it an LLC, a person, how long has that person or entity owned it, why are they selling it? Could be full of old blood stains and demonic pigs named Jody.
5. There is Safety in Cash Flow
The cash flow of a property is the total income (rent) generated from the property minus the total expenses of the property including taxes, repairs, the cost of the property management company, etc.
If your property rents for $1,200 per month and your expenses are $1,100 per month, the cash flow is $100 per month. How much cash flow you need depends on lots of factors but having positive cash flow is a commandment for a low-risk investment.
Well, duh! But sometimes commandments are obvious.
Buying a home with good cash flow is the one of the lowest risk investments you can make in real estate. Some investors operate differently. They buy speculative properties without regard to negative cash flow. These are generally people who can afford to buy inexpensive housing markets like San Francisco and New York City.
Appreciation is a legitimate strategy but it’s a lot more dangerous than a cash flow strategy.
Maybe this type of investor had planned to sell the property in three years but it took six for it to appreciate to a point where they made a profit. A risky strategy and not everyone could absorb that extra three years.
6. Negotiate Everything
Of course you will negotiate on price but people tend to dig in on that or are insulted when you make an offer they feel is beneath them. People are emotional about homes. They are less emotional about things like septic tanks that need to be cleaned out, windows that need to be replaced, or HVAC systems that need to be upgraded.
Know when to walk away.
The other side has something invested in this too and they won’t want to start the whole process over with someone new.
You have more room to negotiate in these areas and doing so may save you more money, not to mention time and aggravation, than if you had been successful in negotiating the price down.
7. Get a Property Management Company
The whole point of owning rental property is to generate passive income. Passive income is money you earn without a lot of effort. If you want rental property income to be passive, you need to hire a property management company.
You are no longer trading your time for dollars so you don’t want to deal with calls from angry tenets, you don’t want to change light bulbs or interview contractors, you don’t want to find new tenets when the current ones move out.
8. Understand Your Neighborhoods
Location, location, location. You have to understand the factors that make a neighborhood a good place to buy a property in. We recently did a great episode on this. The five key factors are:
- Median Home Value: In regard to list price, half the homes are listed above this price and half below it.
- Median Income: Median income is the amount that divides income distribution into two equal groups, half with incomes above that amount and half below.
- Percent Employed: This is the rate of employment in an area. A number above 70% is considered high, under 50%, low.
- Percent of Owner-Occupied Homes: This is the number of people in the area who own rather than rent.
- Average School Rating: Whether or not an area has good schools is one of the most important factors when considering rental property.
You can also Google “Economy of X” and plug in the city you want to invest in. Is it a one industry town? What if that industry takes a downturn? There won’t be any new people moving into the area and the ones already there might not be able to afford the rent you need to charge in order to cash flow.
A great deal in a crap town is a crap deal.
9. Diversify Your Neighborhoods
If you are buying your first property it can be tempting to buy in your local area because you already know the area well. But if you live, work, and invest in the same area, you aren’t diversified. If your area hits a downturn, every aspect of your life can take a hit at once.
If you own several properties all in the same area, even it it’s not the area you live and work in, you can face the same problem. You’re home and job might not be affected but a whole sector of your investment portfolio will.
When you work with a turnkey property management company, you can own property across a wide segment of the country. If one area tanks, your other areas can keep it afloat until things turn around.
Just like your stock portfolio should be diverse, your real estate portfolio should be too.
10. Leverage Responsibly
Leverage means financing debt, in this case, having mortgages on your rental properties rather than paying cash. Leveraging is recommended because it improves cash flow and you can buy more properties. You get to invest with someone else’s money!
But too much leveraging can be disastrous and bring everything crashing down. Just because a bank will give you another mortgage doesn’t mean you should take it. If one of more of your properties is vacant, can you still cover the mortgage? For how long? How much do you need to have in reserve in case one or more property needs a major repair?
Leverage can enable you to expand your rental property empire but it can also destroy it. Use it responsibly.
Rental property investing is one of the best ways to earn passive income but understand the potential for failure. Follow these 10 real estate investor commandments to reduce that potential.
Even More Jesus: An Imperial Stout from Evil Twin Brewing.
Simple Wealth: Research and evaluate rental properties.
Tool Box: All the best stuff to manage your money.