Real Estate 101: Where to Start

The following is a guest post by FMF reader Apex. He has been investing in rental real estate for more than four years and is authoring a Real Estate 101 series, posting every Friday, based on his experiences. (To read the series from the beginning, start here.)  The series is designed to give prospective investors the basic tools they need to succeed.

Investing in real estate requires a little more planning than simply investing in stocks or bonds.  The transaction is more complicated and the investment has more moving parts to manage.  As such the effort to get started is quite a bit higher than a traditional investment.  These beginning hurdles are one of the reasons so few people ever get passed the exploration phase of real estate investing.  So if you have been thinking about investing in real estate, here’s where you start. 

Step 1:

Start!  Most people never get to this step.  They talk about investing in real estate.  They read books about investing in real estate.  They might even go to real estate seminars.  These are not a start.  These are thinking about starting.  These are getting the courage up to start.  These are debating with yourself if you should start.  You haven’t started until you have taken an action.  I mentioned hurdles in the opening paragraph and this is a big one.  You haven’t started to be a runner because you think about running, or read a book about running, or go to a coaching session about running.  You don’t begin to be a runner until you start running.  This can be a scary hurdle because once you start taking actions you have declared your intent to become a real estate investor.  Other people will be involved.  What if you find out you’re not ready or that it’s not for you?  Don’t worry, starting the process doesn’t mean you have to purchase a property.  You can always decide to stop or delay the process.  Don’t stop before you start.

Step 2:

Find a real estate agent who specializes in investment real estate and is also preferably a real estate investor themselves.  This step is especially critical for someone who doesn’t have previous experience or enough local knowledge to make well informed decisions.  It is very important that your agent is focused on investment properties and not owner occupied housing because the choices you need to make are very different and you will rely on this person for considerable guidance in the beginning.  Because your agent has been helping others purchase investment properties and has purchased and managed their own properties, they will have the information and experience to give you some guidance and advice which will help you to reach informed decisions.  They will also have contacts that can help you arrange financing, legal advice, and perhaps a whole host of connections you could leverage. 

As a new real estate investor you just have too much information that you don’t even know that you need to know.  Furthermore this information is unique to each investor.  Books can help but they are going to be mostly written from a general point of view and they also don’t have the advantage of having firsthand experience in the exact locations that you are looking in.  Your agent has that experience and it is essential.

Step 3:

You need to get access to capital.  That means ready cash of your own for a down payment and access to financing from lending institutions to complete your purchase.  Your agent can likely give you some help with the lending aspect but you will need to come up with enough for a down payment.  Don’t wait until you find a property to do this.  That is too late.  You need to be arranging this very early in the process.

Step 4:

Give some thought to the type of property you want to invest in.  Most people start with a single family house or duplex but even among those there is a wide array of choices.  Townhouses vs stand alone houses; newer and more expensive property vs an older, cheaper property which may be more work; ready to rent vs fixer upper.  You should also consider which neighborhoods you would like to focus on.  Once again your agent can give you some pros and cons of each. 

Step 5:

Start looking, and look a lot.  Get a feel for what is out there and how comfortable you feel about what you are seeing.  If you do not like what you are seeing perhaps you need to consider a different kind of property.  This is one area where you should not let your agent’s experience guide yours.  Do not get caught in the trap of letting your agent convince you that the type of properties that were right for him or her are right for you.   Your agent may place a high priority on ROI and purchase cheap units in low income neighborhoods.  You may have other priorities that are more important to you than just ROI.  Make sure your agent knows what your priorities are so they can take you to properties that meet your criteria, not theirs.

Step 6:

While you are looking you need to be thinking about whether or not you want to manage these properties yourself or hire a management company.  As you see properties you may start to see more work than you planned and a management company might be a good way to mitigate that for you.  Don’t let what you see scare you away from real estate investing.  If the thought of dealing with tenants and repairs scares you or you feel you just don’t have the skills to perform those tasks then hire a management company.  That is what they are for.  Literally tens of thousands of people use third party management for their real estate investments.  If you want to hire a management company it is important to begin searching for and interviewing management companies early in the process.  This will become a critical choice for you so do not take it lightly.  Choosing poorly here will impact all of your rental properties.  Your agent can once again give you some advice on management companies.

