Newbies: Wonder if You’re Ready to Buy a Rental? Examine These 4 Factors.
Is now a good time to purchase buy and hold investment real estate?
Want more articles like this?
Create an account today to get BiggerPocket's best blog articles delivered to your inboxSign up for free
When most people ask this question, what they are wondering is this:
Is real estate going to go up in value in the next few years?
This is a terrible question to be asking. When you ask this question, you are playing a game of chance with outcomes that you can’t possibly predict accurately, and that speaks to a gambler’s mindset.
Instead, ask yourself this question:
Is now a good time for *me personally* to purchase buy and hold investment real estate, and will buy and hold investment real estate help me achieve my financial goals regardless of short-term future market conditions?
If you came here looking for real estate advice, you are going to be disappointed. Instead, this article will provide personal advice. Because the truth of the matter is that real estate investment advice IS personal advice.
Now, please also keep in mind that this advice is relevant only for the middle-class W2 salaried employee looking to build wealth on the side. Remember, I don’t write for the real estate entrepreneur who is looking to go all out in his/her pursuit of real estate wealth. They play by a different set of rules than us folk who are employed and intend to remain employed for the foreseeable future.
For us, the answer to the question “Is now a good time to buy real estate?” is decided by personal conditions, not market conditions. Regardless of what the market is doing, the real question is whether now is a good time for you to invest.
Whether or not you are ready to invest in real estate depends upon a number of factors going on in your life. And these aren’t just financial factors. See, real estate is what I like to think of as a “semi-passive” business. Think of it as a hobby that takes a couple of hours a week, but a lot more time/effort/money up front. If you pay high up front and are prepared to cover consistent, long-term cost, you might create an incredible positive effect in your life. If you don’t, you are setting yourself up to get royally screwed.
With that, let’s talk about the factors in your life that determine whether or not you prepared to benefit from the purchase of investment real estate.
Factor #1: Your Personal Financial Position
You are setting yourself up for tragedy if you do not have a strong personal financial position prior to purchasing investment real estate.
We invest in real estate to improve our financial positions. Plain and simple. But the irony of it all is that you are not ready to invest in real estate if you don’t already have a strong personal financial statement prior to going in!
So what is a strong personal financial position as it pertains to real estate investing?
A strong personal financial position is comprised of several key factors:
A Strong Balance Sheet
Put simply, the investor who is prepared to buy real estate will have few bad debts and have not only the down payment for the next real estate property saved up (in cash!), but tens of thousands of additional dollars (also in cash!) ready to go to pay for unexpected things like repairs, maintenance, and six months of mortgage payments when the tenants don’t pay.
The investor who is prepared to buy investment real estate carries good debts only (or no debts!) on his personal balance sheet. He/she might have a mortgage and maybe a car payment, but does not have things like credit card balances, large student loan debts, or other personal, non-asset backed debts. It goes without saying that he/she has an excellent credit score as a result of this long-term behavior.
Further, the investor who is prepared to buy investment real estate will have a substantial amount of cash/liquid funds and does NOT count things like home equity and retirement accounts as part of this. Sorry, the $50K you have in your 401(k) does not count (unless you are investing solely in your self-directed account, but that’s a different story).
Real estate investing for most of us W2 folks requires cash, plain and simple.
If you have no cash or other assets that you can readily liquidate available to you but have substantial home equity and/or retirement savings, you are not in a position to buy real estate currently, and now is a BAD time for you to invest.
The reason that you are not prepared to invest is because your balance sheet indicates a long-term failure to accumulate wealth anywhere but the forced savings plans that are home equity and retirement accounts.
It means that you have systematically failed to preserve your cash and use it to buy assets. It means you spend everything that comes in — and that you can’t get your hands on — immediately.
It means that you are unprepared for expenses like a $15,000 roof repair/replacement, a $5,000 HVAC replacement, or the new kitchen that will help you increase rents by 30%. Real estate investors with strong balance sheets call these expenses “capital expenditures.” Those with weak balance sheets call these expenses “disasters” and lose everything.
A would-be investor with this kind of balance sheet is at significant risk entering the real estate investing world. If you do buy property, you are highly likely to become one of those “motivated sellers” who gives guys like me a great deal by having to sell off your assets in a hurry when the next unexpected “disaster” comes along.
