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The Absolute Must-Have Fundamentals of Real Estate Investing

by Ali Boone on April 26, 2014 · 27 comments

  
Post image for The Absolute Must-Have Fundamentals of Real Estate Investing

What are they? I certainly don’t know all of them because I don’t have experience with all of the different aspects of real estate investing, but that’s why we have BiggerPockets- let’s create the list together.

When I say fundamentals, I’m talking about the first thing you would say to a brand new investor who knows nothing about investing. What is the one thing that stands out above all else that a new person has to know? Without it, they are doomed to failure.

I’ll start.

Cash Flow

For rental properties, the number one must-have is positive cash flow.

Unless you are intentionally buying a property in hopes that it will appreciate and that’s where you plan to see the profits, there must be anticipated positive cash-flow every month.

What does this mean?

It means that the amount you collect in rent from your tenants has to be greater than the total amount of your expenses. This seems oddly simple, but you’d be surprised how many people who are interested in real estate investing, but haven’t yet entered into our world of fun, don’t realize what constitutes a profitable rental property.

I know before I was ever in real estate I had the misconception that just owning a rental property was a good move. I got suspicious about the profit side of it after I looked at a handful of properties in Orange County, CA and couldn’t quite put my finger on why but something about the numbers didn’t make sense to me. Pay $270,000 for a small torn-up property that would rent for $1200/month? I didn’t know what I should be calculating, but that struck me as off. Sure enough, now that I am in real estate, I know for sure those would have been horrible deals. The mortgage cost alone on that property wouldn’t have been covered by the rents.

You should never get duped into thinking that just owning a rental property is a good move. If it costs you money every month to own it, you aren’t getting the benefit that a rental property should be giving you. People skip over this basic lesson usually for one of two reasons:

  1. They have only been taught that owning a rental property alone is a smart move and no one dug into that concept further with them, or
  2. They live in an area, such as LA or NY, where prices are so high that rents would never cover the expenses and they have no idea that isn’t the case in other markets.

Being able to buy the same house in Atlanta for $120,000 that someone in LA would have to pay over $1,000,000 for barely seems realistic, but it is.

Related: How I Analyze a Real Estate Deal, Step by Step

Your Turn…

Okay, that’s my vote for a rental property fundamental and I’m starting the list with that. You can either expand on that concept or give us your own. Especially flippers, appreciation investors, wholesalers, note buyers, and any other type of investors- give some direct input about your field so anyone interested in that field can be aware of those fundamentals. As you start commenting, be sure to specify the type of investing you are referring to or if you are just speaking to real estate investing in general.

What is the first fundamental lesson you would teach your grandkid as soon as they say they want to become a real estate investor?

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{ 27 comments… read them below or add one }

Chuck H April 26, 2014 at 10:39 am

How to understand how a loan is funded and all the fees, commisions and points that are being paid and what interest rate they are agreeing to. Cant evaluate cashflow unless you know your all in costs or if you are getting railroaded with a bum loan.

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Ali Boone April 28, 2014 at 8:10 pm

Yes Chuck, absolutely. And combining what you say with my input about the numbers- understand all of the financing costs and be sure to incorporate those into your calculations on return. For some reason people think closing costs don’t count for anything, or points or whatever else. But money is money and if you spend too much of it, you won’t see a return.

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Sharon Tzib April 26, 2014 at 11:47 am

Understanding the importance of location. It’s great that you found a property that cash flows $500/month, but if you can’t find quality tenants to rent the place, or any tenants to live there at all because they’re scared to death of the area, then you will be out of real estate before you started. And resale will be very, very difficult.

Also new investors also need to be aware of their exit strategy when they buy. Will you be holding long term, fixing up and immediately resaling, or looking for a tenant/buyer? Knowing the answer to these questions going in will help you buy right and plan accordingly.

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Ali Boone April 28, 2014 at 8:13 pm

Great input as always Sharon! I love your practical approaches, and you are totally right about location. We all know I’ve been bitten by the location bug personally! And not a nice bug, one that leaves a burning red mark. Lol. To bring your point up a notch and make it even more general, and it would be the point to immediately follow the one I made up above- the numbers written on paper showing a return should not be taken for gold. Things can look good on paper all day long but once you bring reality into it (location, for example) those numbers may likely not hold. So numbers are key, but don’t get duped into thinking you only care about what someone writes down for them.

