By Don R Campbell
This Is No Time To “Fake it Till You Make It”
Investing in real estate has become a very hot topic. People (and institutions) looking for yield (income) from their capital are discovering a very short list of options.
We have witnessed the so called "Safe Bond Market" yields drop to next to nothing, dividend stocks are under pressure, and alternative options are considered too risky for most. Hence, many turn to real estate as an option. But I MUST warn you, “trying” real estate should not be an option – you either DO it properly and with forethought or DON'T do it at all.
It can be a life changing investment option: positively if you do it correctly, not so great if you don’t.
Strategically investing in real estate takes a great deal of due diligence and some work, but the reward of achieving long term sustainable wealth for you and your family is worth it.
Don't get stalled at the starting line, just make sure you are using the following as a primer, or even a checklist, to ensure you start on the right track. There is a lot of confusion, misinformation, and very poor ideas being floated out around investing in real estate, so before you take the first steps (or even after you have), this article should help give you a clear foundation from which to build.
The First Time or The Next Time - It is NOT a Race
There are some very key components to pay attention to as a first-time investor. Drivers, influencers, cycles – it may all seem like gibberish or jargon at this point, but trust me when I say it will become your language of the everyday once you are comfortably taking those slow, yet deliberate, steps to creating long term success. After each step, your view changes and you’ll be forced to make many decisions as a real estate investor.
The best way to do so is to arm yourself with the information that will point you in the ‘rightest’ direction. Sure, that’s not perfect English, but as in all aspects of life, there is no black & white - your goal is to move in a direction that is the “rightest” direction towards your goal. The road meanders but, by choosing the right path, you know it is eventually getting you to your destination.
Learning The Hard Way
As a new investor and landlord, you’ll be faced with one of the realities of investing – it takes time. There is no true ‘get rich quick’ approach to real estate (despite the many empty promises and stories of massive results you may have read about on the internet).
When you begin, just prepare yourself. Know that it is a long term plan that can be a fun, challenging, exhilarating and, at times, boring road. If you understand this in advance, it can remove a whole lot of ‘performance anxiety’ from the real estate equation. And by managing your expectations, you will help ensure that you do not take a wrong turn, grab a bad property or make a poor investment.
4 Common Pitfalls to Avoid
Here are four of the most common pitfalls new investors face:
- Speed – They treat investing as an opportunity to get rich quick, rather than treating it like the long-term sustainable wealth business that it truly is. When driving a new and powerful car for the first time, you MUST learn how it performs, how you react to its performance, and how to steer clear of danger. Hopefully you don't just hop in, floor it and see how it goes. This is the same when starting out in real estate. You find out what is real, how YOU react to real estate situations, you plan your route and then you implement it. Racing to the "get rich quick" finish line often leads to a major financial crash, so take your time, make your plan and you'll enjoy the drive (the income and the net worth gains).
- Income – They forget about (or don’t fully understand) the importance of investing for positive cash flow from year one. Unfortunately, many seem to be chasing the almighty “home run” deal and eventually they strike out. Home run swingers are speculators and speculation adds a substantial amount of risk to any portfolio. I see it repeated over and over again. So, knowing this, I urge you to focus on the positive cash flow a property creates. Then, as you learn what markets are the hottest, a few of these will turn into a home run of increasing income and dramatic increase in value. Look at how investors have done in Hamilton, or Barrie, or Surrey, etc. Choose strong markets that provide cash flow from day one, ensure those markets have great economics and BOOM – you win!
- Tenants – They live in the old world of thinking that "tenants are always bad and are going to make it hard on me." Strategic investors quickly understand that tenants are actually clients of their business and they should be treated as such. Thanking them for their business, using them for referrals, and providing them a wonderful product (i.e. a nice, safe home for rent) at a price that works for both parties are just a few ways to be a great landlord and great investor.
