Top 10 Real Estate Investing Mistakes & How To Avoid Them – Video
Kathy Fettke: Today, we’re going to talk about how to lose money in real estate. While nobody wants to lose money in real estate, it happens. The more we can learn from those who have lost money– myself included, the more you all can not do it, or learn from our lessons. The number one reason why I think you can lose money in anything is jumping in with both feet when you don’t understand.
Just like a new swimmer, a new surfer, a new skydiver, or anything, you probably want to understand what you’re doing before you do it. For some reason, with real estate, people feel like, “Hey, I lived in a house, I know how to fix things. I can do this.” There’s a lot more to it than that, so let’s take a look.
First and foremost, get educated. That’s why we’re here at the RealWealth to share information from real-world investors. If you are new to our network, then I cannot emphasize enough that we’re trying to be the anti-guru company. I started out in this business going to real estate investment groups, where I’d get mesmerized by these fantastic, beautiful speakers in nice suits. I would hear what they said, they were charismatic, and I’d be the first to run to the back of the room and buy something.
This is not what we do. We offer real-world information and education from real-world investors and real estate professionals that are not upselling, they’re not slick, most of them don’t wear business suits. It’s just a real deal. Get educated, that will make all the difference in anything you do.
Seek counsel, this is so important, from someone who’s done what you’re trying to do successfully. Don’t get counsel from someone who’s done what you’ve tried to do and failed. While you can learn a lot from that, learn what not to do. Again, get counsel from somebody who has done it before successfully.
The next thing is to hire good tax advice. Now, sometimes I forget this little piece of advice. That’s why I’m taking my own advice here because many of the lessons you’re going to be learning are mistakes I made myself. Certainly, a lot of them are mistakes I’ve seen people on our network make. I just really want to put an end to that. I want RealWealth to be a group of people that are really, really successful, wealthy and taking trips to– I don’t know.
Where is a cool place? Fiji, because we’re all sharing in the delight of our success. We want to share this information so we can all be winners here in the real estate game. Sometimes, we forget these very basic things, which is to hire good tax advice because the way that an investment gets taxed can really blow the whole deal for you if you’re not aware of the consequences.
On the flip side, a real estate deal can save you in your future because of your tax savings. Again, if you get the right legal advice, especially when partnering or anything that’s out of the norm. Always get legal advice because that is where the largest amounts of money are lost with partners suing partners. No fun, especially when it’s family.
Speaking of which, probably one of the most important things you can do is talk to your relatives, [00:04:00] talk to your parents, and make sure that they are set up properly, so that you’re not fighting with your siblings over property and your children aren’t fighting over property when you pass on. Getting a good trust in place is so important, and you need certainly a good attorney to help you with that.
Lastly, trust, but verify. I could spend a month talking about this one. A lot of people get into this industry, into real estate investing because there isn’t necessarily a lot of regulation or requirements to get in, so anyone can usually do it. Someone can buy a piece of property, sell it, and they can rip you off.
Now, what I found over the years is some of the nicest people will rip you off. They’ll be people at your church. I watched my father, he’d always trust the people of his church, and that was never the right thing. I’m not saying that there aren’t good people at your church to trust. I don’t want you to not trust, but verify. Verify what they’re saying through the help of attorneys, through the help of tax advisers, through the help of someone who’s done it before.
The number two reason why people lose money in real estate is trying to do it themselves– Trying to do it yourself when you don’t really know what you’re doing. This is related to number one, which is jumping into something you don’t understand. Doing it yourself when you don’t maybe have time to do it, or you don’t have the skills– big mistake.
Here’s a major one– pretending to be a contractor. Now, there’s a lot of fix it people out there. I don’t even know if I’ve ever told this story, but it just came to mind so I think I better. It’s a mistake that I made, but it worked out. It was funny though. My husband had always had a dream of– I don’t know how, when he was young, he was painting a house for some rich guy who owned a mansion on a hill with a beautiful view. When he was in high school, he thought, “Someday, I’m going to own a house on a hill with a beautiful view, and have someone else fixing it up for me.”
I knew of that dream and back in fabulous timing of 2005, I found that house on a hill that needed rehab. It was a million dollar fixer upper in Lafayette. I showed Rich, and it was probably the best view in the San Francisco Bay area. It was just amazing, but the house was garbage, so his dream came true. To be the guy who owns the house and gets it fixed up on the hill.
Well, the first night our loan came through and we owned the property, we had a tear down party and we invited all our neighbors, all their kids, and we just let them bring paint and all sorts of fun stuff, and color all over the walls, hit the walls, and draw a picture of someone they were mad at and then just start kicking the walls in. We just had a fun time tearing down this house.
