The Tech Employee’s Ultimate Guide to Getting Started in Real Estate Investing
While most real estate investing advice is geared to those who wish to escape their current jobs, not much has been written for those of us who love our jobs and don’t intend to quit them.
Personally, if I quit my job, I know I would be bored out of my mind. I enjoy my career and have no intentions to quit, but I wanted to build a real estate portfolio that would supplement my income to achieve my financial goals and my goals to give back to the community. The following is my real estate investing philosophy that I use to guide my decision-making. By no means will my philosophy be perfect for you, but I’ve found the following advice to ring true to those of us who want to get started in real estate without wanting to end a promising career.
I was blessed to start my real estate investing career with my father (which I talked about in BiggerPockets Podcast episode 74). When I started investing in 2013, the market was a much different place. We were just coming out of the trough of the recession so it didn’t take a rocket scientist to do well in real estate because most of the money made in real estate happens when there’s a significant distress in the market.
Without distress in the market, it’s hard to buy properties at prices that will provide you enough return for the time involved. Now that we are approaching the late stages of the cycle, this is where the risk/reward equation is skewed more towards risk and it’s very easy to lose a buck. Construction costs are increasing. New units of housing are coming online, rents are softening, and interest rates are rising.
Now is a great time to study real estate and build your real estate investing network. This isn’t a time to rush into the market to purchase something you’ll later regret.
Before we get started with real estate, you have to make sure you’re covering the basics. Assuming your company matches your 401(k) contributions, you should max out those accounts and invest in a target retirement index fund. An employee match is pretty much a risk-free rate of return that you won’t be able to beat anywhere else. Then you should set up a Roth IRA, assuming you qualify.
Next comes savings. As cliche as the advice sounds, it’s imperative that you live beneath your means by maxing out your savings. Adequate savings provide you the financial security to walk away from any situation or real estate deal if you feel you’re not being treated fairly. Without being able to walk away from bad situations, your life will be filled with constant stress. At the minimum, you need to save months worth of living expenses in the bank so that if you lose your job you can stay afloat during these tough times.
You also need enough insurance to provide your loved ones with support in case something tragic happens to you. We all think we’re invincible, but there’s always that risk something terrible can happen to you. Your company should provide you with the option to enroll in various accidental death, short and long-term disability, and long-term healthcare coverages. Make sure you pay for your disability coverage because if your employer pays for the coverage, you will face a large tax bill. If you haven’t applied for these insurances, please consider doing so.
Then you need to get your estate in order. I’ve seen many families suffer from a lack of proper estate planning. You need to set up a trust so that it’s made clear what your directives are when you unable to act on your own behalf. If you’re incapacitated, who will make healthcare decisions on your behalf? Who should be responsible for maintaining your assets? In the tragic event of your passing, where should your assets go? All of these questions need to be answered now, and you should speak to a trusted attorney.
Finally, you need to prevent yourself from getting caught in conspicuous consumption trap of buying things you don’t need in order to impress others. It’s very easy in Silicon Valley to fall into this trap because so many people are doing “amazing” things such as traveling the world or buying luxury cars and huge homes. You need to focus on your long-term goals and not get sucked into other people’s dreams. If you follow these guidelines, you will be on part of the way there to a healthy retirement.
High Net Worth But No or Low Cash Flow
The reason why I said “part of the way there” is because I’ve come across many tech employees that have stock portfolios worth millions of dollars, but they don’t have a single asset that’s producing cash flow. They are net worth rich, yet cash flow poor. The only way for them to benefit from these assets is to sell them, but once they are cashed out and spent, it’s gone forever. I met hundreds of paper millionaires during the Valley’s first tech crash, and unfortunately, they never diversified their holdings to other forms of assets to take advantage of their new-found wealth.
Related: 4 Toxic Habits That Sabotage Even the Most Promising New Investors
So How Do You Build Cash Flow?
Of course, you can buy stocks that pay dividends, but based on what happened with the GE and Budweiser, dividends aren’t guaranteed. Dividend payouts depend upon more variables than real estate, which increases the odds of companies not paying them out. For stock dividends, you have to hope the company’s business model allows them to earn large returns on capital to pay a dividend, hope the company’s products stay relevant in the future, hope a competitor doesn’t steal market share, and hope the management team is competent.
