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Top 5 Real Estate Investment Mistakes

wgraham

wgraham

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REIN Member
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Sep 14, 2007
Messages
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Chris D got me thinking when he posted his "Top 10 Reasons No One Wants Your F%$#%^ Deal" and I thought I would put something similar but different together. This from my monthly e-newsletter.
The Top 5 Real Estate Investment Mistakes How to lose $50K in no particular order1. You pay too much for the property. This one sounds obvious but 9 times out of 10 this is the one that catches most people. You get excited about the property and forget that this is a numbers game and not a paint colour game. Your agent is focused on making a deal happen so he forgets this is about dollars and not the carpet stain. All of your friends are making big cash (or so you think) and you want in! Who cares about the rent or who is going to pay it! Values go up and that is all you need to know........right?!?

I am not one to negotiate hard for a rock bottom price as there are definitely other considerations in every transaction but unless your rent covers ALL of you costs and makes you money each month you have paid too much. Personally my cut off is $500. If I can`t make that much each month on the investment I don`t invest.

2. Inspections are for rookies! You have done a few renos and owned a couple of houses. You don`t need to pay someone $500 to tell you that this house is in great shape! I have looked at a lot of homes and many of them I thought were in good shape until the inspector came through. My last inspection saved me and my investor roughly $65,000! Was it worth the $500? Unless you have very large pockets (that you are willing to part with) or have extensive knowledge you need an inspection.

3. What is your exit strategy....How do you get out of the investment? Unless you have two very good exit strategies don`t put a dime into Real Estate. Getting out isn`t as easy or cheap as you think! What are all of my costs on exit? Real Estate fees, legal, renos, lost rent, mortgage pay out penalties and the big one (hopefully) taxes! When can I exit? Do I need to wait five years or can I sell this contract to another investor tomorrow? Is refinancing an option? You need to have clear answers to all of these questions or your investment may not be everything you hoped!

4. Who is going to rent my property? Most investments forecast a future value but the problem is that you need to get to the future to get that value. This is where the true asset comes in.....that is right....your tenant!

"A tenant is...a partner in business who will open up the shop each morning and lock it up at night. They will look after security and inform you of potential problems in the business. They will cut the grass, rake the leaves, shovel the snow, pay all the utilities. They will even pay all your mortgage payments and taxes. Then, in the end, they will relinquish all monetary interest in the business and walk away, leaving you with the profits." ~Tim Johnson

So at the end of the day who is it that is willing to pay the rent you need to get to the future!

5. After I buy the property I don`t need to do anything right? Well, as great as that sounds the fun part is now over and reality is about to set in. For those that think that you just collect a cheque at the end of each month, I have some news for you. Not a day goes by that I am not dealing with one of our investments. Most of the things are positive but not all of them. Even if you have just one investment property you had better have some expertise in the following: Property Management, Repairs and Maintenance, Accounting, and Legal. These are things that will come up regularly and they don`t care if you have a job or are sleeping or are on vacation.

Bonus. You bought a property in the United States of America! Again, your friends are making money, even their cats are making money on the foreclosure market. One day, when the time is right I too will be putting money into the US but that won`t happen until the numbers make sense. When the CND/US Dollar exchange rate has a predictable positive effect on my investment. When values start to rise or at least stabilize. When the job market picks up and people can pay a mortgage or rent again. When I have a solid team in place to manage my assets. This is when I will be placing my investment dollars into the US. If you are placing money in the US right now you had better have a very detailed plan and a great team behind you.
 
Nicely done. I`ll keep this close to remind me not to make these mistakes. Anyone can fall for one or more of them.
Thanks,
 
Hey Wade, Great Posting,
I have to say I agree and support everything you mentioned. I am always concerned about people who buy property with neutral or negative cashflow on the belief that property value will always rise.
I spoke with a friend of mine yesterday who is originally from Cincinnati. His Father went partners on a property with another guy that negative cashflowed by $200. That was two years ago. Now, the value has fallen by 20% and the rents have still not been able to catch up to the expenses. Does this sound like a wise investment?
To me, a long term hold has to have positive cashflow. Apprecation is the gravy, the cashflow is the meat and potatoes. Still, I sometimes feel I`m in the minority on this topic.
Regards,
Mac Graham
General Manager
Top-Notch Properties

QUOTE (wgraham @ Aug 6 2009, 02:18 PM) Chris D got me thinking when he posted his "Top 10 Reasons No One Wants Your F%$#%^ Deal" and I thought I would put something similar but different together. This from my monthly e-newsletter.