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Corbin E April 26, 2014 at 12:04 pm

Financial history of the project…being tax returns, property tax bills, expense statements, rent rolls over the previous years, etc… Ensured accuracy of these documents can mitigate ‘surprises’ that may present themselves after the property has been closed on, and can solidify an investment pro-forma.

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Ali Boone April 28, 2014 at 8:14 pm

Good one Corbin. And to further that one- confirm all of the numbers you use to calculate the returns. So many people only use estimates, unnecessarily, while they could have gotten actual numbers just as easy which can make a huge difference to your bottom line.

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Dave Tanner April 27, 2014 at 6:15 am

Fundamental – Know what the P.I.T.I. (pronounced pity) on the property will be.
P.I.T.I. = Principle, Interest, Tax, and Insurance. These are your core expenses, you can know them to the dollar before making an offer/buying. Once you know them you can begin calculating potential cash flow. Sure, there’s more, but this is a basic concept to get rolling.

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Ali Boone April 28, 2014 at 8:16 pm

I agree Dave. And as I just said in another response before I saw yours, don’t use estimates for any of those numbers when you could just as easily use actual numbers. I have no idea why people stick with estimates, but it could be detrimental for your returns.

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ozinvest April 27, 2014 at 6:39 pm

This is a very dissapointing post. No explanation or directions for calculating cashflow. Just publishing emptiness for the sake of it. Please publish something more useful. I know the value of properties, I don’t need this post, I can look on Zillow. Instead write about what you said you would write… explanation of cash flow.

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Ali Boone April 28, 2014 at 8:23 pm

I’m sorry you were disappointed in the article. The purpose of this one was to hit things to consider, not the details of how to dig into those things. I have put out other articles that do detail out those things and might be more along the lines of what you are looking for. The one that would be most applicable to what you are requesting, I think, would be-
http://www.biggerpockets.com/renewsblog/2013/01/19/real-estate-math/

As much as I love to write articles that detail out everything, I also want to write bigger-picture articles that make everything more simple for the newer investors who don’t have the skills and know-how that you might already have. So I can’t say I will only write detailed articles, but I can say that I will occasionally if you want to stay tuned.

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James April 29, 2014 at 10:03 am

Great response Ali!

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Jaren Barnes April 28, 2014 at 10:53 pm

#hatersgunnahate!

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Ali Boone April 29, 2014 at 2:43 pm

#truedat Jaren. Lol

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kathy April 28, 2014 at 7:32 am

Understand yourself and what your goals are. Don’t be mislead by get rich quick gurus. As with any worthwhile endeavor there can be a steep learning curve and some pretty hard work involved at times. Don’t be afraid of learning, making mistakes, and hard work. Start slow and learn as you go. Know what type of living standard you aspire to but remember friends and family are important too. Then you can determine how many and what type of properties you should invest in.
ps. ozinvest, this is how I calculate cash flow. For example if rents are $1000 in an area, the most I can pay for a house is $70-80k and put in with sweat equity about $20k more. I bring up these structurally sound, distressed, dirty, stinky houses to our standards as fast as I can. In this area, if the house is city assessed at $150k, I can right now get a refinance, cash out for about $80k with a monthly payment PTI of about $750, about half of that is taxes, the other half is interest, with a minimal amount going to principal. I find that my nice houses which are located in decent areas where I would like to live (actually nicer than where we currently live) and that attract good caliber tenants will have a minimum positive cashflow at about $200/month unless something major happens. We just buy very slowly buy and hold as I like being a landlord better than flipping properties.

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Ali Boone April 28, 2014 at 8:25 pm

Kathy, your input is amazing. You hit a huge one for sure- don’t be scared of failure. Because it WILL happen. It has happened to all of us. The faster you get the failures out of the way, the faster the successes will come. I also especially like your input about starting slow, don’t get conned by a guru, and be patient. Slow and steady wins the race :)

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kathy April 29, 2014 at 4:19 pm

Thanks! I think you really need to know yourself, where you are in your life, and be specific on your goals.

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Ali Boone April 29, 2014 at 4:29 pm

Absolutely Kathy, I couldn’t agree more. And realize too that who you are isn’t necessarily who someone else is either….everyone will mesh better with different things.

Jaren Barnes April 28, 2014 at 10:52 pm

I’d say the very first fundamental for a new investor in any sub-niche of real estate actually starts with their mindset.