For real estate, you need to buy a good property located in a desirable location for a decent price in order to attract the right tenants for the property to cash flow. This has fewer variables, which decreases your risk exposure, but of course doesn’t guarantee cash flow.
The Benefits of Working in Tech
Being that you work in tech, you likely have a steady paycheck, a generous 401(k) program, and resources to easily qualify for a mortgage. This is an advantage that most investors lack, and you must use this to the best of your ability. While full-time real estate professionals need to buy and sell properties in a frothy market to pay their bills, you have a good job that allows you to wait until a frothy market cools off and then swoop in when the real estate cycle hits a trough.
While real estate is currently in vogue, many people are feeling the pressure to deploy capital as if money is going out of style. Control that impulse! The real estate cycle has shifted from a buyer’s market (roughly 2009 to 201) to a seller’s market (2016 or so onwards). In this market, the returns aren’t as high as they used to be, and I’m seeing people do silly things in the market such as taking out home lines of equity or loans on their stock portfolio to buy low yielding real estate investments. I’m seeing syndication pro formas with assumptions that the economy will grow forever, which isn’t how the business cycle works.
At this point in the market, money is cheap, and deals are being bought at a premium, which is a bad sign for investors because the risk/reward equation is now skewed towards more risk for each marginal unit of reward. When the cycle slows down, then you will see money becoming harder to obtain and home values retreating, which makes it easier to find sound investments. At that point, you are in the driver’s seat and you will have an opportunity to buy real estate at discounted price.
How Do You Know When the Market is Cooling Off?
When you can find a property that meets your strict criteria. Each person has their own criteria that fits their return goals, and you need to create your own. But as a baseline, after all expenses (mortgage, taxes, insurance, operating costs, long-term capital improvement reserves, etc.), you should at the least hit a cap rate of 6% based on historical returns and assuming the property’s price is in line with comparable properties. I’m not saying that’s a cap rate I aim for, but if you’re shooting for anything lower, you are exposing yourself to overpaying for an asset.
Every Investor Hates Sitting on Cash—Until They Need it
I regularly take calls from investors who feel anxious for having large amounts of capital sitting on the sidelines. These investors are already fully invested in the stock market and might have a few real estate investments. When I hear these stories, I think of the lessons I learned from Warren Buffet’s annual shareholder letters. I want to highlight two excerpts from his annual shareholder’s letter.
“Our aversion to leverage has dampened our returns over the years. But Charlie and I sleep well. Both of us believe it is insane to risk what you have and need in order to obtain what you don’t need.”
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“Despite our recent drought of acquisitions, Charlie and I believe that from time to time Berkshire will have opportunities to make very large purchases. In the meantime, we will stick with our simple guideline: The less the prudence with which others conduct their affairs, the greater the prudence with which we must conduct our own.”
When markets are booming, we hold on to cash while feeling great shame. So we must get rid of it as soon as possible because everyone else is making so much money. Yes, losing a small percentage of purchasing power due to inflation hurts, but being knocked out of the game by losing all of your money is even worse. The name of the game is to stay in the game long enough so you can purchase assets that fit your criteria. No one can forecast when the corrections will happen, but you need to be in a position to act when they appear.
Look at your cash as an oxygen canister needed for climbing Everest. At the base of the mountain, everyone has oxygen canisters, and some people carry less because it’s a burden to lug those heavy things along. Some expect everything to go smoothly due to excellent forecasts and expertise of their guides, so they decide to carry just enough to get them up and down the mountain within 60 days. Others know things can get rough, so they will bear the burden of carrying an extra oxygen canister in case things don’t go as planned (source: life).
But when in you’re in the mountain’s “death zone” at 26,000 feet, things change. The weather forecasts are off, and now you’re suffering from a freak blizzard that extends your trip by another 10 days. You can barely breath due to the high altitude. Previously, that extra oxygen tank was looked at as a burden, but now it’s worth its weight in gold. You’ll thank your lucky stars you have an extra one.
Am I saying hold all cash? No, but when you’re already heavily invested and new opportunities don’t meet your investment criteria, think twice before dropping your extra oxygen tank.