- Patience – They don’t have the patience to run the business as it should be: using a bookkeeper to keep things straight, dealing with lawyers for due diligence, screening all tenants to make sure they are perfect for their property, etc. Patience is said to be a virtue and, in long term real estate investing, it truly is. Lack of patience adds risk without increasing reward, which is NO WAY to be strategic.
Patience is a Virtue
If there is one ideal that all sophisticated investors should adhere to, it is this: be patient. Reduce the risk of investing in real estate by doing your homework in advance. Find an area with an economic future (not a past), buy cash flowing properties in that area, and manage those properties to the best of your ability. Your job as the CEO of that property is to find ways to increase revenues and decrease expenses, all while keeping a well-maintained property that tenants (clients) love. Market values will fluctuate up and down, rents will follow the market, and costs will fluctuate. The key is to have a long term view and be pro-active at all times.
Debt: How Comfortable Should It Be?
Investors need to understand how to use debt, how to manage it and how to negotiate it. A simple rule for “too much debt” is when your revenues (rents) are not able to sustain all of the operations/payments of the property. There is a massive difference between non-deductible consumer debt (non-deductible debt you pay with after-tax dollars) and “for business” mortgage debt (business expense paid for with before-tax dollars). Unfortunately, the usual school of thought is to lump consumer and business debt into one pile and call it debt. Investors must understand the big difference: one is used to create income and sustainable wealth, while the other is often just to keep up with the Jones’ and in fact makes you work harder.
It is also important for investors not to run around with rose-coloured glasses on. We know that eventually interest rates will go up, so you need to build this into your budget and ‘stress test’ your portfolio to see at what point of an interest rate increase the properties will go from positive to negative cash flow. This will help you to determine when it is time to lock into longer financing or sell the property altogether.
The Exit Strategy
Many times investors will ask the question, “Do I need to plan my exit strategy from day one of purchasing a property? Should I stick to this throughout holding the property?” The answer in simplest terms? It depends!
Pretty lame answer, but once again there is no black and white when it comes to investing in real estate. Each individual has their own goals and reasons they need the long-term income or equity growth that property can provide you. Your personal overall financial plan – including real estate as part of your portfolio – is going to determine your eventual exit strategy.
I have met many strategic investors who do not want to sell their properties, ever. They want to buy in a region with a strong economic future and then slowly pay off the mortgage and hold those properties as their “retirement income source” for the rest of their life, then pass them along to their family as a legacy. Others want to invest, sell everything within 5-10 years and take the cash they’ve made to do something completely outside of real estate.
With all that in mind, selling time is really determined by the long-term economic fundamentals of the market, combined with your long-term financial strategy. Strategic investors study their markets and even take it a step further – they become geographic specialists. They know their target city/town/neighbourhood and they watch for changes in the job growth and population trends so that they can make strategic moves (sell, increase marketing for renters, etc.) to counteract any shifts in the marketplace.
So, after all that, does real estate investing still look like an option for changing your financial future? You bet it does. Nobody wants to go into something blind; you’ll quickly understand that there is a commitment of work and due diligence that comes with investing in real estate, but the sophisticated investor understands this and uses it to their advantage for their long-term goals. Keep your vision pointed forward – you wouldn’t drive a car while looking in the rear-view mirror the whole time. Real estate works under exactly the same principle.
Feel free to post questions on our discussion forum at www.myREINspace.com. It is free and is used by thousands of investors across North America.
For 97 more tips on investing in real estate wisely, grab a copy of the book 97 Tips for Canadian Real Estate Investors 2.0 (100% of all royalties go directly to Habitat for Humanity).
Don R. Campbell began his investing career in 1985 with a house purchased in Mission, BC. He is the Senior Analyst at the Real Estate Investment Network and currently owns nearly 200 doors in BC and Alberta. A seven-time best-selling author, Don’s expertise and passion for teaching Canadians how to create wealth through real estate are far-reaching and have made an impact on the lives of thousands. You can follow his daily thoughts on Twitter – www.twitter.com/DonRCampbell and on Facebook at www.facebook.com/thereinman.