A Long History of Positive Life Cash Flow
It should come as no surprise that the personal statement of cash flow and personal balance sheet are closely linked. A long history of positive cash flow is likely to be reflected by a balance sheet with large and growing cash positions and real wealth that you can spend today.
The investor who is prepared to buy investment real estate spends significantly less than he/she earns and has done so for years in a row, without any significant interruptions.
Keep in mind that we aren’t talking about a few hundred bucks a month over a few years. The middle-class earner who is prepared to purchase investment real estate saves at least $1,000 (cash!) per month, not including retirement contributions and home equity, as stated previously. Hopefully, you are saving much more than that if you are earning $50,000+ per year.
This eliminates about 95% of Americans right here.
If you are breaking even and struggling to bring in more than you spend on a monthly basis, you are in a poor position to begin investing in real estate. Many new investors find that properties do not produce the cash flow expected by their projections, especially in the short-term. A property that bleeds (loses money every month) is a HUGE detriment to your personal financial position if you have no positive cash flow.
But a loss of a few hundred dollars per month on a first deal, while not ideal, is not life-altering to the guy who comfortably saves $1,000, $2,000, or $5,000 per month. He can weather the storm for a few years and come out smiling on the other side with a strong cash flowing portfolio, after the hiccups of those first few properties and the school of hard knocks has taught him a few lessons.
To conclude this section about the prepared investor’s financial position, it basically boils down to three questions:
- Do you make a solid, stable income that you can rely on?
- Do you spend way less than you earn, and have you done this for several years in a row?
- Do you have a large amount of liquid cash that you can use for a down payment AND repairs/big expenses that might come with a new real estate purchase?
If you can’t say yes to these questions, then real estate is a highly risky investment for you at this time, regardless of your predictions for future market conditions.
Factor #2: Knowledge and Commitment to Learning
Real estate is a business that requires continuous learning. It is literally a lifetime commitment to knowledge accumulation as it pertains to general business practices and the specifics of real estate in your target market.
Listening to all the episodes of the BiggerPockets podcast, reading a dozen books on real estate investing, and reading a few hundred blog articles is a pretty good start to your real estate education as you get your act together financially, but it will never be enough.
You need to make it a habit. A habitual process of continuously studying your market, your properties, your contractors, your network, general business acumen, and your overall financial plan.
There is always more to learn and always ways to improve. There is no such thing as “set it and forget it” when it comes to investing in real estate while working a full-time job. You have to be prepared for every problem that comes up and continuously increase that preparedness with each passing month and year.
Perhaps one day, you can train up others to run your business for you and watch it grow from a distance. But if you go in with the expectation of rapidly achieving that end goal, especially while working a full-time job, you are in for some nasty surprises. Plus, even if you do manage to build a passively managed business as a hobby, then at that point you’ll have to just make a commitment to continuously learning about how to manage managers and run an effective organization.
If you aren’t prepared to put in a huge upfront effort in self-education and then continuously stay sharp on the fundamentals of business and real estate, you are setting yourself up for failure. You are just as likely to end up a “motivated seller” as the guy who is buying rental properties with his HELOC because he can never seem to make it through the month with anything left to spare.
If you have a full-time job and aren’t dedicated to self-education in this business, then now is a very bad time to buy investment real estate.
Factor #3: Commitment to the Area You Are Investing in
Remember how I said that investing is personal? It is.
When you buy investment real estate, you are tying yourself to a physical location. You are tying yourself to a block, a neighborhood, a city, and a state — and you had better be comfortable making a long-term commitment to having that physical location remain a significant part of your life.
You are also tying yourself to the people and network that you must set up in that physical location. You will have to find an agent in your area — likely a lender, a property manager, handymen, contractors, a lawyer, and the like. And you are going to have to manage these folks.
Yes, you’re going to have to manage them personally.
Because let me tell you that nobody is going to look after your property like you. Nobody.
If you work a full-time job, are a new investor, and have no ability to conveniently, physically visit your property and the people that you depend on, you are missing out on a tremendous amount of opportunity, and you are likely setting yourself up for a whole host of problems that a local investor can avoid.
