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I’velearned that real estate rental property can be one of the best methods ofpassive income. Instead of putting all youreggs in one basket with the stock market, you can set yourself up with steady rental income that can last a lifetime. Additionally, you pick up some tax benefits and might even get some appreciation off the properties as some icing on the cake.
Because of that, I’m starting to chase this a little more. However, I’ve also made some mistakes as a newer investor. The good news is that if you’re a newbie as well, maybe my mistakes and lessons I’ve gone throughcan be an opportunity for you to learn from them as wellto avoid these same blunders.
No investor gets by without making mistakes – the key is to learn and grow from them.
If you’re not familiar with my experience in real estate investing, as of this writing, I currently own a single family rental house and a duplex that I purchased in 2015. Ibought thatfirst house in 2003. The game plan was to live there for a few years and fix it up and then move out and start renting it out. Unfortunately, I fell victim to a big time mistake…
Mistake #1 – Location, location, location
The house was probably about a half hour south of my normal lay of the land growing up. Ihadbeen to the area, but I didn’t know it well enough. While I was living there, I quickly learned that this was a much lower class area than I had thought. While living there,there weremeth labs busts on neighboring streets and I realized it was not a place I (much less my wife) wouldever walk down the street alone.
So, I changed the plans and after a short amount of time, my wife and I moved out of the house and tried to sell it… ever so unsuccessfully. I then decided to go back to the plan of renting it out and, fortunately for us, we’ve been lucky and had a family in there for the past 7 years.
In the time since I moved out, there was a shooting in the street directlyin front of the house by some punks, which, for whatever reason, didn’t spook the tenants from leaving. Regardless, as I’m sure you’ve figured out, this is not one of those houses that followed the location, location, location mantra.
What I learned:
You need to 100% know the area where youplan to buy… period. I was young and stupid when I bought the house and didn’t understand that (obviously!). Since then, I’vechanged the area where I’m looking for real estate and found a couple great sweet spots that Iknow much better. That’s where I made my subsequent purchase of the duplex and where I’ll be looking forfuture real estate purchases.
Mistake #2 – Not UnderstandingCash flow
I made another newbie mistake thinking that my monthly cash flow was my rental income minus my mortgage payment. Makes sense, right? Nope. I actually learned this one after I bought my duplex a couple months ago. I’ve been learning a lot from theBiggerPockets podcasts and webinars recently and this was a topic that has been discussedon several occasions and was a real eye opener for me. In other words, there are plenty of other expenses that you need to take into consideration other than just the mortgage: taxes, insurance, repairs, vacancies, long-term capital expenditures (you’ll need a new roof someday!), etc. And this is just scratching the surface – here’s a great article that helps you to figure out what your cash flow really is.
My rental house is not a good cash flow property – I aboutbreak even when everything is said and done (and that doesn’t even count saving forCapExitems like saving for a new roof). Lucky for me, I will have it paid off in a handful of years and thenthe cash flow will be really good. In the meantime, I try to look at it from the perspective thatthe tenant paying off the house for me, so that’s not so bad.
On the duplex, my financial mentor had helped me vet itand even with my previous misunderstanding of the formula, my cash flow is good.
What I learned:
Your cash flow can make or break you. If you don’t do the math correctly, you can easily start breaking the bank on expenses – not something you want on an investment property. The good thing is that rental properties area numbers game and you can actually get a pretty accurate idea of what your cash flow will be even before you buy the property.
There are plenty of good calculators to help you figure out your cash flow. BiggerPockets’ calculatoris pretty nice though – however, you can only try it for free. If you want to use it on a regular basis, you would need to become a Plus orPro member. This will run you either $90 (Plus) or $290 (Pro) a year – I haven’t made the jump yet, but when I’m ready to start looking for my next duplex, I think the investment will make sense (there are a bunch of other benefits you get as well!).
Mistake #3 –Complacency
When I read Rich Dad’s Prophecyprobably around the year 2002, my world changed… I finally got it. You can sit around and follow the same day in and day out (time to make the donuts!) or you can make something happen. So here’s the thing – I made something happen. I bought that first house the year after I read that book and eventually started renting it out.
But then I stopped. Life happened. I got promoted at work. My wife and I got married. Webought a house. Wehad a baby.
Here’s the problem – if you just ride the waves and don’t hustle in your free time, nothing changes.
When I actually took a few minutes and looked back and realized that I had only bought one rental house since I read the Rich Dad book, it was a new wake up call. That’s why I stopped thinking and started doing. That’s when I bought the duplex.
What I learned:
So here’s the deal – and this might be the most important takeaway from this article–I know a lot of people who have an interest in real estate but are too scared to make the jump and convince themselves that it’s a bad investment. And some people want to understand and analyze everything before jumping in. The problem with this is that you’ll never knoweverything and this cankeep you from ever doing it. I was actually part of this latter group – even though I had purchased the house and rented it out, I wanted to understand everything better before buying the next one… andthat ended up costing me another 12 years where I could have purchased several other properties!
A way to help get past this is to set goals for yourself. I’ve always scoffed aboutwriting out goals – that’s just a lot of blah, blah, blah hype. I’m here to tell you that I still don’t write my down goals in a notebook or anything, but this blog has definitely made me a lot more accountable so I don’t look like a fool in front of you guys! 😉
As of this writing, I’mleaving my job in just over 9 years. That really doesn’t leave me a ton of time. However, I don’t want to look back once I’ve left my W2 income behind and not have any new purchased rental properties. My goal is to get another twomultifamily properties before I leave my job… maybe three if things really start rolling. That isn’t a tremendous amountof time, but I think it’s a fairly reasonable goal to give the dust a little time to settle from the duplex I just bought, buy another, let the dust settle again, and then get another.
This should play directly into my aha moment and make my financial freedom even less reliant on the money I have in the stock market.
What I Did Right –LivingFirst in Your Rental Property
Ok, so I’ve made some mistakes, but I thought I would share with you something smart that I did… but not necessarily on purpose. When I bought my first house in 2003, my sole purpose wasfor it to be a rental property. And then I did something smart–I lived in it first.
Why is that a big deal? First of all, you’ll likely get better terms on your loan. Loans for an investment property tend to have higher rates than rates for place you’ll be living. Youusually need to put a larger percentage down on a conventional loan for rental property as well. To satisfy lender requirements though,you’ll need to live there for likelyat least a yearbefore leaving and renting it out. I believe putting less down and getting a better ratehas helped me to be in a position to get that loan paid off in just another handful of years.
As an added bonus, while I was living there, that was my house. So while I worked on fixing it up, I wasn’t stressing that I had a place that was sitting empty with no tenants and a mortgage payment rolling in. I was able to take my time and get it to where it needed to be before making it available.
If I had to do it all over again and was in my younger days, I would have purchased a duplex and rented out one side while living in the other. Then I would have moved to another duplex and done the same thing. On BiggerPockets, they call this House Hacking and can make you rich without a lot of the risk. Now that I’m older and married with a child, I think I would have a hard time convincing my wife to do this.
Here’s the deal – just like anything else, you’re going to make mistakes as you start taking on something new. Theimportant thing is to be well-informed so you can help to minimize the mistakes.
Do you have any rental property and did you make any mistakes that you want to own up to? 🙂 If you don’t have any rental property, has this post helped or hindered any interest you might have had in going down that route?
Thanks for reading!!
— Jim
