Did you get a chance to listen to that amazing, crazy interview with Tom Krol on the BiggerPockets Podcast? Tom is a great evangelist for real estate investing. With enthusiasm, he exemplified what you can get from a little grit, elbow grease, and persistence.
Now for the Debbie Downer perspective: Tom Krol is one of the investing world’s many examples of survivorship bias.
Survivorship bias, or survival bias, is the logical error of concentrating on the people or things that “survived” some process and inadvertently overlooking those that did not because of their lack of visibility. This can lead to false conclusions in several different ways (source: Wikipedia).
Media is less depressing when it features the fortunate minority who overcomes the odds. It leaves little room for those who fail, quit, or never got started.
Survivorship bias inevitably causes many listeners to ignore first principles. If you’ve spent a few days on the BP Forums, you’ll recognize this post:
John Doe from Springfield, Any State
Hi everyone! Really excited to get involved in real estate. I’ve been scanning the forums for a few weeks now. Done my reading — INSERT_BOOK_HERE was really inspiring.
My credit is pretty bad, and I have several thousand dollars of credit card debt. I really hate my job and am trying to get out there and use OPM to conquer my local market. Thinking of getting started with value-add flips and residential buy & holds. Looking to connect!
When I respond to a post like this, my eyes are pulled to a short list of issues:
- “My credit is pretty bad”
- “I have several thousand dollars of credit card debt”
- “I hate my job”
Would you believe that conquering these three bullet points are the key to John Doe’s success in real estate? I believe it. If Mr. Doe ignores these bullet points and their underlying causes, he’s headed for a larger correction, only later.
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“My credit is pretty bad.”
There are a million and a half reasons why people find themselves with less than ideal credit. Some of the reasons are plain old erroneous. John Oliver did an interesting show on that if you want to know more. For the sake of this article, let’s consider the two cases where credit reporting is valid.
1. Credit Issues Under Your Control
For items under your control, the prescription is pretty obvious: STOP LIVING BEYOND YOUR MEANS. I don’t want to over-simplify the process, but that’s the big part. Realize you may need a smaller home, a more affordable car, fewer expense-ridden hobbies, less shopping, fewer vacations, and more meals at home.
The secret is that anyone willing to overspend in their life is assuredly willing to overspend in the real estate business. For instance, a flipper willing to live on credit for a nicer car is likely to do the same for granite countertops. It’s not easy to force discipline in your business if you can’t force it at home.
2. Credit Issues Outside of Your Control
For things you don’t control, the answer is not as simple. Medical expenses are a big one. It’s a classic example of an unexpected expense that hits randomly. Some people have obligations to family members. These obligations will not disappear, and they are definitely more important than growing your investment business.
Here’s an interesting thought. Maybe you have a sibling with an unexpected, long hospital visit and subsequent disability. Maybe you’re on the hook for some of the costs associated with the episode. As any landlord will tell you, tenants do the same thing. Sure, you won’t pay their medical bills, but you will be stuck with a few months of lost rent.
I did my first eviction this year. All told, it cost me three months of rent and some of the turnover costs. Despite that, this one was considered pretty smooth! I wouldn’t have made it without some cash reserves.
Unexpected and unplanned setbacks are a part of the real estate business. The same reserves that will keep your future credit intact will help you be a better landlord, flipper, or wholesaler. Everyone can use their money for flexibility, but only if they have the discipline to hold some back.
“I have several thousand dollars of credit card debt.”
Credit cards are one of the easiest and still most abused topics in personal finance. If you have credit card debts, you want to target the most risk-free way to pay them down. The most risk-free way is to work for money (maybe take some side work), cut your budget, and pay.
Many interest rates are in the 20%+ range. I know no part-time real estate investors who predictably make these kinds of returns year over year. Certainly not when they’re getting started. You won’t be able to move faster than your APR.
Another way to think about it: If you save $300 a month, you get $300 a month to invest or pay down debts. If you earn an extra $300 a month, you get $300 – ($300 x your marginal tax rate). Depending on your tax rate, this will be anywhere from $195 (35%) to $270 (10%). A penny saved is truly better than a penny earned.
Managing outflows always will be a part of your investing story. I’m encouraged when I hear investors talk about personal finance goals. Even if they never get started in real estate, the discipline will be an asset in every business and stage of life.
“I hate my job.”
I may not be the best person to offer advice on this. I definitely like my job. In fact, I think my job is the most critical aspect of my real estate strategy. I have access to a unique and creative source of funds: my income.
Some people have got the talent to propel themselves full-time into real estate investing. To those who can take the heat, more power to you. To everyone else, I suggest you wait to cut off your legs until you test the water. Your job will give you a couple things that should not be underestimated:
- An initial source of funds
- Access to conventional loans (assuming you managed to get your credit in order)
- Access to potential partners and finance — through colleagues at work and in your industry
- A hedge against your real estate investing dreams
Remember survivorship bias? Number four should help you out with that one, just in case you’re the kind of person who doesn’t survive or you hit a rough patch and need some reserves.
Give some discipline to your occupational pursuits, and you will be the kind of person who commits to a rough rehab or a bad batch of tenants. If you’re convinced to leave your job, make a minimum savings target before you leave.
I’m encouraged when I meet new investors who wish to be financially healthy. Real estate pressure focuses on deals and pounding the pavement. The healthy players survive, and getting yourself up to health is much harder when you lack trust, discipline, or reserves. There will always be a bias towards survivors who take another path. For the rest of us, some personal finance focus is a great way to get started.
Newbies: What items are holding you back from success? Experienced investors: Anything you’d add to this list?
Leave a comment, and let’s talk!