I get asked all the time by potential real estate investors how much they should invest in a rental. They do not want to be a line item on the “Why Real Estate Investors Fail” sheet. Some want to take a 401K loan out. Some want to bypass their 401K contributions to save money for real estate investment. For some reason, saving money seems to be difficult for many potential investors.
I say, do not do anything that may run you short of capital for your own life. Make sure your own life is secure, before you risk it all.
Here are some thoughts that I have written down.
Why Real Estate Investors Fail
It is not cheap to invest in real estate. In all of my rentals, it required a minimum of $100K just to ante up to the table. A 25%+ down payment was required for a non-owner occupied investment. After that, it required some fix up expenses. Painting, appliances, carpet, etc. were all more than I wanted to pay at the time.
If I did not have the capital to make the necessary improvements, I may have gone broke. If I could not recover from a bad tenant, I would be done. Never underestimate vacancy expenses either. If I could not pay the mortgage for months on end if needed I would be finished.
In one building, a 4-plex, I purchased, people told me that I could probably rent it out, as-is, for $800 a month. I explained to them that the people that would rent out this place for $800, I do not want. I wanted the people that will pay $1000 a month, for a fixed up place.
The Risk Premium Must Be High
Getting a lower return than the risk is a major fault of investors. If the stock market returns between 7% and 9%, and you can buy fairly safe dividend stock that return 3%-5%, why do some people buy real estate when the return is either less than 5%, or even negative? You can buy a REIT with a 5% return, and not have any work.
Stick to a minimum of 10% cash-on-cash return, or skip to the next investment. You may get lucky with appreciation, or depreciation, but you could have less risk in a MUCH safe investment. And it will be less work, and a lower initial investment.
Pay Yourself First
Never give up a 401K investment to invest in real estate. A tax deferred investment is worth a lot, especially if an employer matches some portion of it. If you have the ability to max out the 401K as I do, it does two things. First, your 401K account grows faster the more you put in it. That’s a no-brainer. Secondly, you learn to live on less. Passive income is what you are shooting for, why not start with a time tested idea, the stock market.
Then, max out your Health care Savings account, if you have one. Then max out your Roth or regular IRA.
And then, save for a real estate investment.
Understand Your Expenses (they will always be higher than you expect)
Far too many investors start to get nervous about cash flow and stop the improvements. Or they do not even realize they are that close to going broke. They are spending money hand over fist, and they take the first tenant that applies and the tenant was a scam artist or worse. Not much after that, they give up real estate. That is why you often hear of people who would not want to be a landlord “ever again”.
Mitigate Your Own Risk
Pay off your own mortgage. That gives you the freedom to explore riskier adventures. Get a HELOC on your own property to use as a temporary source of funds. That source of funds is not only cheap, it doesn’t cost anything if you do not use it. And if it’s large enough, you can make cash offers. Cash is still king in real estate investing.
Never chase an offer. Responding to a counter offer is OK, if the numbers still work. I passed on responding to a counter offer a $325K investment, only to see it sell just a few months later for $355K. The investor who bought it eventually might make money, but for now it is a lot tighter for him.
Learn some skills to preserve your capital once you own the property. Nothing eats up capital faster than paying some handyman $100 an hour to run a snake down a drain. Or paying to change out a light fixture or a simple light switch.
I do my own maintenance. Work always takes longer than you want to take, and fixes always cost more than you think. You start one fix, and it makes sense to fix the next thing while you are at it. You tear up the flooring, why not paint the ceiling and trim? You tear out the cabinets, it’s time to replace the counter-tops. Each month, the bank wants a mortgage payment, whether or not you have tenants.
I actually paid a painter quite a bit of money to paint an apartment, something I can do in less than 16 hours now. He took a week for each unit, I take two days, with lots of breaks. Looking back, this was money wasted.
Here are some painting tips I learned from a professional painter I worked with, and was a friend from a different life.
Paint out of a 5-gallon bucket with a painting screen. Pour in 2-3 gallons of paint in a clean bucket. You do not have to fill up the bucket near as often as a roller pan. That saves a LOT of time.
Use a 9” roller. No other roller fits in a 5-gallon pail. Sure, you can get a larger pail, but a heavier roller take more energy to use and tires you out faster.
Use a sheepskin roller cover, it holds more paint, and it has less dripping. It also cleans easier. Just drop the roller in a bucket of warm water, let it sit while you clean up the rest of the tools, and rise the roller cover out. Simple.
Tape only the horizontal lower edges of the painted areas, the rest you can cut in. You should be able to draw a clean enough line near the ceiling, and paint doesn’t drip uphill. On the bottom edges, such as baseboard molding use tape, you cannot control the gravity action of the paint near as well.
Use cheap quality 1.5” masking tape, not any ‘blue’ tape. You do not need the tape to be safe removal after a week, you are going to remove it about an hour after you paint. It will save a ton of money, and stick better.
Use a quality brush, like a Purdy to cut in the edges. I use a 3”, straight, swain brush. It is quite a bit thicker than a regular brush. It hold more paint, so less going back to the can to re-fill the brush. That saves time.
Use a paint roller extension handle. I use a 3’ handle. It allows me to roll a wall right close to the ceiling, and not have to extend my arms way up over my head. It also allows me to dip my roller in a bucket on the ground without bending over.
Use a long, but narrow, quality drop cloth – made from cloth. Slide it along as you paint the wall. Often, you will be spending as much time moving the painting cloth as you do painting. My cloth is 5’ x 15’. It takes about 5 minutes to cover the 15’ and it’s time to move the cloth again. Do not use a plastic cloth, they always get twisted and torn. And they catch on your feet when you walk on them.
Get rid of any fancy “cutter inners”. Use a brush. Spend the money on a quality brush and get rid of the gimmicks.
Do not use a fancy masking tape holder. Just pull the tape off the regular tape roll. The only exception is if you tape off a place with taping paper. I have a 3M masker that applies tape to a roll of brown paper that works great, especially if you are spraying paint.
Have you thought about investing in real estate? Do you think it’s easy to make money in it?