Preparing Your Emotions
Currently, everyone I speak to wants to invest in real estate. Some people think if they don’t buy something now, they will never ever be able to do so in the future. That sentiment concerns me and causes me to be even more conservative than others.
Related: What Newbies Should Know About Financing Investment Properties (Versus Homes)
During the financial crisis, when stocks were falling to all-time lows, my father had a very clear sense that it was a great time to invest in general. He deployed an immense amount of capital picking up stocks and pushed me towards investing in real estate. He kept telling me that in order to make a great return, you need to have confidence in the long-term future of the market so you can think clearly while other people are losing their heads.
What you need to do now is reflect on the last market crash and how you handled yourself. Did you lose your cool? Did you sell off? Did hide your money under a mattress? Or did you start deploying the excess capital you had to pick up assets at a discount? If you did lose your cool, what will you do now to prevent yourself from missing out on a great opportunity?
Staying in the Game
Many of you are super eager to get started, and that’s great! But you have to understand real estate is a multi-decade endeavor—not a one-year sprint. The real gains from real estate appear when years of rent increases, appreciation, and currency inflation, which allows us to use weaker future dollars to pay down debt that was denominated in current more expensive dollars, combine. As time goes on your properties loan-to-value ratio will decrease allowing you to pay off your loans completely and free up more cash flow or roll them into larger properties.
But in order to be successful, you have to develop staying power to ride out of the ebbs and flows of the market. Many investors have been shaken out of real estate investing due to not expecting the market to go down and paying too high of a price for real estate. Some have short time horizons of five years or less, which increases the volatility of returns and increases the odds of you selling your property in the midst of a downturn.
The truth is that if most investors were able to hold on to their cash-flowing properties purchased before the 2006 peak until the present, they would be back to break even. But unfortunately, most investors didn’t buy cash-flowing properties with enough margin of safety or had holding periods that were too short.
Understanding Conflicting Incentives
Real estate agents, syndicators, wholesalers, and other real estate professionals who make money off of transactions have short-term incentives that can go against your long-term goals. This isn’t a ding against these real estate professionals. I know many of these professionals, and the ones I associate with do their best to balance their interests and their fiduciaries interest.
I don’t begrudge them for trying to make a living, but you have to understand they only get paid when money changes hands, so they have the incentive to pressure you into an investment that doesn’t make sense. You will also find other investors trying to sell their poorly performing properties at the peak of the cycle to offload their duds to newbie investors. Just because an investor owned a property doesn’t mean it’s the right property for you. Make sure to do your due diligence.
A Note on Due Diligence
Real estate is a cutthroat business, and you will come across many unscrupulous actors. If you get a referral, whether from BiggerPockets or outside of BiggerPockets, don’t assume it’s a good referral. Do your homework. Always ask people who are trying to steer you into an investment or working with a particular person, “Are you receiving a commission from this deal? And if so, are you a licensed real estate professional?” If they answer yes to the former, they should be a licensed real estate agent. If they aren’t, back away because if the deal goes south, you don’t have the benefit of the department of real estate backing you up.
Winning the Battle and Losing the War
Think of the times outside of sports where you have competed for something and were happy with the results. Maybe you fought hard for a promotion by isolating your peers. Perhaps you lowered your commissions in order to beat another real estate agent to a deal. Or maybe you overpaid for a piece of property in order to close the deal. All of these scenarios result in a win in the short-term at the expense of losing the long-term battle. This is known as a Pyrrhic victory.
The most important thing in real estate is buying a property at a profitable price. If you screw this up, the rest doesn’t really matter.
Competing for bad deals lowers your return on real estate, causes undue stress, and leads to poor decisions. It’s as if you are fighting for the lowest return on your time and money. If you don’t remember anything else I said here, remember this: There will always be another deal. Having the ability to walk away from a deal (or anything else in life) is the most important power to have in real estate. Most investors can’t do this, and they will suffer the consequences. Because you have a job, you have the power to walk away from deals when the real estate market gets out of hand.