There is no replacement for being able to see a property that you own. There is no replacement for understanding the little problems that go with rental properties. There is no replacement for having at least a basic understanding of what goes into routine maintenance and contractor projects in real estate investing.
There is also no replacement for physically meeting with the folks you do business with. I know — there are folks out there who can look me in the eye and screw me over with no qualms. But I believe that when I meet with someone face to face and tell them exactly how I want our relationship to go, the results are dramatically better.
Call me old fashioned if you want.
I don’t care how great technology gets or how much you trust that property manager. You need to be able to visit your first properties if you want to build a real estate business. It’s that old saying that you’ll see countless times over this site:
Trust, but verify.
Sure, there are some reputable firms that can let you invest turnkey in the podunk Midwest and basically match the returns of the stock market if you want to, but if you are looking to actually buy real estate that will produce excellent returns for you, you need to be present and need to run a business.
And when you do things yourself, you have no idea going into your first investment just how long and how often you will need to be present. Problems you think will take forever take just a phone call to the right guy. Problems that you think will take 10 minutes turn into a five-hour ordeal, complete with three trips to and from Home Depot.
That’s real estate investing. Get over it.
It all boils down to this — real estate is local.
Plan to either invest locally or to be doing a lot of travel to your chosen location if you want to get into this business and make a real go of it.
Just make sure that you are comfortable with the location you choose. Forever.
If you can’t make that commitment, I’d suggest that you aren’t ready to purchase buy and hold real estate just yet.
Factor #4: Personal Life Conditions
Real estate requires not just upfront cash, upfront learning, and a commitment to the area that you are investing in. It also requires a commitment of time, in especially large doses at first. While the amount of time you spend on any given property will (hopefully) diminish as you stabilize it, be prepared to spend many weeknights and the better part of many weekends in the process of turning a new investment into a stabilized one.
This means that you will have to forgo other things like extra hours at work, leisure activities like hiking/skiing on the weekends, or hanging out with your kids. Real estate will dominate that time in its place.
This is particularly true for folks who work jobs and partake in activities with very limited flexibility. If you have to be in the office every day from 9-5, have an hour commute each way, and have things going on most weekends that take you out of town, then this real estate business will be a particularly harsh experience for you.
If you believe that making a significant time commitment to stabilizing your next real estate investment over the next few months will be a struggle, then I believe that the conditions in your personal life will make real estate investing a poor choice for you.
Here’s the good news: If you have a strong personal financial position, have built up a large amount of real estate knowledge and plan to continue reading, networking and learning, and are committed to being physically present in the location that you choose to invest in, then you are in good shape.
Now is probably a GREAT time to buy your first (or next!) investment property.
You have a high likelihood of success, and if the market tanks, GREAT! You will have a little bit more experience in real estate, and your strong personal financial position will enable you to buy many more deals at bargain prices in that future buyer’s market.
If the market continues to go up, then GREAT! You’ve built a ton of equity and can now intelligently harness that to buy more quality, stable investments that make sense for your life and investment strategy.
On the other hand, if you don’t have these conditions present in your life and the market tanks, then you will be screwed. You’ll be a motivated seller, and your investment will leave a terrible scar on your life and personal finances.
If the market does well, then you’ll be able to breathe a sigh of relief knowing you got away with one if you’re smart, and you’ll leverage out the wazoo thinking you’ve got it made if you aren’t.
In that last case, you’ll be on the other end of the phone from one of my yellow letter campaigns…
And I’m sure one of us will be getting a great deal.
Looking to set yourself up for life as early as possible and enjoy time on your terms? Scott Trench’s new book Set for Life, slated for release April 23, 2017, is now available for pre-sale! Whether you’d like to “retire” from wage-paying work, become less dependent on your demanding nine-to-five, or simply spend time doing what you love, Set for Life will give you a plan to get there. This isn’t about saving up a nest egg. It’s not about setting aside money for a “rainy day.” Set for Life is an actionable guide that helps readers build the accessible wealth they need to achieve early financial freedom.
Investors: Do you agree with this assessment of factors that need to be in place before buying rental property? Why or why not?
Leave your comments below!