Business Management

The No. 1 Reason Newbies Go Broke in Real Estate (& How to Avoid It!)

Expertise: Real Estate Investing Basics, Real Estate News & Commentary, Personal Development, Flipping Houses, Landlording & Rental Properties, Personal Finance
103 Articles Written
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The TV real estate gurus advertise that you can get started in real estate with no money.

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I guess technically this is true. I stayed at a timeshare resort in Breckenridge once, and one "owner" was so desperate to get out of his timeshare commitment that he was offering his rights for $1.

There are properties in Detroit for around that much, too. So technically, you can get started with no money, but you certainly can’t continue without any.

In both examples above, the money out of your pocket doesn't stop at $1. At the timeshare resort, there are annual maintenance fees that average $660 a year. In Detroit, $1 properties come with back taxes pretty much guaranteed. The city of Detroit is cash-strapped, so they start foreclosure proceedings as soon as the ink dries on your deed, desperate for any possible funds.

What if you CAN somehow miraculously invest in real estate with no money? What are you going to do when there’s a problem?

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That One Rental Where Everything Broke

I have friends, Ruby and Peter, who lived in a small house in my town. When they were pregnant with their fourth child, they decided that a two-bedroom just didn’t serve their needs any longer, so they bought a larger house and decided to make some quick cash renting out the original home.

Ruby and Peter don't manage their money in the best possible way. They never have any extra cash, and Ruby has confided in me that she has missed a couple mortgage payments on her primary residence.

A few months into being landlords, the hot water heater broke. They didn’t have any reserves set aside for emergencies. Luckily, a hot water heater isn’t a huge expense. Let’s say $1,000.

I live a frugal life. I have adequate reserves for anything that comes up, so $1,000 wouldn’t have me scrambling. Don’t get me wrong, I am not actively looking for ways to spend $1,000. It’s just that sometimes, ways to spend $1,000 come looking for you.

Related: 3 Rental Property Expenses Investors Should Always Anticipate

Ruby and Peter absorbed this expense, although it wasn’t easy for them. Their rent was more than their expenses, and they started to recoup their cash for a few more months until…

The furnace broke.

And not just the blower on the furnace, which is easy to replace and runs around $100 or so for the part. Not the $30 igniter, either. Nope, this furnace had reached the end of its life and needed to be completely replaced. Of course, this only happens during the winter. (Who’s running the furnace in the summer?)

Murphy’s Law presides over furnace replacement. It will only need to be replaced when the temperature dips below zero. You can’t really shop around for a furnace guy or a furnace itself when you own a rental and the furnace is broken — you just have to get it replaced as soon as possible.

Not only are you required by law to provide heat to your tenants, your pipes will freeze if left without heat for too long.

Ruby and Peter ended up not renewing the lease for the next year and instead sold the property, not wanting to continue the financial drain.

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What a $1,000 “Free” Ski Lesson Taught Me About Reserves

In the state of Colorado, children from Kindergarten through 5th grade get a free ski pass. It comes with four lift tickets for four different resorts, plus a free lesson in January. I am an avid snowboarder and want my two children to love being on the slopes as much as I do, so I signed them up.

We scheduled their lesson for this past weekend, and a few days before we went to the mountains, the weatherman started talking about a huge storm. Snow was supposed to start falling around 3:00 p.m. on Saturday and would be pretty heavy — up to 14 inches. But weathermen are always off when they forecast the start of a storm, right? They are usually several hours off, and the lesson was only supposed to last until 3:30 p.m. PLENTY of time to get out of the mountains.

So we went, and they loved it. Mission accomplished!

Except that weatherman was off about the start of the storm — it started an hour before he said it would.

For our trip back, Google Maps routed us through local mountain roads instead of the highway. We blindly followed, only to discover that the road was closed. By the time we turned around and got back into town to take the highway, the highway was shut down, too.

I started making phone calls to every hotel on Google. “Do you have any vacancy?” “Nope. We’re all sold out.” Times 20 or so. Sometimes accompanied by a laugh.

I was extremely fortunate to get a call back from one of the hotels, telling me they just had a cancellation. I hadn’t brought any blankets or supplies with me, thinking I’d be able to make it back home before the storm. (I know, I know. Next time I’ll be prepared.)

Related: How to Estimate Future CapEx Expenses on a Rental Property

I asked how much the room would be and shouldn’t have been surprised at the answer. I live a pretty frugal life and don’t spend a lot of time in expensive hotels. I like to pay less than $100 per night for my room — I don’t spend a lot of time in it while I’m on vacation; it’s just a bed and a shower. (I know there are some of you who wouldn’t step foot inside these lower priced hotels. That’s OK. Someone has to keep these higher priced hotels in business.)

This day ended up costing us right around $1,000, when we were planning on it being free. Mountain prices are high, and beggars can’t be choosers.

I wasn’t actively looking for a way to spend $1,000, but sometimes ways to spend $1,000 come looking for you. Especially when you don’t plan ahead. Or you ignore blizzard warnings.

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Protect Your Investment

The whole reason you’re investing in real estate isn’t for the stress of finding an HVAC technician at 3:00 in the morning. You also probably aren’t itching to experience an eviction.