The Difference Between Linear Growth and Exponential Growth
When newbies get started, it’s easy for them to get discouraged because real estate is not as easy as purchasing stock. They look at real estate as a linear game, meaning for each unit of time input, they should receive an equal amount of cash output. WRONG! Real estate is more of an exponential game. When you first start off, you will see little or no return in your efforts. It took me about a year of research and hard work before I made my first investment, and that was when the market was buyer friendly.
In this market, it could take much longer. That being said, since I’ve made my investments in real estate, there are months when I’m not doing much work in real estate, yet the returns from my initial input of time are exponentially increasing in the forms of output of cash flow, appreciation, and new opportunities to set up partnerships with other investors. While others are living off the cash flow from their properties, we have jobs that pay our bills so we can reinvest our cash flow into other properties to take advantage of the power of compounding interest.
So don’t get frustrated, take it slow, and consistently spend time studying real estate. Don’t focus on the output. Focus on what you’re learning and how you’re growing personally.
Comparing Yourself to Others Will Only Hurt You
Never compare your real estate success to others because we all have unique life circumstances. Hearing the first BiggerPockets Podcast episodes about people buying houses in the depths of the recession for a pack of smokes or a jug of moonshine definitely can be disheartening when current prices are in the stratosphere. Don’t freak out. Real estate goes through cycles. You need to focus on your own immediate goals—and don’t compare yourself to others. Comparing your real estate endeavors to others is a great way to make poor financial decisions.
Be wary of hindsight bias. You really would have to try hard not make money in real estate between 2010 and 2013. Some people take absolute credit for their success and are willing to sell bootcamp tickets to cash in on their luck. But due to survivorship bias, we aren’t hearing the stories from the people who used the same strategies before the financial crisis. The reason why we don’t hear from them is bankrupt people don’t like to share their stories of failure. They sort of disappear and are ignored. People would much rather chase the gurus who spin their stories of success and wisdom.
So when you see someone who did well during this last period of time, realize that a certain aspect of it could be sheer luck, and if so, don’t be so eager to attribute it to their sage wisdom.
Related: The New Investor’s Simplified Guide to Landing a First Investment Property
What Does This Mean for You?
This is a great time for you to build your real estate investing network, learn about real estate investing, and save your money. This is also a time to be cautious when it pertains to deploying capital in real estate. Sure, you might be able to find an opportunity here and there, but you have to take it slow.
What Types of Real Estate Investing Should You NOT Do?
Fix & Flip or Any Major Rehab Project
This strategy is out due to the major time requirement, the knowhow involved in managing such a project, and the increasing cost of construction labor due to a shortage in contractors. Not to mention, if you miss appraisal or your expenses balloon, you’re going to have a bad time. Right now, BRRRR is in fashion, but once properties start missing their appraisals, you will see why that method can be so risky and was part of the reason people failed catastrophically in 2006.
Tax Liens and Note Investing
These investments are doable, but you miss out on rent growth and appreciation. I’m assuming you’re aiming for rent growth and appreciation. In some cases, the borrower is unable to pay back the loan and you might be able to scoop up the property, but the foreclosure process can take forever and there are no guarantees other parties won’t try to bid up the house price via a shill.
Most importantly, you have a full-time job and you don’t have the time to head over to the courthouse and bid on failing properties. Also, we never count on appreciation when building our financial models, but if we don’t have appreciation, it hurts our ability to raise rents down the road because appreciation is a quantitative measure of the desirability of an area and a person’s willingness to pay premium prices to live there.
No. Development projects have a million ways to implode for first-time investors and you really need to know someone you trust can walk you through all the intricacies of development. My family did make money off of our own projects, but that was after years of experience in investing in real estate, building experience in construction, and developing relationships with the city. We had great success, but we also had our butts handed to us on a deal. For newbies, I suggest staying away until you truly understand development.
3 Types of Real Estate Investing You Should Consider
Being that you have an awesome career to focus on and family responsibilities, you need to use an investment strategy that fits within those time constraints. I recommended tech employees start with the following are three strategies when they begin investing in real estate.
Buy & Hold Within an Hour-to-Two-Hour Drive From Your Residence
This is hard for most of us to do in the Bay Area, but in an ideal world, you would be able to easily drive to your property to check on it and make sure your property manager is doing their job. If you decide to pull the trigger on an investment, buy something conservative. It should be a single family house or a small 2-unit duplex.
