“My parents home was trashed by renters, they’ll never do that again…”
“My uncle flipped a house and he ended up losing money”
“My best friend’s brother went out of business”
“My Management Company was terrible to work with, cost me tons of $”
“We soon discovered meth, termites, and water damage…”
There’s a lot of stories out there about the good and the bad of real estate investing. What grabs our attention are the horror stories we hear from friends and family. This instills fear from ever entering the investing world. Over time we hear from the same friends and family that someone they know is making a fortune. Soon you become open to the idea but the fear stills remains. How do you first go about investing in real estate?
Fact: There’s ALWAYS risk
The Question: How do I LIMIT that risk?
There’s a lot of “Games” within the “Game” of investing. We’ll cover the basics of THE RENTAL and THE FLIP.
Fact: With both these strategies, you “make” your $ when you buy, not when you sell.
THE RENTAL: This “Game” has the greatest upside. It’s the long-game. You want to make sure you purchase with 2+ exit strategies and the right terms for those strategies.
The biggest misconception is that you could/should jump right in. Like any business, it’s survival depends on systems being in place. At the heart of every horror story, you’ll find that the owner/manager relied on the Stamina Approach. This is basically reaction management. Always reacting to tenant problems leads to early burn out and carelessness to your own hard-fast rules. You soon realize (yet again) why you put those rules there in the first place. Very soon you’ll start to associate pain and loss to what could’ve changed your life for the better.
FREEDOM and/or RETIREMENT: Let’s start with the “End in Mind.” There are a lot of ideas floating around out there of what these both mean. To keep it simple, we’ll define it as being relieved of financial pressure. Whether by entirety or slight relief, real estate CAN be one of the best vehicles to take you where your dreams have been your whole life.
APPRECIATION: This is where most people get in trouble. They look at a piece of real estate and make the assumption the market will continue to go up. They then rely on this potential future, having 1 exit strategy, and roll the dice. Sometimes it works out, sometimes it doesn’t. This becomes irresistible in swing areas like Park City and St. George where prices shoot up. This also means they come crashing down. Consider Appreciation as a BONUS, don’t rely on or expect it when you crunch the #’s.
USE: Not always an option, but it’s always nice to have a flexible rental. Whether you use the detached garage to store your extra toys or to let your daughter stay when she’s in-between places.
AMORTIZATION: Any homeowner is familiar with the concept of principle reduction. At the beginning of the loan term, most of the monthly payment goes toward interest. With each subsequent payment, a greater percentage of the payment goes toward principal. This is where deciding your preferred terms for your exit strategies is crucial. If you’re convinced you’re in it for the long haul and cashflow is a priority, then a 30 year fixed mortgage would be preferable. If equity is the top priority and cashflow isn’t an issue, a 15 year pay off schedule would be ideal. The safest choice might be to get a 30 year and pay it as if it’s a 15 year. That way if things get tight you have more flexibility.
EXPENSES: As with any business, you’ll have expenses to go along with your income. “Business” lunches are my favorite ;). These are useful in offsetting some taxes. *Consult Accountant on possibilities and strategy.
MANAGEMENT: This can go along with your expenses. The reason I’ve itemized it is because it’s so crucial to your Return On Investment. This is where most people stumble in the landlord circus. If you decide you’re not the person for the job, you’ll hire a management company. These companies are dime a dozen. Unfortunately there’s a lot that are mismanaged themselves. Pick one that won’t nickle and dime you. When they do charge you, make sure it’s self motivating (half of late fees, etc.). The reason for that is, they’re motivated to collect the late fee, just as they’re motivated to keep the property occupied. They should not charge any $ while it’s vacant, except for agreed maintenance. They should have guarantees to limit your vacancy losses or if not a guarantee, then a strict system to avoid it. More on how to Vet a Management Company.
DEPRECIATION: In theory this is “a paper loss.” Although, in reality I was once told when I began investing by a friend that it’s not “a paper loss,” it’s a real loss. Things deteriorate and the “savings” eventually catch up and result in REAL expenses.
Purchase Home $200,000 = Building $125,000 / Land $75,000
Depreciation Expense = $125,000 divided by 27.5 years of useful life allowed by IRS = $4,545 a year
Assuming you can use passive activity losses = Tax savings of ~$1,000-$2,000
*Make sure you understand this completely with your accountant.
CASHFLOW: This is Passive Income. Be cautious of thinking this is a Passive Investment. Sure, it’s able to leverage your time vs income but the less you maintain the property in good health the more it’ll build into a future nightmare. This is where horror stories are born. Hopefully you’ve purchased a property that after all monthly and yearly expenses, you’re able to take a good slice off the top, you’ve earned it. Eventually once you’ve mastered the game and developed all your systems it will require less of your focus and time.
LEVERAGE: Yes, you’re able to leverage your time tremendously, however with this I’m talking about Financial Leverage. Let’s say things are going smoothly, you’ve mastered the management game and have built a reliable income stream. If you’re ready for more, you can now show the bank that you’ve learned how to play the “Debt Game.” They’re able to see that you’ve been calculated in your strategy and trust you with more debt. Yes, there’s such thing as good debt. It’s debt that puts $ in your pocket, rather than taking it out. They’ll make sure that you can handle yourself in a worst-case scenario as well, hence the need for multiple exit strategies (equity position for quick cash, seller finance, assumption, rental income, lease option, etc.).
THE FLIP: This “Game” is the Short Game. It’s a good way to earn chunks of $ to invest in future projects. There are tons of other sources out there to explain “How to Flip” so I won’t get into that at this time.
The Very Best Way to Start & My Personal Favorite Way to Flip:
Find and Buy a Fixer Upper (w/ sweat equity & After Repair Value potential)
Fix as Primary Residence
Span Repairs Over 2 Years
Take Advantage of Home-Sale Exemption: 250-500k tax free
It seems like the investors that most often go out of business are the one’s that rely on flipping exclusively. The game is good ’til the market falls. Then the high interest short loan they have eats them alive while they scramble to liquidate. This is the end of the road for them unless they stashed away food for the winter. Winter is always coming, being prepared is the difference maker.
I’m sure this has been one of the scariest posts you’ve ever read, (especially if you love clowns) but with any real estate market there is always opportunity, it just requires a different mindset and another game. Contact Me with questions about your situation and the best way for you to get started.
Other Resources
- How to Vet a Property Manager
- THE ULTIMATE W-2 Employee Investment Strategy
- First-Time Home Buyers : The Ultimate How to Buy Guide
- How to Vet an Agent
- The REAL Value of a Strategic Agent and his Marketing Plan
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The above article “Avoiding The Horror Stories of Real Estate Investing” was provided by Tanner Johnson. If you’re thinking of selling or buying, I’d love to share more information with you.
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Greater Salt Lake UT: Central Salt Lake City, Downtown, West Temple Addition, East Central, Sugar House, South Salt Lake, Liberty Wells, Arcadia Heights, Yale Heights, Federal Heights, Arlington Hills, Greater Avenues, Capitol Hill, North Salt Lake, Castle,
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