Look, you’re going to have to get started at some point if you want to join the wave of real estate investing. The bummer is that you are likely going to have to teach yourself how to do it because I don’t know any of us who learned this in school. It’s kind of ironic that real estate investing is so tied into something that is extremely important in our lives—financial matters—and is such an in-depth topic with a potentially large amount of risk—and yet we’re taught nothing about it.
But you can do this. Part of the fun is learning.
What is the best way to dive into this industry while minimizing your risk as much as possible? Preparation. Benjamin Franklin once said, “By failing to prepare, you are preparing to fail.” This could not be truer in real estate investing.
Now, there are two extremes of preparing:
- Diving in with minimal to no preparation, i.e. having no idea what you are taking on and what the potential outcomes are going to be.
- Paralyzing yourself with over-analysis/preparation, i.e. analysis paralysis.
I don’t want you on either end of those extremes because you will either get yourself in trouble or never make a move.
I want you prepared.
I am offering you a concise checklist of the things I think you need to be well-educated on before you dive into an investment. Now, don’t go to the extremes of any of them because you will paralyze yourself, but have a confident understanding of the basics of each, and you will be setting yourself up pretty good.
If you have absolutely no knowledge of any one of these topics, do not invest yet.
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6 Aspects of Real Estate Investing You MUST Understand Before Your First Deal
I could scream about understanding numbers all day long. I know for a fact that I didn’t have a clue how to read numbers when I got started in REI, and I know for a fact most people don’t even realize they need to be studying (and understanding) numbers. Hello! It’s investing—the whole point is to make money, and money happens to be quantified in numbers. If you are flipping properties, you’ve got to understand what an ARV is, how to buy a distressed property for a smart price, how to estimate a rehab, and how financing each part (if applicable) will work with the numbers.
If you are buying rental properties, you have to understand what “cash flow” is. You have to know how to determine if a property you are looking at is even potentially going to get you a profit, outside of the assumed 3% appreciation per year that people think every rental property is going to experience. The point of owning a rental property is so that the income you receive on it is greater than the expenses that go out on it, however that may happen. Appreciation is one way, but cash flow is a fundamental basis for success. If you don’t have a clue how to run numbers on a rental property, first of all don’t buy anything just yet, and second of all, check out “Rental Property Numbers So Easy You Can Calculate Them on a Napkin.” Numbers are easy to calculate, but you first have to learn how to do it! This is truly the crux of your investing, so dear golly, don’t short yourself on it.
You’ve probably noticed by now that there are several ways to be involved in real estate investing. What people don’t tend to notice, however, are the implications of each strategy. Every investing strategy gets you something different, accomplishes different goals, and comes with different levels of risk. Before anything, even probably before you learn numbers, you need to understand what you want to accomplish with investing. What are your ultimate goals, and what levels of work, effort, and risk do you want to take on? I promise you there is a strategy solution for every combination of goals, involvement level, and risk, so take the time to understand what each strategy offers and see which is the best fit for you.
I would first ask yourself how much time you want to spend on your investing. If you want to be completely active and busy with REI, you may not want to buy rental properties and have a property manager landlord them for you. If you want to be as least active as possible and just have investments for financial gain and not to take on extra work, buying rental properties and having a property manager landlord them for you might be perfect. Flipping, on the other hand, may not. Are you super-risk adverse? Well, then you may not want to flip or invest in rental properties in low-income, dangerous areas. If you love a challenge and don’t mind the risk, buy a distressed apartment complex in Compton and have at it. If you have absolutely no idea where to start on figuring out what REI strategy is your best fit, check out “Which Real Estate Investing Route Should You Go?” It’s very basic, but it can at least get the ball rolling for you to start your exploration. If you don’t have a clue what strategy is best fit for you or which one you are most interested in, don’t invest in anything yet.
3. Niche Know-how
Once you decide on your strategy, you need to understand enough about it so that you don’t get yourself into a huge heap of trouble. I will list some of the things you need to know about your strategy below, but first you’ve got to know two basic things about the strategy that you choose:
- What factors are involved in a successful investment as opposed to an unsuccessful investment?
- What is the general process to carry out said strategy?