The Top 5 Real Estate Investment Mistakes How to lose $50K in no particular order1. You pay too much for the property. This one sounds obvious but 9 times out of 10 this is the one that catches most people. You get excited about the property and forget that this is a numbers game and not a paint colour game. Your agent is focused on making a deal happen so he forgets this is about dollars and not the carpet stain. All of your friends are making big cash (or so you think) and you want in! Who cares about the rent or who is going to pay it! Values go up and that is all you need to know........right?!?

I am not one to negotiate hard for a rock bottom price as there are definitely other considerations in every transaction but unless your rent covers ALL of you costs and makes you money each month you have paid too much. Personally my cut off is $500. If I can`t make that much each month on the investment I don`t invest.

2. Inspections are for rookies! You have done a few renos and owned a couple of houses. You don`t need to pay someone $500 to tell you that this house is in great shape! I have looked at a lot of homes and many of them I thought were in good shape until the inspector came through. My last inspection saved me and my investor roughly $65,000! Was it worth the $500? Unless you have very large pockets (that you are willing to part with) or have extensive knowledge you need an inspection.

3. What is your exit strategy....How do you get out of the investment? Unless you have two very good exit strategies don`t put a dime into Real Estate. Getting out isn`t as easy or cheap as you think! What are all of my costs on exit? Real Estate fees, legal, renos, lost rent, mortgage pay out penalties and the big one (hopefully) taxes! When can I exit? Do I need to wait five years or can I sell this contract to another investor tomorrow? Is refinancing an option? You need to have clear answers to all of these questions or your investment may not be everything you hoped!

4. Who is going to rent my property? Most investments forecast a future value but the problem is that you need to get to the future to get that value. This is where the true asset comes in.....that is right....your tenant!

"A tenant is...a partner in business who will open up the shop each morning and lock it up at night. They will look after security and inform you of potential problems in the business. They will cut the grass, rake the leaves, shovel the snow, pay all the utilities. They will even pay all your mortgage payments and taxes. Then, in the end, they will relinquish all monetary interest in the business and walk away, leaving you with the profits." ~Tim Johnson

So at the end of the day who is it that is willing to pay the rent you need to get to the future!

5. After I buy the property I don`t need to do anything right? Well, as great as that sounds the fun part is now over and reality is about to set in. For those that think that you just collect a cheque at the end of each month, I have some news for you. Not a day goes by that I am not dealing with one of our investments. Most of the things are positive but not all of them. Even if you have just one investment property you had better have some expertise in the following: Property Management, Repairs and Maintenance, Accounting, and Legal. These are things that will come up regularly and they don`t care if you have a job or are sleeping or are on vacation.

Bonus. You bought a property in the United States of America! Again, your friends are making money, even their cats are making money on the foreclosure market. One day, when the time is right I too will be putting money into the US but that won`t happen until the numbers make sense. When the CND/US Dollar exchange rate has a predictable positive effect on my investment. When values start to rise or at least stabilize. When the job market picks up and people can pay a mortgage or rent again. When I have a solid team in place to manage my assets. This is when I will be placing my investment dollars into the US. If you are placing money in the US right now you had better have a very detailed plan and a great team behind you.
 
Excellent points Wade!

What do you mean by "Is refinancing an option"? how do you know if refinancing will be an option in the future say 3 years from now?

Thanks,
Neil
 
QUOTE (MacGraham @ Aug 7 2009, 12:59 PM)
..

I have to say I agree and support everything you mentioned. I am always concerned about people who buy property with neutral or negative cashflow on the belief that property value will always rise.