If you don’t have experience managing tenants, you shouldn’t set yourself up for failure by making your first investment a property that has 3+ units. Ease yourself into it by starting with a duplex. Most importantly, invest in a neighborhood that’s no lower than a B-class area, which means low crime, with blue and white-collar workers, within the path of economic development.
Out-of-State Buy & Hold With a Property Manager
Many employees are doing this right now. They are buying properties out-of-state and using a property manager to manage them. I suggest you find one primary market to invest in and then do your market research on the state to learn about demographic trends, job trends, government climate for business, earning potential of residents, etc.
Then pick a city and neighborhood to research crime rates, schools, location relative to job centers, and the city’s general plan for development in the area. For the love of all that is good and science, when you’re starting, don’t invest in a neighborhood lower than a B. The lower you go, the more crime and the more landlord hassles you will have to deal with (more on that for another post). And most importantly, get yourself on a plane to see the area in person. Nothing beats visiting an area before investing there.
Basically, you’re a silent partner in a deal for a large apartment complex or commercial building that’s already constructed. For these deals, you need to be an accredited investor or a sophisticated investor. Syndication is similar to buying a stock without having the benefits of liquidity. When you buy a stock, hopefully you read the 10-K to understand the company’s business model, opportunities, management, and risks involved in buying the property. Once you’ve read it, then you make a decision to invest or not. From there, you’re basically a silent partner, and hopefully the company does well so you receive a gain on equity or a dividend.
For a syndication, instead of reading a 10-K you receive an Offering Memorandum, which is essentially a 10-K but for investing in a large multifamily property, retail building, storage facility, or development deal (development is the riskiest). After reading the terms, if you like the deal, you can write a check to the syndicator for an equity or debt position in the deal. If the deal goes well, you receive regular rent distributions, and once the holding period is over, you receive your principal and appreciation.
You can find syndication deals via RealtyShares, Fundrise, and Realty Mogul.
Wait, Why Didn’t You Mention REITs?
Yes, REITs are freely traded on markets and you can get in and out whenever you want, but they have an added level of volatility so they aren’t for the faint of heart, and when you see those daily price fluctuations, it can compel you to cash out too soon. The problem I have with REITs is it’s hard to get specific exposure to a desired area, and it’s hard to see the specific assets and returns in the fund.
For instance, I’m exposed to Sacramento for my buy and hold, but let’s say I want direct exposure to Texas, specifically South Austin near a recent development. It’s hard to find an REIT that is micro-targeted. Also, you don’t have that much control over the actions of management or exposure to them, so you better hope the team knows what they are doing. That being said, REITs can be great investments; it’s just up to you if you want to go that route.
Spreading Yourself Too Thin
I’ve known quite a few investors who have scattered their buy and hold rental portfolios over numerous states in the hopes of higher return. While they have the energy and time to do this, they forget that even returns have a law of diminishing returns. Scattering your portfolio creates an added level of complexity for your investments, which can lead to poor decision making. As you grow older, keeping track of the economies, policies, and tax regimes of multiple states can be more trouble than it’s worth.
Assuming this is your buy and hold real estate, I recommend investors go deep in one market before spreading themselves too thin between multiple markets.
As you begin to develop a better understanding of your primary market, you can spot opportunities and deploy capital faster than rookie investors. Eventually you’ll develop rich networks you can tap into to provide your business with the strength it needs to succeed.
A Blended Approach to Real Estate Investing
You should own buy and hold real estate indefinitely because you have a much longer holding period than standard partnerships or syndications. But you should have exposure to syndications, REITS, and other real estate partnerships to broaden your exposure. Using the latter forms of real estate investing, you receive the benefit from exposure to other markets, while leaning on professional management to protect you from the potential pitfalls of entering markets you’re unfamiliar with. Of course, you need to do your due diligence! The only problem with partnerships and syndications is that eventually they end, and you’ll have a chunk of cash you’ll need to reinvest. But by having a healthy buy and hold portfolio, you’ll still have exposure to the market while you’re looking for a place to reinvest your capital.
Well that’s it for now. Let me know what you think.
Next time I will go into a deep dive on how to analyze real estate markets.