9 Things I Learned the Hard Way in Real Estate Investing
By Lou Gimbutis, Chief Homebuyer, Property Solutions, LLC
Why is it that so many of us with the entrepreneurial mindset tend to learn best through the medium of pain? Was it indeed a fundamental truth that Mark Twain voiced when he said: “A man who carries a cat by the tail learns something that he can learn in no other way?”
Contemplating goals for another year and looking back over the good and the bad of yesteryear, I decided to try an interesting thought experiment: What if Dr. Emmet Brown, from “Back to the Future”, were to be so kind as to lend me his time machine, and I had the opportunity to go back and spend ten minutes with the Lou Gimbutis of 2004? If such an event were to happen, I would have absolutely no lack of words of wisdom with which to fill the 10 minutes. I would find myself somewhat more open minded, a tad more energetic, and excited as a kid at Christmas over my new Quick-Turn Real Estate toy (I still am on the last count). I’d find my younger self about to embark on a remarkable journey, and about to make some colossal mistakes in the process. Here are 9 things I’d cover with myself that would make life a heck of a lot easier over the 30 or so deals that I’d be about to do:
- Cash reserves: If Dr. Brown gave me only ten minutes with my former self, I would spend eight of them hammering cash reserves. Yes, it’s that important. As you’re building your financial tower, a neglected foundation of solid cash reserves can very quickly and very easily cause the other two pillars of strength it contains, cashflow and equity; to come crashing to the ground with uncanny ease at the onset of the first, inevitable storm.
At the height of my momentum, I was responsible for making payments on 13 single family houses. To some, that may not sound too bad. To a 28 year old guy with very little cash reserves, who’d never made more than $27,000 in a single year in his entire life; it can be pretty stressful. Every month on the first, I was responsible for making 13 house payments (15 counting second mortgages). After the first of the month, it’d be time to sweat bullets over the six or so people who did not have their money there on the first when it was supposed to be. Of course, they all had good excuses. I’ve yet to hear a tenant say “Well, I just really didn’t feel like paying you this month”. Their excuses, however; carried alarmingly little weight with the institutions or individuals who received my underlying payment(s), a fact which meant that I needed to make payments out of pocket, and collect from my tenants/buyers as I was able. This is an exercise, I can assure you, engineered to elevate the blood pressure, and shorten the lifespan of the unsuspecting, cash-poor investor.
- Buying houses isn’t “cool”: Ok. Maybe it is cool. There are few absolutes in life. However, what I’m referring to is the over-eagerness some of us have to get our first few deals under our belt. Now granted, and “itchy trigger finger” is easier to cure than the old “butt print in the recliner”, but it is no less of a liability for its being the lesser of two evils.
I moved out of an apartment and into my first single family house in 2003. I was now a “homeowner”. Within a year, I bought my first investment property. To me, buying houses was “cool”. The newness hadn’t worn off yet. I could stick my chest out a little farther than before. Therefore, I overlooked a number of factors which I should have considered more carefully. My first house was in a bad neighborhood. My first investment property was across the street (almost literally, it was across and one house over). This was also a direct violation of lesson number nine. I never could sell it, it attracted only the most horrible lease-option candidates, and the house continued to punish me for three years, until someone was kind enough to set it on fire in 2007 (no, it was not me). No one was hurt, and as I suspect that the firestarters were the tenants I had just evicted, all occupants were safely out of harm’s way.
- Lease-options don’t cash out: Ok, you got me again. Some of them do. Before the subprime shakeout, mortgage meltdown, or whatever term history will ultimately attach to the fruit of the stupidity that ran rampant throughout the mortgage “boom”, the nationwide statistic for lease-option tenant/buyers who actually exercised their option was under 5%. I’m pretty sure that figure would be much lower today in our current lending climate.
My limited experience tends to confirm this. Over my career spanning maybe 25 tenant/buyers, only one of them has ever cashed me out.
One time, and one time only did the vehicle of lease-options transport me to that magical place where equity, through alchemical means unknown; may be transmuted into cash without the simultaneous creation of an equivalent debt. I had bought the house three years before, and was on my third tenant/buyer. All things taken together, I worked pretty darned hard for that check.
The problem I ran into was the impression, gleaned from a variety of real estate “gurus”, that a lease-option was as good as a sale, and that you will be cashed out at your inflated sales price in the not-too-distant future. This being the case, why worry about buying a house with very little equity, or where the monthly spread between your incoming and outgoing payments couldn’t feed a third-world orphan? You’ll be rich when your tenant/buyers exercise their options by getting a new loan, as they’ve solemnly sworn to you that they’ll do once they’ve tidied up their credit a bit.