Step 7:

You want to be checking on rental rates for comparable properties in areas that you are looking to see what type of rents you can reasonably get.  You then need to run some numbers with typical expenses to ensure the properties you are looking at will make for a good financial investment.  Running numbers is a critical step to narrow down properties.  No matter how much you prefer one property to another if the financial numbers do not work on a property you must not purchase it.  Once again your agent can give you some typical expected rents and some typical expenses.

Step 8:

After you have done all that legwork and have looked long enough to find some properties that make for a good investment comes the last and often most difficult step of all.  Buy something!

When I first started looking at properties my agent introduced me to his money guy and I spent about an hour talking to him.  As it turned out he was not able to help me much with financing due to the circumstances of the property I was looking at, but he said something that has stuck with me to this day.  He told me that regardless of what my goals were, one property, a few, or an empire, to not get stuck in a mode of second guessing or waiting for the perfect deal.  He had talked to hundreds of people who were thinking about investing in real estate but very few ever actually became investors because they simply couldn’t get to the point of pulling the trigger on a deal.

I have seen the evidence of his words in people I have personally talked with and I even had to fight it a little bit in myself.  Many never start as I already mentioned.  Once you do start, cold feet come quickly.  As you are looking at properties you may not like some of what you are seeing.  You can always find something wrong with a property or some reason not to proceed.  You should of course never do a bad deal or a deal that you know won’t work well for you but if you have looked long enough at enough different properties there are deals out there that are right for you.  The problem is that one of those beginning hurdles I mentioned in the opening paragraph is the “perfect deal” hurdle.  The perfect deal could be a mindset that says you have to get a steal on the price.  It could be that you feel you need just the right property that is in the right location or the right condition or whatever it may be. 

To clear the “perfect deal” hurdle you have to accept one very important thing.  You will make mistakes on your first deal and that is ok.  You will probably make a number of mistakes on your first deal.  As long as you have done your homework and your finances make sense these mistakes are not only not a problem, they are essential to your development as a real estate investor.  Success is a process of incremental improvement and improvement only comes by learning from mistakes.  Most of us don’t tell our kids to expect perfection the first time they attempt something, yet it’s easy to fall into the trap of thinking we cannot make a mistake on something this important.  A mistake is not going to kill your business unless it is a fatal one.  If you have an experienced agent helping you along the path and do your homework on the number, you are not going to make a fatal mistake.

My first property had multiple mistakes from my point of view.  There was nothing drastically wrong with that deal and I still have the property, but I would not purchase another one like it today for a number of reasons.  In spite of the mistakes, that deal is the most important deal I have ever done.  It’s important for 2 reasons.  First it put me in the game.  With that deal I went from a real estate explorer to a real estate investor.  That change in status comes with a big change in mindset.  Once you have done a deal and went through the steps, you know you can do this and the next one comes much easier.  Secondly, most of the things I now know about how I want to do real estate and how I don’t want to do it, I learned from that deal.  I read a number of books and looked at literally hundreds of properties.  I didn’t learn half as much from all of that as I did by simply buying and managing that one property. 

It took me another year to purchase the next property after that one.  I was enjoying what was working with that property and learning from what wasn’t.  It helped me hone my search and I was able to focus on a narrower slice of the market that would work better for me.  When I found my next deal I closed on 4 properties within 6 months.  Everyone’s experience will be somewhat different, but once you have taken these beginning steps and cleared those initial hurdles, you will begin to know what works for you and what doesn’t because you are doing it.  There is no short cut for just doing it, and it all starts with having the courage to trust yourself, get started, and go do that first deal.

Update: For the next post in this series, see Real Estate 101: Running the Numbers.

Comments

[Ray]

I might suggest that properties built after 1978 are the safest bet,no worries about lead based paint.
Check with city hall if there are mandatory property inspections.If there are,read the rules.

As far as financing,find a local community bank or a credit union.Many local banks don't sell their paper (loans) and you won't be subject to fanniemae rules.

A good amount of the properties I've boughten over the years were from absentee landlords.Some had moved to a different state and found out how badly they were getting ripped off by their property management companies and wanted to bail out at any cost.Others were in at very high percentage loans and wanted to bail.Most of these I bought at sixty cents on a buck.

Get involved with a landlord association and pick the brains of experienced landlords.
Spend an afternoon sitting in on court eviction hearings.