In order for us to become successful, we need to start with changing the way we think. That’s why books like “Rich Dad, Poor Dad,” “Four Hour Work Week,” etc. are normally the starting place for most people.

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Ali Boone April 29, 2014 at 2:45 pm

Ooooh good one Jaren! You’re taking it back even further to the beginning. Yes! You are totally right. Most people grow up with the mindset that you go to college, work a 9-5, save as much as you can, and if you invest at all it should be in stocks. Rather, if you learn the truth about money (and lifestyle design), that mindset will help you succeed with real estate because it’s the whole point of doing it in the first place.

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Scott April 29, 2014 at 9:11 am

Ali,
As an absolute beginner – Thank You for a post that is a helpful reminder to me to keep a solid foundation underneath my more complex studies. This is an area I struggle with as I learn about different facets of RE investing – too often many posts are about the details and how to figure “this cost” or “that projection” and the “other analysis.” Those will be very useful discussions for me as I grow into a successful and seasoned investor, but it’s nice to see a refreshing, simple return to the basic truths.
As commenters above have said, I have found both the “Change your Mind” ideas to be very useful (I took a Rich Dad coaching course which opened my eyes and dramatically changed the way I view finances, although they took me for about 5K) and the very powerful, very simple, very basic idea of “If the property doesn’t put money in your pocket every month, it is NOT an asset to you” that you call Cash-Flow. Thanks to simple truths such as these, I am preparing myself to make an entrance into this wonderful world and will hopefully not mash-up my first deals too badly!
I would add as a fundamental to any new investor – JUST DO SOMETHING! I could spend all day analyzing, searching, blogging, posting, talking, and more until I am blue in the face. It’s not until I TAKE ACTION that I will effect any change in my circumstances. Attend a REIA meeting; go to a MeetUp, call the number on a bandit sign, go to an open house, talk to a realtor, talk to a title agent, talk to a mortgage broker or banker, go to a county auction. Get out in real life and get moving, and you will accomplish something.
I look forward to participating in this wonderful community!
To our common future successes, in whatever niche, in whatever way!
– Scott

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Ali Boone April 29, 2014 at 2:47 pm

Well welcome to both BP and real estate Scott! Great comment and you’re totally right- just get started. If you are that scared of failure, you’ll never get anywhere. Plus every investor will fail somehow so you might as well just dive in. Dive in with some education, but don’t wait until everything is perfect because it never will be.

Good advice coming from a newbie :) Rich Dad taught you well! Which advanced course of his did you take?

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Scott April 29, 2014 at 3:02 pm

Thanks Ali!
I don’t think the course I took was terribly “advanced.” It was their 12-month “Personal Coaching Program” – 12 weeks of 1x-week online group classes on how to think like the Rich Dad philosophy, and 9 months of supposedly “personal follow-up mentoring” by their coaches. While I personally wasn’t so impressed with the materials or coaching, and it cost me $5,000, it was very useful to spur me into action. LOL now they give away the curriculum free on their website – “Choose to Be Rich” and the like. But it was a good experience, just HIGHLY overpriced, oversold, and over promised.

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Chuck H April 29, 2014 at 4:39 pm

I did a personal coaching program from Loral Langemeier. Well, I thought it was going to be her. Wound up being a coach with a great attitude and little else to offer except to read from a script. It was all good stuff, but it I was light year ahead of the guy. I should have been coaching him. Lol. Wasted 5k.

Ali Boone April 29, 2014 at 10:32 pm

Well the way I look at spending money on any kind of education at all is for most things, I would nearly guarantee I learned something worth what I spent. Even $5k, while quite expensive, is nothing compared to gaining the swift kick to get going. Then that $5k was worth it! Although I am really disappointed to hear you didn’t get better education for the money. I’ve had faith in their advanced courses but hadn’t heard feedback about the coaching programs. They’ve pitched those to me in the past, but didn’t go through with them. I always assumed they would be worth the money. Very sad to hear it wasn’t.

Ali Boone April 29, 2014 at 10:34 pm

Chuck, I’ve never heard of Loral. Who is that? (and a he or she?) That definitely sucks to hear! What was the information supposed to be on?

Jordan Thibodeau April 29, 2014 at 5:43 pm

The importance of thorough due diligence.

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Ali Boone April 29, 2014 at 10:35 pm

Totally Jordan!

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