BiggerPockets

5 Questions A New Investor Should Ask Themselves

Why Real Estate?

This is an important question because if you do not have a solid understanding of why you are investing your time, money and energy in real estate you will washout quickly. You will encounter roadblocks on your path to investing success and if you do not have a concrete "Why" you will eventually quit. You might quit before you buy something or worse you might quit after you own a rental or two. The simple fact is you risk quitting if you don't have a concrete "Why". You will know the strength of your "Why" only after you encounter challenges and keep going.

What are my/our goals (be specific)?

First thing we want to be clear on is if you are in a committed relationship you need to make sure both of you are committed to investing and you both are committed to the goals. There must be no confusion. I suspect it is possible to go it alone but I wouldn't recommend it as you will have some months where cash is tight due to a new purchase or an unexpected expense or you will lose a couple of weekends a months to perform repairs or remodels. If your significant other is not on the same page you are going to have BIG problems. So get on the same page and talk with your investing partner.

Second when we say be specific let me give you an example:

We'll ask a New Investor: What are your goals?

New Investor: I want to buy cheap real estate and create cash flow.

When we hear these types of answers we ask the investor to go back and really rethink their goals, because a goal needs to be specific. In the answer above what does "cheap" mean? Is a 5% or 15% or 40% discount cheap? Also "cash flow" if $10 or $100 or $300 enough expected cash flow?
In addition to the undefined words we have a problem with lack of specifics. There are no defined dates or quantities. Are you going to buy 1 or 5 or 10 properties this month, this year or this decade?

In the end you need to define for your self what cheap means, the acceptable cash flow target, the quantity you expect to buy and when you expect to buy them buy.

So let's revisit the question:

We'll ask the new investor: What are your goals?

New Investor: Our goals are to buy 4 Rental Properties in the next 12 months. Each property will be purchased at least 25% below Replacement Cost and produce greater than $200 in cash flow each.

Now we have something to move forward with!!!!

What are my current resources?

We suspect it is possible to make money in real estate with no money down but we haven't done it that way so we can't speak to those facts. We can tell you it is possible to make money in real estate without any of your own money by using investment partners but we have found this avenue only opened after we have had a fair amount of success.

Thus instead of preaching about how to find partners and create win-win agreements we are going to talk about current resources from a beginners perspective. The most obvious resource being do you have any cash, stocks, options or maybe your 401K at work? When we started investing in Real Estate years ago we had a little cash but we had a 401K at work that had been built up for 10+ years. So we researched how we could get access to these funds and to our surprise it was fairly easy and as long as we stayed employed we could pay back the loan a little at a time with each paycheck. Please note we are NOT financial analyst or your accountant and there are some risks in do this so review your own situation. In our specific case we had identified the source of at least a couple down payments.

While cash is important and required to enter the market we will also ask you to inventory your resources around fix up and repair work. Do you have the skills and the time to tackle a quick unit turn or remodel after acquisition. Now we are not talking about adding rooms or baths. We are talking about cleaning, painting and maybe some light plumbing work. If you have the skills and the time you might be able to save some of the labor costs in the repairs. Keep in mind ever dollar saved is a dollar that can be used for the next purchase. For the record when we started we possessed the skill but not the time so we paid for repair crews to perform this activity. They got it done faster and at a higher quality but it cost us cold hard cash.

The final set of resources to review are, your knowledge or lack of knowledge of an investment market along with any contacts you may have in the market or with real estate investing experience.

As for the market you need to research and insure the market supports your goals from the initial question of this article. If the market doesn't support it we suggest finding another market. For our perspective you need to invest in a market that you can get to with in a couple of hours drive (note we use Property Managers for our daily management). It is possible with enough support from a mentor or investment group that you can invest in another state or country but you will need to have faith in your support team. We like to go and touch our investments and insure we understand the steps to turn a profit, but we understand this may not be possible for some investors.

When we mention resources with real estate investment experience we are not talking about the negative history some people hear about our love to talk about. We want you to find contacts that have history or maybe they know someone who has been doing it for awhile. The more contacts you have with positive history the better your chances of ramping up the learning curve. You will make mistake but perhaps these contacts can limit the damage or frequency.

Do I want to buy and sell or buy and hold or some combination?

We added this question to our top 5 recently given all the chatter about flipping real estate. While it is true we did flip a house and a duplex year's ago it is not what we like to do. We want to own our properties for the long term and if we do chose to sell we will likely exchange the proceeds into a bigger building. We want our investments to pay for monthly expenses and not produce one lump sum of cash that we must pay taxes on.

However, we know some very successful investors who buy and sell (aka Flip) full time and if this is your goal go for it but please run the numbers very carefully and make sure you are in a market that will support the sale side of the flip. You don't want to get caught with a property you can't sell or rent at a profit.

As we mentioned we like to buy and hold our rentals as we believe this is the slow path to long term wealth and a stress free retirement. Owning long term cash flow positive rentals is our chosen path. It is not as exciting as flipping properties but once we own enough of these we can ride off into the sunset and not have to buy another property. A real estate flipper has to continue the buying and selling regardless of the market and a buy and hold investor can chose which markets to invest in and more importantly which markets to not invest in.

The final option is a blend between the two strategies. For example maybe you buy and sell the first two properties to increase your cash holding and then buy and hold the third property. In the end we strongly recommend that you have a defined strategy for each property before you close escrow. You need to have a plan for each and every property you buy or you will quickly spin out of control. In the end you need to know what type of investor you want to be.

Do I want to be an Active or Passive Investor?

The final question we think you need to ask yourself is do you want to be an active or passive investor. For the record we are active investor and we are always looking for the next deal, turning rental units and managing cash flow not to mention looking for the next source of capital. Being an active real estate investor takes time, can be stressful but is full of rewards.

A passive investor is someone who understands that real estate is secure especially in our current buyers market but they don't want to take the time or risks to begin investing in physical buildings. They would rather sit back and collect a solid return of 12% on their money by seeding an investment acquisition. These passive investors will simply review a deal, evaluate the risks and then get a secured 1st or 2nd deed of trust (or like security in your market) in exchange for their cash. This provides the passive investor with a secure return. We have also seen occasions where the passive investor is given a piece of the upside (action) in exchange for a slightly reduced monthly interest rate. These types of investors can earn large returns and participate in some of the upside instead of getting 1% in a savings account or 4% in a CD.

In the end both types of investors offer solid returns. Someday we will likely become a passive investor but at this point we are happy to be an active investor who is growing our portfolio and offering large returns to passive investors who chose to invest with us.

Comments

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  Andrew Martinez — over 1 year ago

  As someone starting out, I greatly appreciate the content of this article. This definitely gives me plenty to think about before I fully "dive into" the world of REI. Many thanks!