I’ve never done one of those $5,000-20,000 guru courses, but I would imagine that those courses spell out exactly these two things. What factors go into whether flipping a property turns out to be a success or a total failure? What is the difference between a rental property that will turn out to be a success in the long-run versus a rental property that could turn me upside down financially? If you don’t know the answer to that general question, do not invest in either of those strategies yet! Once you find out what can make or break an investment, then you obviously have to know how to do it. Make sure you learn the right way to do it. There are wrong ways to do everything, especially when we are all left to figure out how to do something on our own. Ensure that you find someone respectable and proven in their strategy that you are interested in and follow their lead. This may take some shopping around, and you may get bad pieces of advice along the way, but you can learn how to do any kind of investment correctly. If you have not taken the time to understand the proper steps involved in the REI strategy you want to be involved with, don’t invest yet.
Part of learning what factors make or break an investment is learning about market fundamentals that pertain to that strategy. I will use flipping and rental properties as my example again because they are two of the most common REI strategies. While one market may be extremely favorable to flip properties in, it may be a horrible market to buy rental properties in—and vice versa. A particular market may be horrible for both or amazing for both. How do you know? What are the traits of a market that make it good or bad for an investment? You have heard the phrase “location, location, location.” There’s a reason you will always hear it. But what about a location is important? For flipping, arguably the most important part of that strategy is selling the property for well over what you put into it. Can you do that in the market you are considering flipping in? Don’t be fooled into thinking you can do it well just anywhere.
For rental properties, what are the different traits that vary between the markets that you should look for and know how to assess? For one of the most general considerations about for rental property markets, check out “How To Know if a Real Estate Market is Wise to Invest In (With Real Life Examples!). “If you want to know different traits that can vary between markets and how they may impact your rental property investment and if you love nerdy graphs, check out “How Do Real Estate Markets Differ and Which Should You Buy In? “At minimum, you have got to understand market fundamentals as they pertain to the route of investing you want to pursue. The market you invest in is one of the biggest…
5. Risk Factors
Oh, hello, risk factors. I was wondering where you were hiding this whole time. I had a feeling you were coming up soon since we were talking about markets. If you do not know what factors in an investment strategy affect your risk level, you are in for a wild ride. It’s not about securing whether or not your investment will for sure be successful—because there’s no guarantee of that no matter how many risk factors you mitigate. Still, there is a huge difference in levels of success within the different risk levels. It’s the whole reason why returns are typically projected to be higher on riskier investments—because the higher return is compensation for taking on the higher probability that the investment won’t pan out. And remember, just because a property projects a certain return, it in no way means it will ever actually happen. If you are up for the challenge of taking on a risky property and seeing if you can get it to achieve the projected numbers, then go for it. At least in that case though understand how to best counter those risk factors. There are specific strategies for higher-risk investing that do differ than regular procedure. If you don’t know those for whatever you are buying, you are crazy if you go ahead and buy. Not able to get a feel for what kinds of things might be risk factors with a property? I’m not going to speak for flipping since I don’t do that, but for rental properties consider these things: “The 4 Main Risks of Owning Rental Properties (& How to Mitigate Them!).” Had you considered any of those before you just read that article? Whatever your investment strategy, know what traits or factors or fundamentals will directly affect your risk. If you don’t know that, you’ll have no idea how to prevent your investment from taking a downturn.
6. Exit Strategy
Always know your end game. You want to know your end game for a few reasons: to better help you strategize along the way, to know your options for getting out of an undesirable investment if needed, and to help set up your buying from the get-go. You buy a property to flip or rent or leaseback or light on fire? Well, what is your plan for it down the road? If you don’t know that, how do you know if you are buying the right thing or that this strategy will fit your goals? Again, what is the end game? This ties back to “what factors are involved in a successful investment as opposed to an unsuccessful investment?” Exit strategy is part of the answer to that question. If you buy a property to flip and you don’t have a detailed plan for the exit strategy, you may be left with an unsuccessful investment because you can’t offload the property in a profitable manner. If you buy a rental property and don’t consider the possible exit strategy factors, you may very well set yourself up for getting stuck with an underperforming property. Don’t just prepare for buying an investment property; prepare for the end of your investment property as well, and you will be 10 times better off. If you have no idea what exit strategy even means or what factors go into exit strategies, don’t buy an investment property yet.
If you can’t speak to any particular one of these items, you aren’t ready to invest yet.
The good news is a lot of this is easy to learn. Just take the time to learn it, and confirm the validity of where you are learning it from. There is a lot of false information out there, so be smart about your sources.
Did I leave any must-knows off the list?
Anyone feel free to chime in!