by Theresa Bradley-Banta
What’s a real estate investing money rule? It is a non-negotiable rule or guideline set by you specific to your investment activities and strategies. This is the criteria you apply prior to making all of your real estate investment decisions. Without deviation. Without exception.
Money rules are a personal thing. They are your rules. No two individual’s rules will look alike.
This article will give you some ideas for setting your own money rules. You will probably continue to tweak them for years to come as your investment strategies change and as you continue to learn from experience.
Remember, Everything is Negotiable
When presented with an investment opportunity negotiate terms that work for you rather than accept a deal as presented. Everything is negotiable—especially in real estate investing.
Never Use Pro Forma Numbers in Your Cash Flow or Acquisition Analysis
In this rule I define pro forma numbers as financial projections based on assumed events.
Pro forma numbers will include items such as:
- Potential market rent on an apartment unit. For example proforma numbers may show higher rents after renovations.
- Rental income at 100% occupancy.
- Management costs under new management.
- Higher income and lower expenses under new management.
- Utility costs when residents pay a portion of utilities, etc.
These are what I call the “grass has been fertilized” numbers—numbers that can quite possibly qualify as wishful thinking.
If you are buying a single-family, multifamily or apartment building property you’ll want to use the current financials for the property, not the pro forma financials. Brokers and sellers are famous for using pro forma analysis when presenting a real estate property or business for sale—and for basing the asking price on those projected numbers.
Know Your Exit Strategies Before You Make the Investment
Your exit strategy is how you plan to capitalize on your investments. For example you:
- Renovate and sell a property.
- Refinance a property.
- Convert a property to another use: For example you convert the units to condominiums; tear down and sell or redevelop the land; or convert space to another use such as retail or office.
You need to understand your exit strategy when you make the investment.
It is possible and advisable in most cases to have several exit strategies in place. Determine who gets paid what and when. When planning on how to capitalize on an investment use pro forma financial analysis conservatively and judiciously.
Diversify Your Portfolio
Establish what type of diversification you desire to have in your portfolio. For example, you might target diversification as follows:
- Short-term real estate flips.
- Long-term hold rental properties.
Having a strongly diversified portfolio will protect you from short-term fluctuations in each asset class.
Establish short-term and long-term plans for your investments to include cash flow, passive income, equity growth and capitalization on your investments (how you get your money out).
One other important item to consider here is your liquidity needs. You do not want to find yourself in a situation where you badly need funds and they are tied up in a long-term hold.
Decide If You Are Going to Be an Active or Passive Investor:
Do you need to feel in control of your investments? How much time do you have for hands on management of your portfolio?
I’ve been able to find a good balance through experience and have over time decided on what I enjoy doing. When I began investing in real estate I started with single-family properties and found it took too much of my time because of the hands on management involved. I later moved to multifamily properties and apartment buildings that supported the hiring of a third party professional management company.
Changing my investment strategy freed up my time so that I could continue to build businesses, acquire assets and to manage those assets rather than being involved in property management on a daily basis.
Decide What ROI is Acceptable to You
What type of return on investment do you require? Are you comfortable with a 7% return? 10%? If a deal comes your way that does not satisfy your minimum requirements, don’t do the deal.
Don’t Follow the Crowd
Never invest in a deal just because everyone else is doing it.
This rule speaks for itself. It is easy to fall into the trap that if everyone is doing something it must be good. The danger here is that you are unlikely to do your own due diligence if you believe the group or crowd has already done it.
And who knows? The “crowd” could be dead wrong.
I’ve seen a handful of investors in my area who are renting out condominium quality residential units as apartment units because they came too late to the condo conversion game. A very expensive mistake you do not want to make.
Verify, Verify, Verify
Always complete due diligence and inspections of numbers, books, reports, data and physical properties. Obtain everything in writing. Speak to others that have experience in a particular asset class and compare numbers. Ask for references and follow through by contacting those references.
Run the numbers and make sure you believe they make sense. If you are not confident in running the numbers get someone on your team to do this for you and have them give you their evaluation of the deal. Have the proper tools and know how to use them (or a team that does). These tools will include real estate investment analysis and financing spreadsheets, commercial due diligence checklists, etc.
Take Advantage of Tax Benefits
Prior to investing you need to clearly know what the tax implications and benefits are (both on your investment and your current income). When you invest be aware of the tax implications not only for the current year but also for the following years and for the day you exit your investment.
Use a CPA or tax attorney to assist you in reviewing how your investment returns will impact your tax rate and your regular income.
Ask for the Property Financials
Create a list of all documents required by you. You’ll find a sample checklist here: Apartment Building Due Diligence Checklist and Documents Requested By a Buyer.
For example, when looking at a real estate investment ask for the trailing financials (past 12-24 months) in addition to an offering memorandum. Documents such as cash flow statements, balance sheets, profit and loss statements and pro forma analysis will assist you in understanding how an investment will perform.
Don’t Try to Time the Market
This is just too hard to pull off. By this I mean don’t try to second-guess the timing in a market.
Don’t try to guess when a real estate market has reached its peak or bottom. By the time you realize a market has moved most of that movement has already taken place. No matter how tempting, do not forgo diversification to jump into a “hot” asset class with a large portion of your investment dollars.
Don’t Invest More Money Than You Can Comfortably Afford to Lose
Know your worst-case scenarios and determine if you can ride them out. Take calculated risks. Be sure you have an emergency fund and the proper funds for maintaining your real estate investments.
Follow your money rules religiously.
Always remember, no one knows your investing psychology, goals, priorities, risk and comfort levels more than you do.
Recording your own money rules can be a profitable and fun exercise. Real estate investing rules can help you avoid doing deals you’re not 100% sure about. My free download Invest In Apartment Buildings Resources includes a sheet where you can start writing down your own money rules. You’ll also find some rules that are not included in this article.
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