- Home warranties: How I wish I’d know about these babies at the start of my investing career. I’m sure many good companies provide them, but I always used American Home Shield. With a multi-property discount, it comes out to about $330 per year per property, which they will even break up and let you pay monthly for less than $28 per month (can you say “Make your tenant pay for it?”.
Now, I can already hear some of you asking, “Can’t I just use a lease-option that passes all major repairs on to my tenant/buyer and make them pay for it? Sure you can. However, that can be a double-edged sword, as you will inevitably end up getting houses back with buckets under the sink or things duct-taped together to avoid the tenant having to pony up and pay a contractor to fix it. AHS does not even inspect the house before issuing a warranty, and will do anything from re-plumb the house, to replace the furnace if necessary. All for a $60 service call. How many unanticipated $2,500 furnaces does it take to make the warranty pay for itself? I’ve had to replace two out of pocket, and each one worked perfectly well when I tested it upon purchasing the property.
- Home inspections: I had two mentors when I got started in the creative real estate business. One of them was an interpersonal and financial genius, who could reduce an incredibly complex situation with multiple sets of numbers into its simplest, most logical solution, almost instantly. The other one, while also a brilliant guy, had as his claim to fame the fact that he had worked at or owned construction companies for the past 30 years. I’ll bet Warren walked me through 30 houses, pointing out every potential problem, and teaching me what to watch out for. With that level of detailed instruction, it would surely be foolish to pay $350 for a home inspection before closing, wouldn’t it? After all, I was now an “expert”. Wrong, wrong, wrong. I don’t’ think I ever bought a house where I did not miss something of decent significance, and sometimes the errors ran into the thousands and thousands of dollars. I could not have reaped a better return on those skipped $350 investments with a jockey’s eye for horseflesh, and a pocket full of four-leaf clovers tucked away in my lucky rabbit’s foot bag.
- Tenants are guilty until proven innocent: “But this America”, you say; “Isn’t everyone innocent until proven guilty??” Folks, every time I have gone against my training and better judgment and trusted a tenant, I have lived to regret it. The check is not in the mail. They are not moving out peaceably, so “you can just save yourself the hassle of having to evict us”. They are not “cleaning the house like new on the way out”. The milk of human kindness is a wonderful thing, but it quickly sours in your tenant’s refrigerator.
- Listen to people who are smarter than you: Boy, did I ever have a hard time with this one. My mentor advised me against buying the first three investment properties that I ultimately ended up buying . “Easy for him to say”, I rationalized, “he’s got houses coming out of his ears and I hardly have any!” I lived to regret each one. From time to time I’ll be listening to an audio training cd (Ron Legrand, Lou Brown, etc . . .) from years ago, and for maybe the 20th time I’ll hear a piece of advice that, had I heeded it; would have saved me a good deal of time, money, and grief.
- Have an attorney prepare/review ALL of your forms and paperwork: I like to think of myself as a pretty smart guy. Starting with top-notch forms like Lou Brown’s, there’s no reason to go to the “extra expense” of paying an attorney to make sure that each element of each transaction is watertight, is there?
Wrong, wrong, and wrong again. On one joint-venture deal, I “saved” myself a couple of hundred bucks by taking a “guru’s” joint venture agreement and customizing it for the transaction myself, rather than paying an attorney. When the “you know what” hit the fan during the exit strategy, it became painfully obvious that my paperwork was woefully inadequate for the task at hand. That is not good news, as most courts, when dealing with vagueness in contracts, tend to side against the person who drafted the contract (in other words, against me). I knew a losing battle when I saw one, so settled for a pitifully small amount and moved on. Net cost to me for being Mr. Smart Guy and doing my own paperwork: around $40,000. That, my friend; is a hard way to learn a lesson.
- Stay out of marginal neighborhoods: “But the deals look so good right on the other side of the tracks”, you say. “You can hardly tell the difference between this house and the one on that other street that costs 30% more”. Your tenants and buyers, my friend, will know the difference. They will not need any advanced real estate training, an appraisal, or a list of comparable sales. Good tenants and good buyers know where they do and do not want to live, and you will violate this rule at your peril. If you would not want your fifteen year old daughter staying the night at a friend’s house at this location, I strongly suggest you keep looking.
As I leave you, I sincerely hope that these lessons that I wish I could’ve shared with my former self will act as a dose of preventative medicine in your business career, the presence of which should save you many an Advil, and countless sleepless nights.