...

To me, a long term hold has to have positive cashflow. Apprecation is the gravy, the cashflow is the meat and potatoes. Still, I sometimes feel I'm in the minority on this topic.

...


of course real estate values will not always rise, year-after-year .. but if you buy real estate with an assumption of "no increase" then in many cases you should not buy at all as often cash-flow is tight, especially if levered 75% or more ..



Thus: you must compare cash invested in real estate with other asset classes .. and ensure that the risk, liquidity, time involved and personal guarantee on mortgages is worth the cash-flow and potential equity gain .. and you must come to the conclusion that in most cases it makes sense to buy certain classes of real estate ONLY if there is a realistic chance of value growth !!!



And of course, to get that value growth eventually, you must have cash-flow .. but the cash-flow is usually not where the true profit potential lies !



Related post:



Equity Gain not the only way to make money in RE: http://myreinspace.com/public_forums/Real_Estate_Discussion/62-10711-Equity_is_not_the_only_way_to_make_money_in_real_estate.html
 
QUOTE (thomasbeyer2000 @ Aug 8 2009, 10:41 AM)
And of course, to get that value growth eventually, you must have cash-flow .. but the cash-flow is usually not where the true profit potential lies !



Related post:



Equity Gain not the only way to make money in RE: http://myreinspace.com/public_forums/Real_Estate_Discussion/62-10711-Equity_is_not_the_only_way_to_make_money_in_real_estate.html




Thomas can you please explain your statement in more detail.



It is my understanding that your buildings increase in value not so much as a function of appreciation, rather as a function of improvements in the physical structures and/or systems thereby increasing the rents and achieving greater cash flow and hence better cap rates, not to mention better tenant profile - yes?
 
QUOTE (EdRenkema @ Aug 8 2009, 03:10 PM) Thomas can you please explain your statement in more detail.

It is my understanding that your buildings increase in value not so much as a function of appreciation, rather as a function of improvements in the physical structures and/or systems thereby increasing the rents and achieving greater cash flow and hence better cap rates, not to mention better tenant profile - yes?
correct !

simple math:

buy property for 75/door .. say 20/door down .. 55/door mortgage .. plus closing costs + reserve of say 5/door .. 25/door down ..

this would yield a cash flow of perhaps 1/door annually after mortgage payments and operating expenses ! so this 4% cash-on-cash yield is OK .. but not fantastic .. but sufficient to hold for 5 or more years .. hold for 25 years .. in a flat environment and the mortgage is 0 .. bingo you turned 25K into 75K .. a 200% ROI in a totally flat market with no cash-flow or 300% (75K + 25K cash flow) ..

of course in most instance we do not hold 25 years (but we may, of course ..)

Let`s say we sell in 5 years. 4% annual appreciation in rent times 5 years = 20% i.e. a building value of 90K is the low end of the scale usually .. so a 20K/25K = 80% profit in a normal dismal sluggish market .. or triple digit if the rent goes up more than 5%/year which is what we expect in a growth market (like Top 10 REIN towns in an undervalued asset that we improve from a C class to a B class asset ) !

Let`s use our recent Abbotsford acquisition (108 units @ $8.5M) as an example in rough terms. Purchase price @ 79/door. 22/door cash (including all soft costs) to 62/door mortgage.

Cash flow in 5 years, say 5/door. Mortgage paydown, 10% or 6/door .. i.e. 11/22 = 50+% ROI .. in a completely flat market for 5 years !! Plus, a given rent controlled 3-4%/year rent growth or 12-16/door i.e. 110 to 135%+ ROI cash-on-cash easy .. by doing little to nothing for 5 years in an average market .. and with a new and widened Highway 1 between Vancouver and the Lower Mainland, daily train service, Port Mann bridge widening and BC in-migration Abbotsford will continue to grow above average. Thus, prices of well located apartment buildings will easily be well over 100/door in 5 years as 79/door today is below historic prices .. so we`ll see another 10/door upside realistically in 5 years over and above the rent controlled growth .. so about 160-200% ROI cash on cash most likely .. .. and 60% of this goes to the investor .. and there still is your 80-100% ROI target we aim for in 5-6 years .. yes, worse than 2001-2007 .. but hey .. NOT BAD ... especially considering the low risk of capital loss that all of a sudden is a real issue to be concerned about when considering formerly high-yielding investment classes such as the stock market or development deals or mutual funds ! We have always believed and continue to believe that our asset class is delivering good returns especially when adjusted for risk .. even in a recession !!!

