Analysis paralysis or due diligence?

Question

Hello BP community,

First post here and a newbie, wannabe re investor. I have been educating myself for the past 6 months, reading books, blogs, listening to podcasts etc. I feel like I've maintained an objective point of view throughout and have taken steps to learn how to analyze properties without the emotion. In the past 6 months, I have evolved from long term investment, SFR (I was ok with break even)  to multifamily units that cash flow. I have capital available to get started. Taking the next step is proving to be the most difficult. For every post I read about investing for cash flow (and surviving any down cycle), I see a post on the impending "correction" or "bubble." For every post about investing where you know and live (if it makes sense),  I see one on out of state investing for better cash flow opportunities. I am having difficulty reconciling every pro/con argument there is out there. Its just too easy to talk yourself out of taking action when you over analyze. I can anticipate the response from this post will be something to the extent of identify your goals, establish your criteria and go get it. My problem is, that my re market (I live in San Diego) is simply not meeting my demands/terms, however unrealistic they may be. Does that mean the timing is simply not right for me or should I take what the market is giving me and come up with more realistic expectations (i.e.: less cash flow or lower ROI).

An overwhelming number of "experts" have claimed that we are at or nearing the top of the cycle. Objectively, it seems imprudent to want to jump in right now. A few years from now, will I say I should have jumped in in 2017 or will I say, good thing I waited? I am interested in learning where folks draw the line between analysis paralysis and proper due diligence.

thanks,

Felix

Brian Burke · Answer

@Felix Yam, timing is a very important element of successful real estate investing. If anyone doesn't believe that, ask all the landlords that bought SFR rentals in California in 2005.  Or you could ask folks who bought rentals in Buffalo in 2005--they had a totally different experience and didn't see a 50%+ drop in prices like owners in Fresno CA.

My point is that markets across property types and different areas of the US don't track in parallel.  Houses in Florida might be appreciating while apartments in Detroit are declining.

So rather than waiting for a huge decline that might never materialize, look for markets that have strength and fundamentals that support the type of property you want to buy. As you analyze investments be sure to forecast future income and expenses and stress test your numbers to make sure that you can survive an adverse cycle.  And use conservative leverage--the hardest hit when the chips are down are the ones with the most debt.

If the market does decline, that's a good time to look to further expand your portfolio.  Debt and equity is harder to get in down markets and lenders and investors will be looking very closely at your experience. The assets you buy today could form the foundation for the experience you'll need to get funding in a down market.

Kristina Heimstaedt · Answer

First, figure out how you protect yourself or hedge your bets. It's with this in mind that people say look for cash flow. California is a special market given that we have higher prices and don't always have good rates of return. However, we have significantly bigger swings which can result in massive appreciation and depreciation.

If I were in your shoes, I'd reach out to people in my local market and get an understanding of how they structure things. I'd then take their rate of return that they look for in opportunities and look for something similar as I assessed deals. If deals aren't meeting that criteria, don't do the deal. The people who got hurt during the recession were the ones who said "it's real estate, it doesn't go down" or "I just feel like this is a great deal". Look at the numbers. You know how to do that.

I'd also stay local given that you don't have any properties yet. Nice to be hands on when you need to especially if you want to keep costs low and decide that you'd rather do the work yourself. You also know where people want to live and where they work and what they want to do. Having that insight is valuable.

Bottom line, set your criteria and be disciplined. FOMO often results in bad results in real estate.

Justin R. · Answer

@Felix Yam No opinion on which strategy is right for you, but I've purchased enough small MFR locally to have a defensible opinion on what will make you money and what won't.  If you'd like to walk through a couple proformas (based on actual income and expenses) for some stuff I'm operating, I don't mind showing you.  If nothing else, it'll give you some concrete data so your analysis can accurate measure local stuff vs other opportunities.  Feel free to DM me.

My one piece of advice is the following: In the real estate game, "experience" is measured in decades.  Place extra weight on the input you get from those who have been around for a decade or more.

Jesse Imes · Answer

Love the idea of always making income in retirement as your no exit strategy. I have two properties in Buffalo, NY and I know I will make a 25% + COC return on the first year and it may decrease over time, but my end goal is to have income in retirement. Or for my kids to take over and use the income to help with college, etc.

Brian, do you invest in Buffalo? I know you mentioned the city above. I'm looking to link up and help finance some projects in Buffalo with trusted and seasoned investors if you have any recommendations?

Thanks!

Brian Burke · Answer

I always factor my exit.  In fact, I work all of my investments backwards from the exit and that's how I determine how much I can pay to enter.  If you buy right, even out of state, you can exit when the timing is right.  And if you are paying attention you should know it when you see it.

