I recently spoke with an investor who told me that he has $500,000 in cash and is looking for the right investment property to acquire. As usual, I asked my standard set of questions: What are your goals, time horizon, risk tolerance and experience level? His responses were stable cash flow with some potential for appreciation, long-term time horizon of 5 to 10 years, not tolerant of high-risk investments and his real estate experience was limited to the purchase of his single-family residence. These are fairly common answers for new investors who are looking to steadily grow their wealth. So far, so good.
Then, I asked how long he had been looking for a property. What he said next shocked me: five years. This investor had been searching for the “right” property to deploy his money for five years. This means that he lost out on the last five years of cash flow and appreciation, and his money suffered from five years of creeping inflation — a poor outcome.
Although shocking, this type of story is not uncommon. In fact, I hear it frequently. Plenty of people desire to be in real estate, but consistently fail to invest successfully. Here are the typical reasons why:
1. No Clear Objectives
The primary reason investors I meet do not make any money in real estate is because they have not taken the time to establish specific, clear objectives. Most investors have answers for the questions I asked our representative investor above and believe that is sufficient for moving forward. But the objectives need to be “SMART”:
Specific: What type of property? Which neighborhood? What price range? What condition?
Measurable: What annual percent cash flow is your threshold? What percent appreciation do you expect to see in five years?
Actionable: What specific steps are required to get to a successful outcome? What are you doing this week to progress?
Relevant: Why are you doing this — to retire, pay for your child’s college education, replace your current income? What will get you out of bed to make this investment successful?
Time-bound: What is the date you plan to have acquired the property?
Without taking time to establish these, like many things in life, failing to plan is planning to fail. No investment is made, or worse, the wrong investments are made and for the wrong reasons.
2. Lack Of Time
A real estate investment must be viewed as a business. As with any business you have clients (tenants), vendors (property managers, contractors, utility providers) and possibly employees. You have cash flow, accounting and capital allocation decisions to make. You must have a marketing and sales strategy in place. And you must be able to generate a return on investment.
All of this can take a significant amount of time to learn and master. There are hundreds of professional investors who do this full-time and are competing with you for the same properties, vendors and financing. It takes real commitment to do properly. You are buying a house — will you dedicate the time and nurturing it requires to thrive, or will you neglect it and drive it into the ground?
3. Poor Management Skills
Whether you self-manage your property (and I highly recommend that you don’t) or utilize the services of a professional property manager, you will need to have effective management skills. Interacting with tenants is part art and science as it involves the attraction and retention of quality tenants, balanced by the legal requirements involved with being a landlord. Managing the property manager is a different skill set altogether, as you need to be able to establish an alignment of interests, motivate the property manager to perform and then monitor that performance against expectations.
We constantly acquire properties for our investment funds, and a key gating factor when deciding whether to pursue a property is if we have a quality property management firm in place to run it. We have, on multiple occasions, walked away from deals that were otherwise great investments because we could not find a reputable, aligned property management firm to work with. This is critical: Buying the property is getting to the starting line, not the finish. Once acquired, the real work begins in making improvements and bringing the property into a stable run-state.
4. Inability To See The Big Picture
When buying properties across the U.S. and in many different markets, there are two critical factors we look for before considering an investment: net population increase and diverse economic base. Whether through a high birth rate, people moving into the area or both, the population should see an uptrend. This does not require breakneck population growth, but the population needs to be increasing, which serves as a tailwind to demand.
Secondly, jobs support buyers and renters, which is critical for all real estate asset classes, especially multifamily. Metro areas with two or more major (and growing) industries are ideal. The big picture matters and must be closely aligned with your SMART objectives.
5. Buying The Wrong Property
Even if you’ve done all of the above, you can still go wrong if you buy the wrong property for your given strategy. Want high cash flow in a tier-one coastal city? Good luck. Are you buying a high-vacancy value-add property 1,000 miles away with no team on the ground? The cards are already stacked against you.
How can you tell if you are buying the right property? Again, it comes down to knowing your overall strategy, talking to experts and local investors and being honest with yourself about your strengths and weaknesses. Finally, if you are new to investing, start smaller and give yourself a decent cash cushion. Repairs will come up, you will experience vacancies and there will be surprises.
Real estate can be a fantastic investment, or it can be the exact opposite. It all depends on how seriously you approach the business aspects of it.