This article is by staff writer Adam Baker, whose own blog recently featured a must-see graphic on credit card transactions around the world. This is part two of a three-part series on how he stumbled into real estate investing at age 23. Be sure to read part one here.
When we last left off, I'd just walked away from my first real estate closing with an eight-unit apartment building and $1000 cash in my hand. I was riding high. Unfortunately, the reality of the situation hadn't sunk in. Over the next year, my low-income, eight-unit apartment building was going to take me on the most wild roller coaster ride of my life.
Instead of providing a chronological list of events (which may be entertaining, but of little use), I want to share the mistakes I made and the biggest lessons I learned throughout the process. In this second installment, I'll share the first two mistakes (of what could be dozens). Neither of these first took long for me to realize.
Mistake #1: I bought a negative cash flow property without an emergency fund
Yes, it was purchased at a great price. Yes, it did have an amazing amount of potential. But all the potential in the world didn't change the facts:
- 7 of the 8 units had people living there.
- Only 3 of them were paying tenants.
- I needed at least 5.5 tenants paying to break even.
- All of the units, even the vacant one, needed repairs before they could be rented.
In theory, I knew all this before I bought the property. I had a detailed plan on how I would attack these issues quickly. I would file evictions the next day on those tenants that had gone months without paying. I would immediately hire people to get the vacant unit up to minimal renting standards.
In theory, it was all going to work perfectly. But then it came time to actually execute the plan.
Coordinating quotes for repairs took longer than expected. Eviction filing took money up front and the courts were running an extra week behind (4-5 weeks instead of 3-4 weeks). Tenants became optimistic about the management change and wanted to work out repayment plans.
In the first two weeks, a storm broke a large front window, and a back door was kicked in (probably by the tenant who lived there, although I had no proof). While insurance would eventually cover the window, both had to be fixed immediately, as it was winter and both were security concerns.
Repairs and maintenance were both accounted for in my number crunching, but the emergency fund that could smooth out an early spike in the averages was nowhere to be found. I didn't have a penny to my name and the $1000 check at closing went much faster than anticipated. The lack of the emergency fund compounded into several other problems in those first few months.
Mistake #2: I got emotionally involved
Back in part one of this story, I outlined my previous success in building up a property management business. With my client's properties, I was cool and calculated. I treated management as a business. The property owners were clients. The tenants were…just tenants.
When I signed the dotted line on my own property, the idea was to simply plug it into our property management system. It was going to be “just another set of units.” We'd coordinate repairs, screen tenants, and handle issues in the same ways as we had set-up for our clients. I was incredibly naive.
Without an emergency fund, we needed money. Sure, we had plenty of clients who had also needed money at one time or another. It was my job to set expectations and to advise them on the best course of action. I sought to remove emotions from the equation and ensure that they didn't make a rushed decision.
I was good at this part of my job and we made nearly no exceptions. If a client had a monetary circumstance where they had to make what we thought was a bad decision, they'd usually cease to be our client. It was that simple.
It's amazing how quickly exceptions are made when you are the one that needs money.
It happened slowly at first. One tenant, whom seemed genuine, wanted to set up a payment plan to get back on track. It was a weekly payment plan, something we would have never agreed to with our normal clients (too much time commitment). We had two choices in our situation. First, we could head through evictions (2-5 weeks), coordinate repairs (1 week minimum), and re-rent (1-4 weeks minimum). Or alternatively, we could try to squeeze money out of the existing tenants.
The former was the smart, long-term, and business-oriented option. It was the only one we would have offered to our clients. I could have listed at least two dozen reasons why it was the best option. Of course, we chose the latter.
This ushered in a four-month period of various weekly payment plans with not just the one tenant, but with 3-4 other tenants as well. It did help bring in the immediate cash we needed, but we paid a hefty price. Juggling these weekly re-payment plans with tenants who had already proven they weren't reliable:
- Took additional time.
- Added large amounts of stress.
- Caused problems with repairs (easier to fix up a vacant unit).
- Fostered a “but you made an exception with him” mentality among all of the tenants.
- Lowered the value of the property (a fresh, consistent tenant would have increased value).
It was a horrible pattern, one that I knew far better than to fall into. I assumed there would be no emotional difference on how I would handle the property…and I was wrong.
These first two major mistakes arose in the first few weeks and months. We haven't even touched on the issues that came up when we replaced three furnaces and four water heaters. Nor have we revisited the most bizarre moment of the entire year, which involved a split-personality tenant, no less than three fire trucks, and fraudulent accusations of animal cruelty.
For that, you'll have to wait until next week!
J.D.'s note: Adam doesn't realize it (because he's a young pup), but this post makes a New Wave geek like me think of this Culture Club song…