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 Marty from TX: Hello Brian, I just received a court settlement and real estate investing has always fascinated me. Still, I know some investors succeed, others do OK, and some fail. I have a very simple question. Why do some real estate investors succeed and others fail?
Answer: Hello Marty. I appreciate how simple your question is but I suspect you know the answer is much more complicated. Is the answer as simple as some people get lucky and others are not lucky? I don’t think so. I can’t cover every smart or bad decision that every person might make. But I will cover a few of the most common mistakes that beginning investors make.
Taking too much risk. Every investment has some level of risk, whether it is real estate, Wall Street, buying gold coins, or something else. You must understand the basic risk that you are taking and then drill down into the details. For beginning investors, I consider rehabbing and flipping houses to be high risk. There are too many unknown variables. If you buy a dilapidated house, there is a big risk of uncovering a very expensive repair that you didn’t know about. You also need to be an expert at repair and remodeling costs along with knowing which upgrades are going to bring the most profit.
At the other end of the spectrum are turn key rentals when working with a reputable company. (Note: I’m ignoring things like REITs that don’t directly involve owning and managing properties.) Typically, a turn key is freshly remodeled and has a highly qualified tenant already in place. Often, a property management company takes care of day-to-day operations. The investor’s return on investment is lower but the income is passive.
In between, are things like inheriting a rental house from a deceased relative and you just continue the program they already have in place. You can also purchase a rental that is in good shape and develop your rental policies and program. Marty, as you can see, there are a lot of different investment strategies. You should study several that appeal to you and then select one where you believe you can manage the risk.
Not understanding the financing. Most investors want to use other peoples’ money to make money for themselves. It’s a huge attraction to real estate investing when you can invest $5,000 to control a $100,000 property. This works well as long as you understand all of the conditions of the financing and can keep up on the payments. Remember, the property is collateral that can be foreclosed on and take away your original investment if you fail to meet the conditions of the loan. Mortgages on investment properties are not the same as on your primary residence. You’ll almost certainly pay a higher interest rate and need a larger down payment.
Typically, there will be other clauses in the mortgage like requiring you to maintain a minimum financial reserve and promptly make repairs. There are also multiple sources of financing that don’t involve banks. Everything from hard money lenders to equity sharing partners. There are balloon loans and adjustable rate mortgages. These all involve legal contracts that don’t have the level of consumer protection that primary residence mortgages come with. Real estate investors need to understand the fine print and risks in financial contracts.
Not sticking with one strategy. This also has a lot to do with not having enough education. An old saying in real estate investing is “you make your money when you buy the property.” The point of this is that you have to have an exit strategy or an income strategy when you purchase the property. You need to be sure how you will make money. It’s fine having a plan B but plan A has to be a solid plan. The type of mistake beginners can make is starting with a turn key strategy and then coming across a rehab/flip deal that looks too good to be true. If all of your research, education, and planning are for a turn key rental, you are not prepared to take on a high-risk strategy. You should pass on the deal and keep looking for something that fits your skillset.
Marty, there are a lot more reasons that can cause an investor to fail. Most recently, Airbnb investors have taken a beating that no one saw coming. The Airbnb market depends almost entirely on travelers. COVID-19 has destroyed the travel market and the Airbnb market along with it. Still, a lot of average people do become millionaires through real estate investing. In my humble opinion, most failures result from taking too much risk or not understanding the risk. My humble opinion is that success comes by starting simple and adding complexity as your knowledge and experience increase.
What’s your answer to the question, “Why do some real estate investors succeed and others fail?” 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].