The next day, a friend of mine came over who was a contractor and said, “Huh? Did you guys find out exactly how much this rehab is going to cost?” We had a vague idea. Wrong answer, so never pretend to be a contractor when you’re not one. Now, thankfully, we had friends who were contractors, so they helped us finish that project and it was absolutely beautiful. Turned out great, but it was a lot of work.
Too often we see projects half done or poorly done. There’s a tremendous amount of liability in that, so don’t do it yourself. The other thing is don’t do it when you have a full-time job. This is a major problem. If you’re busy and you have a busy life, like many people, full-time job, children, trying to keep in shape, trying to also be a contractor on the weekends is tough.
I don’t recommend it. Hire one. Just put the numbers in your spreadsheet and count that in.
Pretending to be a realtor– same thing. I often see people wanting to save a few dollars here and there by being the realtor themselves. I’ve seen people go so far as to get a license in a State that they don’t live in just so that they can be the realtor on the property. Again, very dangerous.
Realtors know their local area, or they should anyway. When you’re trying to do something you don’t understand, you can not have the right paperwork, maybe not have the right disclosures, or just simply not understand the area that you’re trying to work with. That also goes for people using realtors that aren’t experts in a certain area. I’ve seen people say, “Hey, my friend is a realtor in San Mateo, will you help me find a property in Danville?” Why wouldn’t you just get a Danville realtor? Don’t be nice to your family or friends just to help them out on such a large transaction like buying property. Get someone who knows what they’re doing in that particular area.
Trying to be a property manager. I could go on and on and on about this one. My husband and I tried to be property managers to save a little money on our properties and the opposite happened. That’s the message I’m trying to give you, is that you think you’re going to save a little money here, but you actually are losing a ton of money over there. Again, pay for excellence. Pay for somebody who knows what they’re doing. Don’t try to skimp. We found a property manager who was real cheap, only 5% of collected rent is what they charged. You know what? That’s the kind of service we got too because they couldn’t afford to hire good people to have the management be good and quality, so no.
Trying to be a property manager yourself. There’s rule, there’s laws, and there’s the problem of just being a nice person. It’s really hard to evict somebody or kick them out of your property if they tell you that they lost their job, that so and so is sick, or whatever. Listen, I’m a very compassionate person, and I just don’t make a good property manager because I am too much of a softy.
A good property manager will treat your rental property like a business. If somebody cannot pay or is not paying, then they shouldn’t be there. If you would like to be a compassionate person, if you’ve worked in the numbers that you don’t need to collect rent for six months, then good for you. If that is not a financial situation you’re in, then you need to have somebody else who’s tough. Again, don’t do it yourself if you don’t have what it takes.
Trying to understand tax law. I’m going back to this other one. Oh boy, I could tell you how much money we lost on this one guy who had a sob story every week, and I fell for it every time. The other thing is, I actually heard– this is the true story. Someone in our network told me that this new landlord was so proud of his new property and so angry at this tenant that moved in and was messy that the landlord went in to the property unannounced, and left sticky notes all over the house saying, “Do this, do that, wash this.” They didn’t even offer the 48-hour notice that is required. Of course, that depends on what State you’re in, what city. What do you think happened there? Sure, trespassing, lawsuits– You can’t do it. Don’t try to do something you don’t understand.
Same with tax law, or any law. With property management and being a rental property owner, there are serious laws that you need– You’re just not going to be able to keep up with the way that a licensed property manager can. Bottom line, paying a good professional will be much cheaper than paying for your ignorance, I guarantee you. Become an experienced investor because you get good advice from good professionals, not because you made mistakes. Believe me, I’ve done both and it’s way better to get advice from professionals.
Bad loans Well, we can all agree that bad loans can result in major problems, hopefully we haven’t forgotten those lessons yet. Along with that is getting over-leveraged. I am a huge fan of leverage. I love to borrow money, I love to borrow other people’s money. OPM is my favorite thing, yet getting over leveraged can be the death of your real estate portfolio.
I’ve seen it over and over again, and that’s why we’re taking advantage of so many deals right now because of the over-leverage problem. The property that we just got in Florida, I’m sure that some of you heard about it. We purchased a commercial piece of land just outside of Tampa that sold for $6.5 million, and that company that purchased it got over leveraged, so the property went back to the bank. We were able to purchase this property back from the bank for $375,000. It was good for us, good for our investors. We syndicated that, and we just closed out on that investment last week. It was a really great opportunity for everybody, but bad for the person who over-leveraged for sure. Don’t let that be you.
