How to Lose a Million Dollars from Real Estate: A Step by Step Path
There is something very humbling about being the only person in my house with the technical skills required to replace an empty toilet paper dispenser. With a wife and two daughters I’m saddled with this task at least 10 times a week. I also happen to be the “the man” when it comes to operating a plunger and unclogging shower drains filled with long hair.
But you know what? A little dose of humility is good for the soul.
Take the real estate market crash in 2007, for example. The series of events that followed the historic meltdown of property values bankrupted me. I went from driving a brand new Mercedes Benz to a 1994 Honda Accord.
Talk about being served up a big fat piece of humble pie.
There are those that say you should never waste time dwelling on the past, looking through the rear view mirror. Live your life through the windshield they say. And I generally agree with this wisdom. However, history usually repeats itself.
Now I don’t know about you, but I’d rather stumble and fall with new mistakes rather than making the same ones all over again. After all, the definition of insanity is doing the same thing over and over again expecting a different result. This is why I recently started reflecting on what went wrong with my real estate investment business. How did I lose a million (actually it was millions) from real estate in 2008? What could I do to prevent it from happening again?
If I were to adopt a victim mentality I could have just blamed the whole mess on the big banks, Wall Street, the federal government, black cats and acid rain. I could also claim that even if I did everything right, everything would have still gone wrong.
But I’m convinced my path to failure was paved with Fool’s gold because I followed these five steps to losing millions in real estate:
- Beginning with the beginning in mind.
- Being a novice in my market.
- Investing for appreciation, not cash flow.
- Treating my business like a hobby.
- Giving nothing away for free.
Beginning with the Beginning in Mind
“The Russians don’t take a dump, son, without a plan.”
-Admiral Painter (Fred Thompson) from The Hunt for Red October
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Did I have plan for my real estate business? Sort of. Did I follow it? Not really. I got into investing because I wanted financial independence. That’s it. And in January of 2006 I could have had it. I owned $16 million in real estate (single family homes) with about $8 million in equity. I could have sold everything off and owned my own home and 10 rental houses free and clear. That would mean being debt free with passive income of at least $10,000 per month. Not a bad life.
But I got greedy. I continued to buy more, borrow more and spend more. Finally, the music stopped and I didn’t have a chair.
Being a Novice in my Market
In August, 2007 my brief reign as a real estate expert ended because of rising inventory levels, the sub-prime meltdown, investor paranoia, El Nino and global warming. Prices had hit their peak and I was still buying like crazy. I figured as long as I was picking properties up for 70 cents on the dollar I was safe from a market correction. But, if I had been following inventory levels and absorption rates (the amount of homes on the market divided by pending sales), I would have discovered that the party was over. In Maricopa County, Arizona we went from 8,000 homes on the market in mid 2005 to 60,000 homes by the summer of 2008. This ignorance really cost me. By the time I figured out what was going on it was too late.
Investing for Appreciation, Not Cash Flow
Robert Kiyosaki says that if you own something that costs you money it is not an asset. In 2006, my residential real estate portfolio was costing me over $30,000 per month (this included overhead expenses.) Talk about negative cash flow. At the time I was overcoming this huge deficit by “cash chunking”. I’m sure you’re familiar with the concept of cash flow – your assets generate income through rent payments, interest, etc. Well with “cash chunking” you sell your assets periodically to generate income.
Little did I know that the housing bust was looming and median home prices were about to plummet. Once it got tough to obtain financing my “cash chunking” business quickly went out of business.
Treating my Business like a Hobby
Although I studied my local real estate market, networked with other real estate professionals and spent thousands on real estate education programs, I never really operated as a business. Here’s why:
- I didn’t have formal business plan.
- I didn’t adopt an exit strategy for the business.
- I never understood important financial tools like balance sheets & cash flow statements.
- I had employees but no organizational chart or training system.
Giving Nothing Away for Free
While amassing this great real estate fortune I gave a lot away. I mentored aspiring real estate investors, for free, and spoke at numerous workshops and real estate investing events without the expectation of anything in return.
However, I donated a miniscule amount of my money and time to worthy causes. Imagine all the good I could have done. It’s not that I didn’t think about it. “I’ll get around to it eventually” I thought to myself. But that day never came. Of all the mistakes I made this is the one I regret the most and have vowed not to ever repeat.
Keeping an Eye on the Rear View Mirror and the Windshield
Whether you’re new to real estate or a seasoned pro then no doubt you’ve made some mistakes. What lessons have you learned? What would you do differently in the future?
Since 2009, I made a commitment to not do any of these five things again. I wrote a business plan, learned QuickBooks and started following all of the local real estate industry newsmakers. I donate my time and money to our church and a nearby homeless shelter for children.
Sure, I still make business mistakes like underestimating repairs and overestimating value. And, of course, forgetting to put more toilet paper on the dispenser around my house. But at least they won’t put me out of business.