Remember when you first caught the real estate bug? I do, and I remember being really excited. I remember thinking that all of my worries would soon be over and all of my dreams would be fulfilled. The people I was listening to and the books I was reading were all telling me the cash would just roll in. It would be easy. Nothing could go wrong. I was seeing the world through rose colored lenses.
So, of course, I jumped right in. I have been a real estate investor and landlord now for over a dozen years. The last time I worked a “full time job” was in 2005. And while I was not quite as naïve as I made myself out to be in the above paragraph, I was pretty naïve and the reality of things has been a bit different.
A lot of what I was t(s)old about real estate is true. It is a great way to invest and build wealth. But there is another side of the story that I had to learn from experience. In other words, I wish I had known then what I know now. So to help out those just recently bitten by the real estate bug, here are four things I know now that I wish I had known then.
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The Top 4 Things I Wish I’d Known When I Started Investing in Real Estate
Upkeep is something you shouldn’t underestimate.
All of the books I read said that you should put aside about 10 percent of your gross rents for maintenance. And that is likely about right if you just think about the things people break that you need to repair. But there is often a lot more than simply fixing something after it breaks. For example, what about keeping your properties nice looking and maintained?
Maintenance and upkeep are a bit of a different animal than repairs. What about fixing up your properties after a tenant moves out. Even a good tenant can cause significant wear and tear. I am here to tell you that 10 percent of gross rent does not even come close. It just costs a lot more money to keep everything looking nice, repaired, and in good working order. How much? I would budget at least 20 percent for repairs and upkeep when examining properties to purchase.
Tenants WILL drive you up the wall at some point.
No matter how well you screen them, no matter how well you vet them, there will always be one or two tenants that will drive you nuts. And as soon as you get rid of one, another starts the cycle over again. If you are going to be a landlord, there is no way around tenants. Yes, they will pay your bills, but they will also give you many grey hairs.
Recapture probably isn’t what you think it is.
One of the many things that is promoted about landlording is the income tax deduction of depreciation. Don’t get me wrong, this deduction is a great benefit. But at some point, Uncle Sam is going to get paid if you want to sell and cash out. This is called recapture.
Recapture is something that very few newbies understand, think about, or are told to think about. Basically, recapture gives a lot of that money you saved with depreciation back to the IRS when you sell. Sure, you can avoid it with a 1031 exchange, but sometimes you really just want or need to cash out. If you do, you need to be aware of how big your tax bite is going to be because you may not get all that you thought you were going to be getting.
Your retirement plan may not take everything into account.
Have you thought about your exit strategy? How are you going to retire from being a landlord? How are you finally going to get rid of those pesky tenants and all of that upkeep? There are generally only two ways to get out of the landlording business. Either you sell your properties or turn them over to a management company.
If you plan to sell and cash out, you have to think about the tax bite from recapture. But you also have to think about who will be buying your properties. Most likely, you will be selling to other investors who are looking for the same thing you were when you bought the property. And that is cash flow. So unless the rents in your area have gone up dramatically over the time, you may not get as much out of the property as you think.
On the other hand, you could keep the property and turn it over to a management company. But that is expensive to do and may seriously eat into your cash flow. While there are many good management companies out there, they will never care for your properties like you do, they make money from turnover and repairs, and you may have only traded one headache for another.
Yes — once the real estate investing bug bit me, I was hooked and jumped right in. I was excited and perhaps did not want to hear about the downside of real estate investing. However, even if you do not want to hear about it, you will learn about it at some point. Would I do it all again if I could go back with the knowledge I have today? Yes, absolutely. I would have perhaps done some things a bit differently with business structure or property acquisition. But real estate investing, despite the issues I have mentioned above, has been very good to me. And it can be very good to you as well. Just go in with your eyes wide open.
Investors: What about you — what do you wish you’d known from the beginning?
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