Here are some things that can get you in trouble, and we all know this, so I’m not going to go too much in detail. I’m seeing people do it again, and it makes me nervous.
Adjustable loans. Here’s the thing– the future is unknown. When you get an adjustable loan, you’re just taking on risk. That’s all I can say. We already know, we’ve seen it, so just be careful. I know sophisticated investors do this all the time. In fact, when you go into other countries, this is all you get it. That’s all there is. 30-year fixed mortgages don’t exist in other countries.
It’s a very unique thing to the US government. The US government is subsidizing, so it is very, very– If you can, as long as you can get a fixed rate mortgage. I had somebody at our last event raise their hand and say, “What do you think I should do? The fixed rate or the adjustable? I can get a better rate on the adjustable.” Well, of course you can today, but it’s going to adjust.
If there’s one thing we know, it’s that interest rates are not going to go down, they’re going up. They are the lowest they’ve ever been. If you’re getting an adjustable rate mortgage, your rate’s going to go up. It’s that simple. Just lock it in. Today’s rates are ridiculous, just lock them in. If there’s anything you remember from today, it’s that. Get a 30-year fixed loan, get as many as you can, and lock them in without getting over-leveraged. You’ve got to have plenty of reserves, at least six months reserves for property.
Balloon notes. I hate these. These got my husband and I in big trouble when the mortgage world fell apart and we had a couple of balloon notes. They were basically construction loans.
We got a loan for a one-year construction on a couple of homes in Tennessee, and then when we went to refinance out of those construction loans, there were no loans. The mortgage world fall apart, we had more than 10, and there was no one who was going to give us a loan. We had to figure out how to come up with half a million dollars in a few days, it was horrible. I don’t like them. Sometimes, you can get a construction loan that automatically adjusts into a permanent loan- that’s okay. If you’re going to get a balloon note, just make sure you have the cash in case you can’t refi.
Here’s an interesting one, putting too much money down thinking you’re getting cash flow. I guess it just depends on how you calculate cash flow. I just saw a place in Malibu that sold for $1.1 million, it’s a little townhome. It rents for $5,000 a month. Somebody thought that was a good deal because they bought it as an investment property. I don’t think any of you would do that because you’re a member of the RealWealth, but this person did, and they thought that was a good deal. What they weren’t calculating is that that particular townhome has about $800 a month in HOA fees, plus you’ve got other expenses, so they’re maybe getting a 2% return.
I don’t get it, maybe they are betting on appreciation, another big no, no. I could have found a lot of better ways to spend a million bucks, but it could be that they just wanted to rent it out until they move into it in five years. If that’s the case, good for them. Be careful about putting too much money down thinking your cash flowing.
For example, if this person were literally doing this for an investment and not for future home, then they could have, for the million dollars invested, had $10,000 coming in a month instead of what will effectively be about $3,000-$4,000– big losses there.
Negative cash flow. Anybody had the pleasure of enjoying that? I know that Australians are actually taught by their accountants to negatively gear, they call it. You get tax benefits for doing it, so they do it in Australia. When we tell them about positive cash flow, they really like that better. Negative cash flow is fine if the value of the property is going up a lot, and you’re going to sell or do something, but ongoing negative cash flow is no fun.
If you are buying investment property in a high priced market like the San Francisco Bay Area, Malibu, or LA or something, you’re probably going to get negative cash flow. Your only saving grace is that the property will appreciate, and that’s kind of risky. I don’t like it. If you’re going to do negative cash flow, just make sure you can handle the negative, and know that you’re feeding this property when you could have a different property that’s feeding you.
The fourth biggest way to lose money in real estate if that’s what you want to do is hire lousy property management. It works every time. A good property turns bad when bad moves in and here’s just a photo of an example of what can happen this is pretty good. It’s something you got to be real careful about today because there are pockets in the US that are fully rental, that every single house on the street is a rental property. That’s because every house on the street was a foreclosure, and that’s because every house on the street was a subprime loan before. Those areas are scary to me, so just be careful even if you had a good property manager. Now, poor maintenance makes a poor landlord.
Yes, got another great way to lose money is just not taking care of the property. Just recently I learned that in Texas, if there’s a drought or in any dry location where there’s drought and no water, it can affect the foundation of the property. A good property manager would know that and would make sure that there is some kind of drip system around the house to keep it moist. Again, these are just things that you wouldn’t know if you were trying to manage yourself or you had a property manager who wasn’t super hands on. That can be costly, believe me.
