Have you ever played darts blindfolded? Hopefully not. If the goal is to get the dart as close to the bullseye as possible, throwing blindfolded is a bad strategy. Investing in real estate with no knowledge of real estate investing is the equivalent of putting a blindfold on without even knowing where the dartboard is in the room.
Purchasing real estate is a big deal—and making the wrong investment could cost you a lot more than breaking a few glass vases with a dart.
Best case scenario: you’re putting your hard-earned cash on the line in the hopes that you'll get lucky. But luck isn't enough to guarantee you a good return.
Take the blindfold off. These are the five most crucial things you need to know before you jump into your first real estate investment.
1. The Numbers.
Real estate investing is all about the numbers. There’s no such thing as investing of any kind without numbers. The numbers in a real estate investment are literally your profit or your loss.
If your success with an investment is dictated by the numbers, shouldn’t you know how to run them?
Whether you’re buying rentals or flips or notes, you absolutely need to know all of the numbers associated with what you are doing and how to run them. Without running the numbers, any profit you see is pure luck.
What does running the numbers actually mean?
It’s figuring out where your profit is going to come from.
For rental properties investments, it’s your cash flow from renters.
For flips, it’s the After Repair Value (ARV). This is the money you get for the house minus the money you put into the initial purchase and fixing up.
If you don’t know how to run the equations and calculations on these numbers, it’s time to learn them.
2. Effort and Skills Requirement.
The next biggest way people get themselves in trouble is by taking on an investment project without knowing the requirements to succeed in it.
HGTV shows like “Flip or Flop” and “Flipping Virgins” have infected people with the flipping bug. They make flipping houses look simple enough for anyone to do it without an accurate portrayal of the time, skills, and effort necessary for any successful flip project.
People think that being a landlord for rental properties is straightforward but, when you consider maintenance and legal issues, it can actually be time-consuming and stressful.
But not all real estate investment strategies demand extreme effort and expert skill level. In fact, each strategy requires different effort and skill levels. Even within each investment strategy, there are ways to increase or decrease your own involvement and skill requirement.
Assessing the effort and skills needed for an investment project will force you to be honest with yourself about the likelihood of your success. Consider your constraints.
Are you ready to invest all of your spare time into a project?
How impressive are your rehabbing skills?
If you’re brand new to real estate and you don’t have a clue of what is required for any given project, own it! Being a beginner is fine. Everybody starts as a beginner. What’s not fine is taking on a project you don’t have the skills or resources to complete. You’ll regret it a few weeks in.
If you aren’t aware of what effort and skill level is required for a certain project ahead of time, educate yourself. Learn enough about the type of real estate investing you are interested in so that you can make a reliable assessment of what it’s going to require. Weigh that against your current skill set and what you plan to accomplish to make an informed decision.
3. The Risks.
How can things go wrong? What are all the ways your investment property might go belly-up? You need a well thought out answer to this question—not just a guess.
If you have don’t know your risks with an investment property, you have no way of preventing problems from seizing your profit.
When flipping a property, the main risk is in the resell. The re-sell is your only source of profit here. Success in the resell depends on how much people are willing to buy it for. How much people will buy your resell for depends on the current market.
After the market determines the sale price, the amount of profit you make on the resell depends on how much you had to put into the property. Ask yourself:
Did your rehab costs come at your budget, under your budget, or over your budget?
How long did the rehab take and how costly was that time investment?
Knowing house rehab costs, time, and final sale price are all vital for determining your profit on a flip. Anything that could change those numbers poses a risk. You need to be aware of these risks before you buy the flip project so that you can do as much as possible to mitigate them.
For rental properties, the risk is going to revolve around your tenants. Vacancies are problematic. Bad tenants are problematic. If you don’t have paying tenants or if your tenants are damaging the property without covering repair costs, you’re not making money.
What can you consider to help mitigate tenant problems? The three biggest things are: the location of your property, your price point, and the quality of the property you’re renting.
Whatever your aims are in real estate investing, one of the most important things you can do is identify potential problems beforehand. You can lower your risks substantially by preparing for potential problems in advance.
Location, location, location. Location matters. Where you buy matters, but what matters even more is the macro-market. The macro-market is the bigger city your property exists in relation to. There are three main types of markets: growth markets, steady markets, and declining markets.
Growth markets are . . . well, growing. Usually, markets grow when there are more jobs to be held, bigger industries introduced, or just a general increase in desirability.
Steady markets stay fairly stable regardless of what the rest of the real estate economy is up to. They may dip a little in a real estate crash but, even then, the change isn’t dramatic. The bad news? They don’t see huge levels of appreciation during real estate booms either. This makes steady markets safe rental investments, but it also lowers your chances of a big payout when you eventually sell.
Declining markets exist in cities that are struggling. Michigan cities became declining markets when the automotive industry there went belly-up. There were no longer jobs, so people left. Nobody wanted to buy houses there, so housing prices tanked.
You’re never only buying a property. You’re buying the market it’s in. The nicest property in the world can’t survive an abandoned city. Likewise, the worst properties can still be profitable in the right market.
Technically you can make money in any market, but every market requires a different set of strategies to succeed. You’ll need to learn these strategies and use them to your advantage to make the most of your investment.
Remember: The market you buy into may absolutely be one of your risk factors. If it is, you need to know about it and plan ahead.
5. Exit Strategy.
What’s your escape route?
If you need to know how you’re going to get into a real estate investment, you’re going to need to know how to get out of it too. Is your strategy to flip the house and sell right away or are you planning to hold onto your property for the long-term? How is financing tied into your exit strategy?
If everything goes completely haywire, how will you recover?
The most obvious exit strategy is selling your property. But who are you going to sell it to? You need to have buyers if you’re going to sell your property.
What price can you get for it? Has the property held its value so you can get out of it with a profit? What if the entire real estate market crashes at the time you want to sell it and now the value is in the toilet, then what?
You should never buy a real estate investment property without asking yourself questions like this. If you can answer these questions, you will have tremendously reduced your risk down the road.
It really doesn’t take a lot of knowledge to rehab your chances for success as a real estate investor—but the knowledge you do need is critical. Spending just a little bit of time learning about you are investing in, or planning to invest in, could be the difference between great success and a tremendous loss.
Formerly an Aerospace Engineer, Ali Boone is a lifestyle entrepreneur, business consultant and real estate investor.