It’s easy to fail as a first-time real estate investor. I know, I’ve tried ‘em all! But with a little Insider Foresight it doesn’t have to happen to you. Here are the 5 biggest real estate investing traps and how to avoid them–
In my several decades as a real estate broker, developer and investor I discovered, generally at my own expense, at least five ways one might fail as a real estate investor. The lessons are generally hard learned and not unique to me. As such, it’s well to recognize these five issues going in, rather than after the fact, in Damage Control mode.
Life among the ‘Walking Wounded’
Today, as teacher and “chief coach” of the Chicago-based Urban Rehabber Program, I find too many erstwhile investors join our program either seriously concerned by what they believe to be the great risks involved in real estate investing, or those unhappy others, licking their wounds from “unfortunate” experiences: deals that, for them at least, went awry. Both the skittish newcomer and the bruised investor may benefit from a little Old Timer’s advice.
First of all, Real Estate Investing is A Business!
Chief among the problems is the new investor’s failure to view their interest in real estate investing as a Business Opportunity first of all. And, as a business opportunity – promising rich rewards if done right – recognizing the effort warrants real preparation. If one approaches the Small Business Administration (SBA) today for a loan to open a barber shop or beauty salon or muffler shop, the first requirement will be for you to submit a written Business Plan. How else to assess the prospects of your venture?
A decision to invest in real estate that may quickly involve tens if not hundreds of thousands of dollars deserves some respect!. The purchase and improvement of real estate involves the use of Real Money and, generally, substantial “OPM” (other people’s money). So there’s your capital investment at risk and undertaking of further financial obligations to lenders or investors. As we say, at least in Chicago, “That ain’t playing beanbag!”
Why a Business Plan?
Two important processes take place in preparing a reality-based business plan. The first of these is a careful analysis of the entrepreneur’s financial capacity and needs to accomplish the objectives of the plan. For many this a “reality check” on what this real world venture will require to be successful. Your plan serves as at least a preliminary assessment of the financial side of the whole initiative. But there’s more.
The business plan is not all numbers and spread sheets. There are important narrative sections as well, sections that describe the intended market, competition, staffing or the “team” required or in place, exit strategies, and so forth. The important thing is, the very preparation of the plan requires truly thinking through the many requirements of a successful venture. In many ways your plan is “visualization” of the venture as a whole, from beginning to–presumably–successful conclusion (else why do it at all?).
With your plan in hand – a written document exceeding the confines of the back of an envelope – the venture is no longer simply an expression of one’s “passion for real estate”, but a plan of action based on realities at hand, not dreams or speculation. To proceed without such a plan is a failure in preparation.
Relying on The Wrong Experts
The demands of successful real estate investing are too often under rated. “Investing is easy. Everyone is doing it…” The siren song of real estate brokers and itinerant “free real estate seminar” hacks, hustling their Secret Real Estate “Success Blueprint” at some suburban motel conference center.
It’s never as simple as: 1. Buy the property; 2. Hire a contractor; 3. Sell or rent it up; 4. Profit! (and 5. “Rinse and repeat”). Think of the motives of those involved. Real estate agents want to make the sale and, regardless of their knowing observations on how little it will cost to fix, how simple the work will be, and the great price you will get for the property once completed, can you truly trust this “information”? Your question must be: Have they done such a property themselves? Ever?
When the contractor gives you his initial estimate for work to be done, do you think it is his Best Price, or the price he feels you will find attractive at this early date? (He being quite confident the price will be subject to renegotiation once the project is underway.)
And then, of course, there’s always the relative or friend who owns a 2-flat (and, of course, knows all about it…).
Going into the mission without a Team or Network in place
No matter how savvy, no investor goes far in their program without in place professional and industry-related resources in hand. Your brother-in-law the divorce attorney may not be your best choice for handling your real estate purchases and sales; you need a qualified real estate attorney. Have you identified an architect who would be available, at reasonable cost, in the event you need help with permit drawings or second opinions on building structural issues or municipal code requirements? If you don’t have an accountant now, you will by tax time, one who is particularly familiar with treatment of real estate assets and, ideally, small business tax issues.
All of these professionals, and perhaps a couple more, will constitute your Team, those experts who are comfortable with the more arcane aspects of real estate investing and dealing (buying and selling).
Finally, we have identified no one to whom we might turn for help “in the breach”, for moral support. Real estate investing can be a lonely calling. Brokers, contractors, the professionals we employ, all have their place in your scenario. But each too has his own agenda, which may or may not extend to your day-to-day personal adventures or the inevitable mishaps (short of catastrophe).
For this you need one or more “fellow travelers”, others who share your real estate interests and, ideally, who are likewise directly involved in buying, fixing, selling, or whatever, as your are. You need those few souls who you can call – day or night – to lend a hand. Who will be there for you, as you will be for them. You will find it is your Network that you call upon, during good times, and the other kind as well.