Bad tenants win when landlords break the law, that happens every time. Don’t break the law, don’t go in your house and leave sticky notes when the tenant is not there. Worse yet, when the tenant is there.
Things happen and good management can go bad. Make changes quickly. This is probably one of the biggest lessons we’ve learned at our network is that, “Boy, you think you’ve got a great deal. You leave it be and don’t pay much attention to it, and then something changes.” Then you keep thinking, “Well, they’ll get it together, they’ll fix it. It was just that they had a family situation, divorce, or whatever it might be, an illness. Then suddenly, what was great can turn quickly.
Don’t be too loyal to your property manager. If there’s any property managers on the line, I’m really sorry, I’m just trying to protect our network. That is that if you’re starting to see things go downhill, change. Try to get it fixed, and try to work with the manager, but if you’re not seeing results, move to some other management quickly. You can always go back when they fix their problems.
One of the things we’ve seen is that our members are super nice people. They’re just very forgiving and, “Oh, well, get that statement to me when you can.” No, don’t deal with that. People are people, and in the US, a lot of these property management companies are run by mom-and-pop shops. Again, anything can happen, so you just have to pay attention.
Number five, believing and not seeing. Here you go. Here’s a beautiful three bedroom house in Tennessee that is a great deal. Obviously, you would not want to just trust somebody. Be aware of the internet, be aware of broker promises, not every real estate agent, not every licensee is looking at your best interest. Just because they’re licensed doesn’t mean you can trust them. I’m not trying to put real estate agents down, I am one myself. I’m just saying that we’ve seen enough examples of people getting ripped off by a real estate agent that just don’t believe it, verify again. Trust, but verify.
If you can’t go visit and you just absolutely have to buy the property site unseen, that’s okay. Just send someone to look at it for you. Get an independent inspector out there, go get an agent to come and give you a BPO. Get an appraisal. You can do a lot. There’s a lot of things you can do to have someone check out the property for you if you can’t be there. But, it’s all about verifying what you’re being told.
There it is, the appraisal. This is for our international listeners. Pro formas in the US are estimates, they are not the reality. I know that sounds shocking, but it’s the way it is. Anyone selling something in the US is going to try to make it look good because they’re trying to sell it. Whatever they put in writing isn’t necessarily reality. If someone is selling you an apartment building and said, “Here’s how it’s going to perform.” Well, that’s great. Love the numbers, but get verification. That might mean you need to see the tax returns, you need to see the deposits of the rent, you need verification and proof that what you’re seeing, that the numbers are real.
Someone might tell you, “Here’s the tax rate in this county.” Go check it out for yourself, it might have changed. A real estate agent might say, “Oh, this will rent for this much.” Well, is that real estate agent in an expert in rental property? Maybe not. Go check out with an expert. Who would that be? A property manager, right? They would know. Again, verify what you’re being told.
Buying in the wrong location. This is number six. Number six, best way to lose money in real estate if that is your goal. Here are some wrong locations, in my opinion. Buying when it’s overbought- in my opinion, that’s Phoenix. I believe that the increase in pricing in that market is a direct result of speculation from investors all over the world. I believe there’s a bubble there, and we already know what happens with bubbles, so be careful.
Buying when it’s over-stressed- Las Vegas was one of the foreclosure capitals of the world. When you have all those foreclosures that are now rentals, and now the tax money coming into the city is half of what it was, there’s stress in that city. Again, just be careful. I’m not saying you can’t make money in either of these cities. You can, you just have to be careful.
Buying where no one lives, I made this mistake. I bought a couple of properties in Boise, Idaho because it was sort of the thing to do. Everybody was talking about what a up and coming market that was. In reality, there was only 350,000 people in that market. We’ve learned over time that I’d rather be in a market that has at least a million people because if 50% of those people are renters, well, now, I’ve got a lot to choose from. Whereas in Boise, not so much. It was hard to rent our properties there. You want to buy where there’s people.
Buying where no one works. Remember Patterson and some of these areas outside of Stockton? People were buying properties like crazy out there in the exurbs. If you’re going to buy a property to rent out, most people aren’t going to commute hours [00:26:00] and hours to a rental property. They might for something they’re buying and owning, but probably not renting, so be careful.
Buying where no one is safe. Detroit– no offense Detroit, but that city has gotten an increase in crime over the past few years since so many boarded up homes were there. There are parts of Detroit that are probably safe, but parts of it have such high crime that even if you get a great deal, it could turn into a bad deal real quick. Again, be careful.
