This article is by staff writer Adam Baker, whose own blog previously featured a comparison of money gurus in Dave Ramsey vs. Suze Orman. This is final article of a three-part series on how he stumbled into real estate investing at age 23. Be sure to read part one and part two.
In the second part of this series, I discussed two mistakes I made when jumping into real estate investing. Despite running a successful property management company and knowing how the business worked:
- I bought a negative cash flow property without an emergency fund
- I got emotionally involved
In the conclusion of this series, I want to share three additional mistakes I made, and give my final thoughts on my experience. Let's jump right in.
Mistake #3: I had a short-term mentality
I had just purchased an 8-unit apartment building, the value of which would take several years to restore. Despite knowing this, I was operating as if I could solve all the issues in the first four weeks. But it simply wasn't going to happen. In real-estate slang, I had just bought the quintessential “buy-and-hold” property, but was approaching it as an aggressive “flip“.
On paper, I knew it was a long-term game all along. I had even cited the 2012 Super Bowl (being held in Indy) as having potential to add value to the area when we were pitching our buying plan. Once I signed the dotted line, I allowed my excitement to take control and I tried to inject value into the property as fast as I could. That almost never results in a positive outcome.
In my rush to make my first real estate purchase into a record-setting success story, I was actually doing serious harm. This unrealistic mindset:
- caused me to rush decisions,
- increased the stress of minor setbacks, and
- encouraged more emotional attachment.
In hindsight, ensuring that I had a realistic mindset (on more than just paper) would have made a large, tangible difference. This was one of the few areas that I could have quickly corrected even after the purchase.
Mistake #4: I focused too much on price
As I outlined in part one, we had purchased 8 units for under $80,000. While only three tenants were paying, all units had occupants (meaning they were at least semi-livable). The price was so low, I couldn't focus on anything else.
One of the main reasons for the low price was the neighborhood: It wasn't just a low income area — it was one of the lowest income areas in the entire city. The units rented for an average of $450/month, which included all utilities.
Economically depressed neighborhoods bring plenty of unexpected issues for first-time real estate investors. I had factored in a higher vacancy rate and knew the average tenant would be more transient than normal. However, I hadn't accounted for the emotional impact of dealing with issues like drug addictions or existing racial tensions.
I was especially naive of any racial issues. My race differed from the majority of my new tenants; I didn't anticipate it, but this caused additional hurdles in many situations. As it turns out, you didn't have to travel very far to find examples of racist landlords in the area. Whether I liked it or not, this was a real barrier that I had to work to break through.
Focusing too much on price also meant I skipped looking into problems with the paying tenants. One of the three paying tenants when we took over was named…Amber (at least that's what we'll call her here).
Amber had at least two, completely opposite personalities. The first was of a stereotypical southern belle. She'd greet me with a warm smile, invite me inside, and offer me something to drink or eat. She'd say things like, “I hope you have a Jesus day,” whenever I'd leave. The first three times we met, I assumed she was the best tenant of the whole building.
Unfortunately, Amber's second personality was less friendly. It involved ranting, screaming, and at least three explicit words per sentence. She'd call and leave 17 voicemails within a hour, each one more incoherent than the last. At times it was so bizarre I felt like pinching myself to be sure I was conscious.
Despite annoying several of the other tenants and causing numerous problems for us, she paid her rent in full and on time. As I pointed out in part two of the series, our lack of emergency fund put us in a situation where kicking out any paying tenant was a very hard decision.
The final straw came one day when we were having a company install new furnaces in the building. Amber intentionally waited until the crew was almost done with the job and dialed the fire department. She claimed that the HVAC company was trying to kill her by piping gas straight into her apartment through the air ducts. As you would expect (and appreciate), the fire department takes any calls of gas leaks very seriously.
Within ten minutes, there were three fire trucks parked outside of the building. While examining Amber's unit, she also took the liberty of informing the firemen that the HVAC crew had molested her cat. The biggest problem with her story was…she didn't even have a cat.
While the fire department quickly realized the problem likely existed in Amber's head, they weren't taking any chances. It took almost 90 minutes to allow them to check every unit and for the HVAC company to demonstrate the condition of the new furnaces (which hadn't been turned on yet). At the end of the day, the HVAC company had done everything 100% correct and there was no trace of even the slightest leak.
I left the property and drove straight to the courthouse to file the eviction. I had a long list of violations and tenant complaints against Amber and the on-time monthly payment was no longer worth the hassle. I had dealt with volatile tenants before, but nothing like what I had inherited in Amber!
Mistake #5: I should have partnered to eliminate my weaknesses
What I wanted to do was buy a property in decent physical condition with existing management issues. After all, management was (supposedly) what I was good at. However, I ended up buying a property with both management and physical issues.
While I had people that I trusted to do repairs and maintenance work, I had absolutely no experience in knowing what it would take to get certain jobs done. I was a relationships guy: I did a great job at acquiring clients, managing tenants, and finding dependable people to execute the repairs. What I couldn't do was swing a hammer, let alone estimate what it would cost to replace the gutters.
And while I did have a partner, we had similar strengths and similar weaknesses. Looking back, we should have brought on an additional partner whose strength was in repairs and maintenance issues. This would have allowed us to focus on the management without distraction and would have lowered our need for money upfront.
An alternative solution would have been to partner with someone with deeper pockets who could properly fund our needs. It would have cost us more to outsource all the repairs (which we did anyway), but we could have made up the money by focusing more on our own strengths.
After a volatile year of management and countless hours of effort, I transferred the property for an amount that netted me around $10,000. To be fair, I had also made between $2,000-$4,000 throughout the year. But I'm actually terrified to think of what my hourly rate would be if I factored in the amount of time I spent researching, buying, managing, and eventually selling the units. All things considered, it could have turned out drastically worse. I consider myself very lucky.
Despite my turbulent experience, I'm not against real estate investing. In my experience (with both my own situation and many of my clients), most first-time investors rush into their purchases. My hope is not to discourage people from investing in real estate; instead, I hope that sharing my naive mistakes will help people evaluate whether they have the stability to invest and what type of property best fits their strengths and risk tolerance.
The property I bought was an amazing deal; I still believe that to be true. However, as you can tell from the series, I believe it was a terrible mistake on my part to purchase it. So if you take anything away from my experience, let it be this:
Real estate investing is subjective. A property or purchase can be a fantastic deal for one person and a horrible mistake for another. Crunching the numbers is essential, but you've got to take the steps to ensure it fits into your portfolio and life plans. Finally, keeping your emotions out of the process is going to be harder than you think. Prepare extra for this!
Despite everything, Courtney and I still plan to include real estate rentals in our long-term plans. It'll be at least 5-10 years down the road for us. Once we've finished paying off debt and saved heavily for retirement and college, we'll be ready for round two of real estate investing.
At the very least, we'll have plenty of first-hand mistakes from which we can build!
J.D.'s note: Wow! As I mentioned when Adam started this series, I find myself drawn to real-estate investing. I have no experience with it, have no handyman skills, and have no spare time, but there's just something about owning rentals that appeals to me. Unfortunately (or perhaps fortunately, depending on how you look at it), after Adam's series on being a landlord, I don't think Kris is ever going to let me own a rental!