As it relates to taking advantage of an opportunity in your local market, having investments out of state doesn't prevent you.  Perhaps you've made other money and you can use that money for the local opportunity.  Or perhaps you save the income from your out of state deal just for the purpose of taking advantage of future opportunity.  Or perhaps you refinance your property to free up cash to grab a deal.  And if you think about it, if you had a local investment you face the same obstacles.

But you can also violate all of your own rules...for example I violated my "factor my exit" rule when I made several acquisitions of personal rental properties.  I didn't factor an exit at all because I have no plans to exit.  I financed them on 15 year loans and when the time is up I'll own them free and clear and could retire off of the rental income.  Meanwhile they net me nothing.  But I know that if I do nothing else in life I'll still have an income in my retirement.  So I guess it all just depends on your goals and the purpose for the investment.  And mixing up the strategies a little so you have more irons in the fire.

Felix Yam · Answer

Thanks for the input! I understand the rationale about not being able to time the market, makes sense, even though I don't think we are all naturally wired to be so objective and rational ;)

One of my fears is tying up capital in a so so property that I "settled" on to get in the game...I know, analysis paralysis...

Michael Johnson · Answer

Although the 1% is great to have in a property, in many markets it just isn't possible. I'm sure you're familiar with the Coronado area. Many properties there have 2% cap rates and will never meet the 1% rule. Does that mean they are not investment worthy? Of course not, they offer a safe long-term investment in relation to many markets and therefor pay less premium.

I think it is important to make sure your spreadsheet (or whatever you use to analyze property) is accurate, so bouncing it off someone else who has experience may be a good idea. That way at least you know your estimates are rational and fairly close.

Craig Curelop · Answer

@Felix Yam - It is silly to try to "time" the market. If you do that, you're just gambling, it's not investing.

If you have the capital to get started, my suggestion would be to call a few lenders, call a few agents and start searching for a property that works for you. There are deals out there, they may just be harder to find in your market. Maybe you go a little bit outside of San Diego where properties are a little more affordable?

Either way, my suggestion would be to purchase a property (maybe a house hack?) for your first one. Save, save, save so you can purchase another one next year and the year after. If you purchase a property every single year, you will buy when the market is up, when the market is down, and everywhere in between. That way you mitigate your market risk.

As long as the property cash flows and you can cover your debt payments, you'll be fine. My suggestion would be to stop trying to look for THE BEST deal and get a deal that works for you. You'll be searching for THE BEST deal for a very long time. And when it does come along, what makes you think you'll be in a position to get it over the next guy?

If you find that property, where you can service the debt payments, you will be in a much better position than if you sit on the sidelines and try to "wait" until the next crash.

Felix Yam · Answer

Thanks for the advice! I plan to attend some local meet ups and get a better sense of what local investors are doing. From an objective standpoint, the numbers are telling me to invest out of state for better returns but my gut is telling me to stay in San Diego for security and ease. I try to convince myself that I am ok with breaking even as long as the mortgage is being paid down and my expenses are covered, essentially trading returns for easier to manage properties and less headache. I never intended on becoming a full time re investor and was mainly looking for a relatively "safe" long term investment (compared to equities) that could provide some passive income along the way. With that in mind - would you settle for not meeting the 1% "rule," as long as you don't have negative cashflow?

On the other hand, the more I learn, it seems silly not to pursue greater returns and maximize profit, especially when you have the capital and resources to do so...

@Brian Burke - I get your point about markets not tracking in parallel but part of my fear is entering an out of state market now and not being able to exit when and if the market I live in shows an opportunity and I need that capital back. Do you factor that exit strategy into your purchase when moving in and out of markets or do you consider that capital tied up for a period of time and go raise/find new capital for new opportunities that arise?

Ryan Evans · Answer

You're always going to get opposing views in any sort of business venture. Especially real estate. But there are a million different strategies and they sometimes only work in the right situation. Buying for cash flow can get you through a recession, but appreciation can make you tens of thousands of dollars in a year if you time it right.

When I was in your situation I looked at my first deals as an investment in my RE education. I assumed I would lose a bunch of money on the first one and was mentally prepared for it. Just like getting a degree from college, you expect that the money you spend will come back in multiples down the road. As long as you don't make the same mistakes again you should be headed in the right direction.

Almost all successful people failed a bunch of times before they finally figured it out. You'll only know once you get started.

I spent all the cash I had on my first deal and was prepared to lose it all. Of course, I still did a ton of due diligence, but it ended up working out. I learned a ton and now it's cash flowing over $800 a month. Just go invest out of state, learn the hard way, and get started. We're not getting any younger here!

Analysis paralysis or due diligence?

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