If you don’t have money to put down on a house, you won’t have money when something goes sideways. That $100 you have left over after you pay your mortgage doesn’t cover very much of that $3,000 new furnace.

Be Prepared

Know what you're getting into. Get a home inspection on the property you are purchasing, so you know that the 12-year-old furnace, with its average lifespan of 20-25 years, is probably going to last a little while longer.

Partner Up

Find someone who does have money to cover those surprise visits from the Furnace Fairy.

Save Up

You don’t typically find the perfect property your first time searching. Start throwing every extra dollar you have into a saving-for-my-first-property coffee can or bank account.

Related: 12 “Hidden” Real Estate Expenses That Blindside Investors

Learn While You Earn

Find someone to learn from. There is no shortage of really busy investors on our site and in your area. Connect with people and ask them if they need any help. Provide them with value and begin a relationship. Offer to work for free just to get your foot in the door — it will still cost less than those TV gurus' classes. You'll probably learn more, too. As you grow your relationship and experiences, opportunities just might come your way. Even if the only thing you walk away with is experience, you've still been paid very well.

[Editor’s Note: We are republishing this article to help out our newer members.]

What’s the biggest unexpected expense you have come across through your investing? What advice do you have for new investors who don’t have a lot of money?

Please share your experiences below.

Mindy Jensen has been buying and selling homes for more than 20 years. She buys houses, moves in, makes them beautiful, sells them, and starts the process all over again. She is a licensed real est...
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    John Murray from Portland, Oregon
    Replied almost 3 years ago
    Having electrical, mechanical skill is a key function of why I make money. My uncle has a PhD in psychics and contends that the whole world is plumbing and wiring. Uncle has designed weapons guidance systems but his greatest accomplishment was building a deck and remodeled his house. Way to be uncle Fred! He makes a bunch of money too.
    Salina Robbins Rental Property Investor from philadelphia, pa
    Replied over 2 years ago
    Mindy, Thanks so much for this post. I’m working on making my first investment by September of 2018. It’s posts like this that makes me feel more and more confident in my future endeavors.
    Dave G. Investor from Phoenix, Arizona
    Replied over 2 years ago
    Just read the recent reprint of this blog. Great article with timeless information. As a new investor in my early 20s, I personally experienced the consequences of having essentially “break-even” cash flow and no reserves. I acquired 3 properties for zero down. This was not exactly a great achievement as it was during the fallout of the Savings & Loan crisis market in the late 80s. There were HUD and VA foreclosures everywhere in Phoenix. But I got my 3 properties (plus a personal residence) and was on my way! I rented them out for about break even with the financing (no-qualifying assumable loans!). Tenant screening was not hard and did not cost much $$ or time, I found good ones. But before long, maintenance issues arose. Like in Mindy’s article, I had AC units go out in the middle of summer. This is Phoenix – 115 degree weather and you must act fast! Long story short, every month something costing like $500 would break on one of the properties. It just rotated among the properties each month on where the next $500 problem would occur. I was a starving realtor at the time and was having trouble covering my own bills, much less 3 other properties. After about a 1 year of this (and accruing a large credit card balance for the on-going repairs) I realized this was not sustainable and dumped all three of the properties. I was very deflated. I did not re-enter real estate investment until another ~20 years passed (the 2008 Crash). As an investor now, it is defined within my LLC operating agreement that I’ll keep a minimum reserve value on-hand for each property. My reserve value selection is driven by property type, age and condition at acquisition. I found this to be a good safety net and clearly it will mitigate what was previously my downfall. I absolutely agree – the #1 threat to new investors? NO CASH RESERVES!
    John Cummins
    Replied over 1 year ago
    I don’t get it, the title of this article is “The number one reason… and how to avoid it.” Nice story but where is the proof and the answer. The only thing I can take away is that the author thinks it takes money to make money and all else is doomed to failure. BS – real estate is full of no money success story’s. I believe being strapped forces you to be smart and persevere, failure is not an option for successful people and their projects. Just my humble opinion.
    Don Lewis Investor from Fallbrook, CA
    Replied over 1 year ago
    I ran a business for 25 years and was a sole proprietor. Without cash reserves to start a business or for lean years you’re probably not going to be in business very long. Investing in property is a business, so you better be prepared for the unexpected. I recently bought a condo that the association has below average cash reserves. This could lead to an unexpected special assessment which could be thousands of dollars. For this reason I offered $10,000 less than the asking price(all cash sale) and they accepted when I explained why. I stashed the 10K into my reserve fund, hopefully I’ll never need it.
    John Cummins
    Replied over 1 year ago
    I agree, but I think we are being too generous blaming lack of cash for problems. Basic business irresponsibility needs to be listed. Here are some simple but fatal mistakes. Betting on the future, (assuming income increases.) Allowing debt to climb without income offset. Dumb purchases, (gold plated kitchens, and brand new diesel pickups.) Buying the wrong property. I believe you set the stage and make your money the day you buy a property, not the day you sell it. Lastly, spending tax reserves. Remember, investors with bad credit didn’t get that way by making smart choices. I wager, many fail even with access to cash, only in more spectacular fashion. Just my opinion.
    Mindy Jensen BiggerPockets Community Manager from Longmont, CO
    Replied over 1 year ago
    This is a fair observation. You are 100% correct, people with bad credit didn’t get there by making great choices.