Two Principles of Real Estate Investment

Real estate can be a powerful wealth building tool, but it can also be a nightmare waiting to happen.

Like most other investment decisions, investing in real estate is all about making informed decisions that will benefit you over the long run.

Unlike most other investment vehicles, real estate can be immediately damaging to your financial position because it typically involves a large amount of debt. Few other popular transactions will leave you owing tens of thousands or hundreds of thousands of dollars so quickly.

Be Informed About Real Estate Investing

So what does that mean for you?

If you want to invest in real estate, you need to be honest with yourself and you need to be informed.

For my purposes, I define being informed as knowing what investment strategy you plan to pursue with real estate, what niche you plan to enter, and what your goals are. In other words, what do you intend to accomplish, how are you going to accomplish it, and what vehicle (asset class) do you want to use.

I don’t want to go in depth about what’s available to you in real estate, but if you’re curious, BiggerPockets has a great guide on real estate strategies and niches that I recommend you read if you want to learn more.

In addition to understanding your strategy and niche, being informed is also knowing what the numbers say about your potential investment.

If, for example, you plan on flipping a property and the after-repair value of the property is already near the current selling price you should find another deal, unless you have a compelling and quantifiable reason to take it anyway.

You should also know a great deal about the comparable properties in your market. You can make a great investment by flying blind, but your chances of doing so are much smaller than they are if you already know what you’re looking at and what you’re looking for.

Informed real estate investing is all about the technicals. Just like you should have specific criteria for investing in the stock market and should understand how to evaluate an investment, you should be able to do the same for real estate. Buying a tangible piece of property shouldn’t make you throw away analysis.

Be Honest With Yourself

Once you have a good grasp of the technical side of real estate investing, you need to make sure you’re being honest with yourself.

What does being honest with yourself mean?

It means that you need to set your emotions to the side and be rational.

Despite what your uncle Joe and your own brain will tell you, this is very difficult for most people. The truth is, we’re not rational beings. We tend to backdate our reasons so that they fit the circumstances, instead of admitting that we did something that didn’t make sense. Some people have a harder time than others, but at the end of the day we all do things for irrational reasons.

The problem is that being irrational, especially when money and greed are involved, can lead to making terrible decisions.

For example, let’s say you’ve found a commercial investment property in a great part of town with significant appreciation potential. If you buy the property you have almost guaranteed cashflow through customer leases, maintenance will be low, and you should be able to cash out in a few years for a significant gain.

There’s just one problem.

You’ve run the numbers, and the financing you have available will leave you cashflow negative, even after leasing the property to your future tenants. Should you still make the deal?

a beautiful home at sunset

No.

You need to be honest with yourself.

You might be able to produce significant lease income, but unless you’re cashflow positive, it doesn’t matter. You might be able to sell the property in a few years for an incredible gain, but unless you’re cashflow positive now, it doesn’t matter. Your maintenance costs might be low, but unless you’re cashflow positive it doesn’t matter. You will bleed yourself dry waiting for that payoff, almost every time.

You need to walk away from the deal, or find a creative way to renegotiate your financing so that you don’t end up in a situation where you have to sell before you’re ready because you’re strapped for cash.

The sad truth is that real estate can be a great investment tool, but most of us will get caught up by being uninformed or dishonest with ourselves. If you take the time to be informed and to learn to walk away from a poor deal, it can save you a lot of trouble in the future.

2 thoughts to “Two Principles of Real Estate Investment”

  1. Good stuff! Knowledge is something I feel a lot of people forget about. In order to be a successful RE investor you need to understand how to do things like:
    1) make money at the purchase of a home not base it off appreciation
    2) estimate all expenses beyond just the monthly mortgage payment

    And so many more!

    1. I wholeheartedly agree with your two points. Buying because you “know” the home will appreciate is exactly the kind of thinking that contributed to the recession. As far as your second point, I agree, you need to be conservative in your revenue and expense estimates. That means overestimating expenses and underestimating revenue.

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