Captive to your Contractor
Working with contractors needs special attention. Newcomers to real estate investing are generally advised that, being new to the business, one is best advised to simply find a good general contractor and they will “take care of everything”. There’s a problem with that advice for many beginning investors: Our projects are seldom large or costly enough to attract truly qualified and reliable contractors; there’s just not enough money in it to get their attention. So, we lower our sights–
Traditionally general contractors (“GCs”) undertake nearly complete responsibility for the construction process, subject to the terms of written agreement with the owner. The GC will hire and supervise the many specialty contractors generally required to complete the work: the carpenters, plumbers, electricians and more.
Importantly, the general contractor also “guarantees” that the work meets “industry standard” in quality and application. In event of inadequate or improper work, it is the GC that will be responsible for correcting any problems and delivering the job as specified. It is a very important role, particularly for laymen-owner unfamiliar with construction technology and industry norms.
Unfortunately problems may arise during the course of any construction-related project. Certain sub contractors may fail to perform; there may be unanticipated costs or changes to what is termed the “scope of work” to be performed; budgets may prove inadequate or erroneous, and more. An ill-informed choice of GC may be demonstrated in unexplained delays, cost overruns–in other words, simple incompetence.
While such problems should be sorted out eventually, an inevitable outcome will be additional costs to the owner and delays in completion. It is generally not simply a matter of “getting someone else” to complete the work; to do so inevitably costs the owner more. Meanwhile, the project has shut down, or “gone dark”, while disputes are ironed out, hopefully without resort to litigation.
There are no simple solutions to problems relating to working with general contractors. Other, that is, than avoiding employing general contractors at all. Successful investors undertaking improvements to real estate projects are well advised to manage the project themselves, not as general contractor but as “project manager”.
With rehabilitation (“rehab”) there are generally less trades involved than with new construction. The work involved may in many cases be arguably “cosmetic” rather than substantive. Roof repairs, new siding or windows are specialty trades employing specialty contractors who will bid jobs competitively. Once the work to be done is specified, plumbers and electricians likewise are specialty trades that will bid those aspects of the entire job without regard to the entire project (though they may seek to become the “general contractor” if they believe there is that opportunity).
The point is that by retaining the role of selecting the specific tradesmen or individual contractors the owner is not conveying control of the entire project to any single contracting entity (the so-called general contractor). In the event of dispute with any single contractor or tradesman, the project as a whole progresses without major interruption while such issues are resolved.
In the end, it is a control issue: Control of the schedule; control over payments made to contractors; and control over the quality of the work. There will be missteps and cost overruns, but let such surprises be little ones, not the project budget (and prospect for profit) as a whole. There is a bit of a “learning curve” as one steps into the project manager role but, beginning with relatively simple projects and progressing over time to more complex rehabs, one does master the basics. One project at a time.
No Marketing Plan
Finally, the most overlooked requirement for successful investing is need for a Marketing Plan. For truly savvy investors it has become a truism: A decision to “get into real estate” is in fact a decision to get in the Marketing Business–while recognizing real estate is merely our product or service.
Basically, a marketing plan is “everything we do on a day-to-day basis to promote our business”. The sale or rental of our real estate is simply an event, maybe a highlight, in our overall marketing effort. To assume that that important “highlight” will take care of itself by assigning that activity to an agent is to once again place your outcomes in the hands of others (as with hiring a general contractor).
While that important outcome may well happen eventually, will that sale or rental be timely? Will it satisfy your practical, ongoing need for cash flow in the context of your overall investing program?
When do we start marketing? The day we decide to go into the business! When can we “let up”? Never! It is important that we “become famous” in our market niche as soon as possible, to be visible and recognized in appropriate ways, as a responsible real estate developer, reseller or landlord. This will get us into the marketplace early on and, over time, bring us the referral business that will assure ongoing timely sales or rentals.
It may be pretty to say “our product or service will speak for us”. But in the real world no one will speak for you with the authority you yourself bring to the table. Your marketing plan is your opportunity to set the tone and quality of your message: That you do good work and that you are here to stay.
5 Ways To Fail As A Real Estate Investor
There are five ways to fail as a real estate investor or entrepreneur. Indeed there may be more, but these top my list. First of all treat real estate investing as a business, with a plan–preferably written–including your “plan of action”, budgets, projections and more. (2) Always be selective in who you consult in the early stages, seeking out true experts who will provide objective–not self-interested–advice.
Real estate investing, like any entrepreneurial effort, can be a lonely business. You will need a “team” on hand to support your efforts, and a network of those who both share your interests and care about you as well (call this your MasterMind group).
To the extent possible, take control of your projects without undue reliance on others to manage your outcomes: Be your own Project Manager and your own Marketing Director; this is no place for “outsourcing” no matter how popular the concept.
In the end it is you who will be responsible for your own success. The buck does stop with you. Learn from your missteps and build on your strengths. These concepts are integral to the Urban Rehabber Investing System. Keep learning. You will get better. #