Ask Brian is a weekly column by Real Estate Expert Brian Kline. If you have questions on real estate investing, DIY, home buying/selling, or other housing inquiries please email your questions to [email protected].
Question from Hal in MI: Hi Brian, I’m a wannabe investor worlking with Biticodes but I’m paralyzed with a fear that I’ll do something wrong. I’ve spent hours reading about what, when, and how to invest. More than once, I’ve started making preliminary decisions. But every decision is unfamiliar and new. It all adds up to too much uncertainty as a new investor. I think that I’ve narrowed my fear down to not being positive that I’m asking and researching all the right questions. What can I do to overcome this paralyzing fear?
Answer: Hello, Hal. I get it. Fear is an extremely powerful force. Yours is the adage of not knowing what you don’t know. Here’s something that I don’t know. I don’t know if I can get you over your fear of investing. But what I can do is help make sure that you are asking questions that you should be asking but might not know that you should be asking. If that nonsensical analogy of investing fear didn’t send you running for cover, let’s get on with some important questions that beginning investors should be asking but don’t always know to ask.
1. Do I need a formal business structure as a small investor? Hal, too many investors wait until they need an attorney for the first time before learning that it’s wise to separate their business assets from their personal assets. No matter how conservative you are about investing, there will always be risk. One of the main reasons to register a business is to protect your personal assets if something goes wrong with your business. If you don’t register the business, the default is a Sole Proprietorship that doesn’t offer any personal protection from business liabilities. Many real estate investors form an LLC (limited liability company). Two other common business structures are an LLC Partnership and an S Corp. With a little research, you can figure out which will best serve your investment purposes and goals.
2. How can the investment lose money? Optimism springs eternal when you are about to make your first investment but the wise investor steps back to closely consider potential hidden pitfalls in the deal. Once you identify potential problems, you can put a plan in place to mitigate them. It’s not possible to list all the possible problems but a few are an unknown problem with the investment property, financing that falls through, and the rental or resale market not being as robust as you originally thought. But there are others such as a contractor doing the demolition work but never finishing the job.
3. Having a back a plan for an exit strategy. Mitigating possible problems is part of this. For instance, if you’re flipping a property but remodeling cost overruns eat into your profits, can you successfully switch your exit strategy to rent the property for a few years until the sales price appreciates the property value? You should have multiple contingency plans that include maximizing your profit, a medium profit, and breaking even?
4. Are rent or sales prices trending in your favor? In almost all parts of the country price trends are currently favoring investors. But real estate investing is always local. There are a couple of generic questions that you can ask that mostly deal with supply and demand. Is the local population shrinking or growing? What is the local employment outlook? Can local wages and salaries support further housing price increases?
5. Do you have a competitive advantage in your market? As a beginning investor, you want to know your strengths and weaknesses. Are you already a real estate professional who knows the market better than most investors? At the top of your weakness list is probably your lack of investment experience. A mitigation plan could be having a mentor with experience in the type of investment you are making. Another possible strength could be that you are an experienced contractor who can oversee any work being done and step in to do it yourself if need be. List your strengths and weakness. Then find ways to exploit your strengths and mitigate your weaknesses.
6. Is your financing plan solid? Adequate financing is typically the biggest hurdle to investing. On the other hand, being under-capitalized is the number one reason for failing. Even if you plan to make an all-cash offer, you should have a backup plan. You should also have reserves to cover the unexpected. Hal, if you haven’t started already, now is the time to begin building relationships with lenders or financial partners. Even if you’re wildly successful with your first deal, you might decide to go bigger with your next deal. I don’t think you can have too many backup financing plans. You don’t want to get a great deal under contract and then have your only lender drop out of the deal.
Hal, as a new investor, I think you already have a leg up on your competition because you realize there are things you probably haven’t thought about. It’s true of all of us that we don’t know what we don’t know. You can never ask too many questions.
I’m sure I left something important out. Please add your comments.
Our weekly Ask Brian column welcomes questions from readers of all experience levels with residential real estate. Please email your questions or inquiries to [email protected].