Yes, we can double money in Las Vegas in minutes or some stocks like Nortel or Bank of America or Uranium One or GM in weeks .. but it may also be gone. The market has rallied as of late .. and will remain choppy for some time.

Show me a better investment class .. and I am listening
 
Thanks Thomas, Great real life examples!
To give a more clear meaning to ROI and allow a quick apples to apples comparison, its units of measurement should be %/yr.
Therefore, in your example of 50% in 5 years, it`s really an annual ROI of 8.4% or ROI of 8.4%/yr. hey, still not bad as a minimum expectation!
{I understand to get a good estimate you divide by 5 years and get 10%. The more accurate (compound interest) calculation is: -1+1.5^(1/5) = 8.4%}
 
QUOTE (investmart @ Aug 8 2009, 11:13 PM) Thanks Thomas, Great real life examples!
To give a more clear meaning to ROI and allow a quick apples to apples comparison, its units of measurement should be %/yr.
Therefore, in your example of 50% in 5 years, it`s really an annual ROI of 8.4% or ROI of 8.4%/yr. hey, still not bad as a minimum expectation!
{I understand to get a good estimate you divide by 5 years and get 10%. The more accurate (compound interest) calculation is: -1+1.5^(1/5) = 8.4%}
compounded is one way to calculate interest, but not the only one. Usually we use a straight 5 or 6 year total ROI .. cash-on-cash, net of all of our fees or equity stake (it sounds higher !!)
 
correct.. almost. Depending on who you are presenting this to, either straight 5 yrs total ROI (less financially savvy investors) or annual ROI (more professional investors) may actually sound better. tip: the last presentation does look less manipulative data to the experienced investor. cheers.
 
QUOTE (investmart @ Aug 9 2009, 08:07 PM) ... tip: the last presentation does look less manipulative data to the experienced investor. cheers.

100% in 7 years sounds less sophisticated than 10.5% compounded annually ??

often there is no compounding anyway .. just a straight: cash in .. then cash-out years later !
 
I have to say I agree and support everything you mentioned. I am always concerned about people who buy property with neutral or negative cashflow on the belief that property value will always rise.
I spoke with a friend of mine yesterday who is originally from Cincinnati. His Father went partners on a property with another guy that negative cash flows by $200. That was two years ago. Now, the value has fallen by 20% and the rents have still not been able to catch up to the expenses. Does this sound like a wise investment?
To me, a long term hold has to have positive cashflow. Appreciation is the gravy, the cashflow is the meat and potatoes. Still, I sometimes feel I`m in the minority on this topic.
Regards,
Mac Graham
General Manager
Top-Notch Properties


I am in 100% agreement Mac.

In the case of my property the value is very strongly driven by the cap rate which means appreciation is driven by income more than any other factor.
Kingston`s student rental market value is another good example of this. Directly driven by income.

When I make offers on properties the cashflow always dictates the price as I concentrate solely on cash flow to support my investment.
Simple math indicates a investor can afford to keep more positive cash flow properties than negative properties.
Personally I am not prepared to wait 5 or 10 years to make money on my investments. I want it now.

As you say appreciation is gravy. Far too speculative for me to factor into my investment plan.
You can`t judge the gravy until after the roast is cooked. I am quite content just having my meat and potatoes.
 
QUOTE (thomasbeyer2000 @ Aug 10 2009, 07:33 AM) 100% in 7 years sounds less sophisticated than 10.5% compounded annually ??

often there is no compounding anyway .. just a straight: cash in .. then cash-out years later !