Not understanding market cycles. Here’s just a basic graph of the market cycle. You can see in a decline phase you want to buy. The best time to buy is right before it hits bottom. Then you’re in this absorption place. Then as everybody starts to see prices going up, well, then there’s expansion. At some point, we’re going to get to a point of equilibrium, where “All right, this is about as much as we can expand.” Things are not as expensive as they can get. Then we know what happens, we go back down. This is this is not new, these real estate cycles and market cycles are normal.
When do you want to buy? Buy low. When do you want to sell? Sell at the peak. We had a lot of that reversed over the past few recessions.
Getting bad advice. This is the eighth way to lose money. CPA’s, attorneys, brokers, all the experts in real estate investing- I just cannot believe what bad advice I’ve gotten from professionals who didn’t really understand real estate investing or were afraid of it.
Even when you’re going to pay someone money who’s got a license, it doesn’t necessarily mean they’re giving you good advice. That’s why at RealWealth, we have a list of professionals that we have found to really understand what they’re doing. I can’t vouch for them because we just found in our experience that there is a handful of experts that we’ve been able to rely on. They seem to know what they’re doing. We’re happy to give you that list. You can just let us know [email protected]
Neighbors don’t count as experts unless they are successful in what they’re advising. Same for hairdressers, cocktail party people, and all that.
Last year’s breaking news is this year’s history, so it’s over. We’ve got to look to the future for our decisions today, not necessarily the past. We can learn from the past, but we’ve got to look, as they say, “Where the puck is going not where it’s been.” Wayne Gretzky, I think.
Number nine, not doing anything. This is one of the best ways to lose money, by sitting there in analysis paralysis, missing out on this opportunity of a lifetime. That could be one of the greatest ways to lose money today. Letting your money sit in cash while it’s losing value is a sure way to lose money.
Here’s why and it’s, of course, the dying dollar, this is number 10. The dollar is losing value every day, and the Federal Reserve seems to like it that way because they have committed to QE3, quantitative easing number three which is an endless money printing plan. We don’t know when that’s going to end, but we do know that every single month, the value of your dollar is weakening, so by just sitting there in cash, you’re losing money.
This is a chart of the money base, the money supply. It’s old, I need to get a new chart, but I think it’ll give you an idea of what’s happening. Up until you could see early 1970s, there was not a great increase in the money supply. The reason for that was that our government had a law that you had to have the dollar– which is just a worthless piece of paper, tied to something. It had to be like unto, “We’re holding the gold, but you don’t want to walk around with gold, so we’re going to use this piece of paper to say this paper represents gold.” Then there should be enough gold that that paper is real. Well, in 1971, that all changed when Nixon said, “That’s way too constricting because we don’t have enough gold. Let’s just not do that anymore, let’s make the American dollar the new gold.” That worked. I don’t know how that did, but it did.
You can see from ’72 on that that just gave our politicians the green light to just make money. If we need something, “Okay, we’ll just print it.” It all got a little out of control and crazy up until 2003, 2004, 2005 and we know what was happening then. Look what happened after that, it just went straight up. The money supply just– this world has never seen anything like this before.
A billion dollars, a trillion dollars, who even knows the difference anymore? I don’t even know it comes after a trillion, but whatever that is, that’s what we’re going to be doing next because it’s just becoming normal to talk about billions and trillions of dollars. We don’t even know what that means, but what we do know is the dollar is becoming more and more worthless.
You could go out and buy gold and there’s a lot of people that say to do that. My concern with that, although I think you should have 10% of your portfolio in gold and silver in case the dollar just becomes completely and totally worthless and no one will take it anymore, is you can’t eat it. You can’t make money from it. You don’t get income from it. That is why–
Well, here’s just a slide of the inflation. The way that we see as the dollar value decreases, we need more of it to buy the things that we want and need. You can see the year over year inflation from all this money printing. This is why I like real estate because look at the median single-family home price has increased even with every decade recession.
Every decade had a major recession. The ’80s was huge, the ’90s was huge. Oh, my goodness, the 2000s was huge. But, the median single-family home price still increased. How is that possible? Well, as the dollar loses value, then hard assets go up in value or become more expensive. Like the things that we need, use, eat and live in. There’s a few things that we really need and it’s food, clothing, and shelter, and maybe some guns.
We definitely need food, clothing, and shelter, so these hard assets will go up as the dollar goes down. The nice thing about buying an asset like housing is that you get money from it every month from the rental income because someone else is using it and paying you to use it.