Hi Thomas,

It`s more sophisticated when selling it to certain people. It means nothing to me unless I know the annual ROI.
Example1: how does "WOW 200% in 20 years!" sound?
The answer in my case, and I suspect in your case too, is: I have no idea until I calculate the annual ROI.. which is -1+3^(1/20)=5.5%.
now I know it`s not that good.
Example2: "5000% in 100 years. Ohh Yeah!". If you do the math it`s only -1+51^(1/100) = 4% annually
not mentioning we won`t see much when we`re 100+.

Whether it`s sophisticated or looks manipulative depends on your audience.

Regards,
Neil
 
Amazing how this post has become specific to ROI


Iv`e noticed that each investor has their own investment strategy...some buy and hold short term ie 1-2 year, some longer ie 5-7 years and then some simply chose to buy and hold for whatever time...

Regardless of approach there should always be positive cashflow. I like what one member said...that he looks for a minimum of $500 per month...I agree with that. Buying with as little down as possible over a 35+ year amortization just so that the property breaks even is too risky, even if the property has the potential for upside. What if it doesn`t? I prefer to be conservative and secure the "$500/month" as well because it helps me to sleep at night...not for any other reason.

Kevin B (mortgage broker and REIN member) expressed real estate investing this way to me...its like a 3 course meal. The cashflow is the appetizer, the monthly debt pay down is the main course, and appreciation is desert. Its nice to have the desert, but you shouldnt expect it...but man does it taste good when you get it!
 
QUOTE (JoefromTO @ Aug 10 2009, 11:26 AM) Amazing how this post has become specific to ROI


Iv`e noticed that each investor has their own investment strategy...some buy and hold short term ie 1-2 year, some longer ie 5-7 years and then some simply chose to buy and hold for whatever time...

Regardless of approach there should always be positive cashflow. I like what one member said...that he looks for a minimum of $500 per month...I agree with that. Buying with as little down as possible over a 35+ year amortization just so that the property breaks even is too risky, even if the property has the potential for upside. What if it doesn`t? I prefer to be conservative and secure the "$500/month" as well because it helps me to sleep at night...not for any other reason.

Kevin B (mortgage broker and REIN member) expressed real estate investing this way to me...its like a 3 course meal. The cashflow is the appetizer, the monthly debt pay down is the main course, and appreciation is desert. Its nice to have the desert, but you shouldnt expect it...but man does it taste good when you get it!

The ROI is just a minor comment. I just thought we kinda covered the initial bigger topic - top RE mistakes.
I, too, believe Wade`s criteria of $500 minimum net income a month is an excellent one, perhaps the most important #1 criteria to use before considering anything else. However, if Wade purchased apartment buildings he would probably revise that to minimum net income per door or minimum CAP as in the case of 20-plex for example, $500 is way too low. I`d add that up to and including a 4-plex, $500 is a good rule.
 
QUOTE (investmart @ Aug 10 2009, 04:09 PM) The ROI is just a minor comment. I just thought we kinda covered the initial bigger topic - top RE mistakes. I, too, believe Wade`s criteria of $500 minimum net income a month is an excellent one, perhaps the most important #1 criteria to use before considering anything else. However, if Wade purchased apartment buildings he would probably revise that to minimum net income per door or minimum CAP as in the case of 20-plex for example, $500 is way too low. I`d add that up to and including a 4-plex, $500 is a good rule.
indeed .. cash-flow is essential to survive, hold an asset long enough to capture mortgage paydown and inflationary (lazy) appreciation .. but what is "cash-flow" ? Frequently we buy assets that need upgrades: new roof, new boiler, new hallways carpets, new bathrooms ... much, but not all, of that expenditure is done in year 1 or 2 .. and as such is it positive cash-flow from an operational point-of-view but negative if one counts all capital improvements. Those capital improvements improve the overall building quality, frequently lower the CAP rate and usually increase rents and thus building value dramatically yielding an impressive cash-on-cash ROI if one levers prudently !

Thus: Cash is King - Cash-Flow is Queen ! ™ !!!
 
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