Screen,screen,screen. most of my units are in low to low middle income areas.I'm not as concerned about credit scores as I am about civil and criminal backgrounds.I check all the local muni court sites on the web for backgrounds,this can be done free.

Money makes the world go round.new landlords and often times experienced ones will feel sorry for a tenant that has a great story as to why rent was not paid.BUT..the story is more often a lie rather than the truth.I allow a grace till the fifth of the month,no pay,no stay.You can't write off lost rents and you can't claim deadbeats on your own taxes.Give them an eviction notice,it's amazing how quickly they all of a sudden find the rent.

Remember........the landlord is the one in charge,not the tenant.

I would also suggest learning how to do many of the easy jobs rather than paying someone $100.for a ten minute fix.If tou are not sure how to do something,there are many handyman sites on the web that give directions step by step.We do everything ourselves other than roofs or carpeting.Prior to being a landlord my tool of choice was a cross pen,now I have a van load of tools.
A plumber will charge up to $150.to clean a p-trap on a sink,that is about a three minute job.

As a last thought.......it's better to keep a property vacant rather than place a bad tenant in it.

[so]

Steps 3, 4 and 8 are the most important. If you have access to capital and are properly reserved, you can learn on the fly and having the reserve solves a LOT of problems.

[retirebyforty]

I think a great way to get started is to rent out your old home when you buy a new house. You know the property very well and it already has built in equity (hopefully.) The monthly cost should also be lower if you lived there for a while.

[RichUncle EL]

Great advice Apex, Question what area of the country do you do your investing in? I live in the norteast and the taxes here eat up a lot of the profits a potential investor might make. Just another barrier I have noticed.

[Apex]

@RichUncle

Minnesota. Next week you will see the property taxes I am paying on one of my units.

[Scott]

It was funny to come across this article today as I'll be giving a speech on this exact topic on Saturday. Although I agree that "just doing it" is a major obstacle that people need to overcome, I would advise that potential investors have some basic rules for the property they will purchase. You don't have to necessarily wait for your Goldilocks property but you SHOULD pinpoint your price range, desired number of units and neighborhood. These 3 factors will have a significant impact on your bottomline and your ability to effectively manage your property.

[Ari]

The best properties to invest in are multifamily units (3-4 families). The first two units pay your mortgage/expenses and the third unit provides the profit. Investing in single families/duplexes is for suckers.

[Apex]

@Scott,

I agree that you need to have some sort of plan. That's part of what step 5 is about. You need to be formulating that as you are looking. It is difficult for a new investor to know for sure what that plan should look like however. That is why I think the real estate agent that has experience with investment properties is important.

Along the lines of getting this plan well defined, I have a post coming in a few weeks on exactly that. I just think it's nearly impossible to have a well defined plan like that before you have any experience actually doing it.

I hope you will come back and read that post (probably about 4 weeks from now), and offer your feedback on the ideas presented in it.

[Apex]

@Ari,

So you are saying you get to keep about 1/3 of your rent as profit.

See my post next week to see actual numbers from one of my single family townhouses which show that I keep the same 1/3 that you are mentioning above.

[Jonathan]

Ari - it's all about the numbers. You can get great cash flow off of SFH just as with multi-family. The cost to invest for a SFH is lower. Single family homes are often in nicer neighborhoods than multi-family, and in some areas multi-family properties aren't common. I own 3 SFHs and the cash flow on each is great, and a problem tenant in one doesn't affect the livability of the other two homes. There are pros and cons of each.

[SteveD]

Apex -- Thanks so much for writing this series. I'm also a huge FMF fan, and got into real estate investing myself three years ago. For me, #1 and #8 were the most important steps -- do something! I was able to figure out everything else along the way. By acting quickly, I was able to buy my first three properties in 2010, right at the bottom of the market in my area (Silicon Valley), and all were making money on day 1. While the market has turned around here, there are still great opportunities in other parts of the country.

One thing I'd add -- property management is far easier than I thought. It's an emotional challenge to pick the best tenants (and you never have perfect information, so you just have to pick and hope you're lucky), but I've had very few problems managing the challenges of mine (I always went for extended families who were already in the neighborhood). Sometimes you have to pay money to fix things (but why pay an intermediary extra to handle that?) and sometimes you have to remind them about the rent, but it all adds up to a couple hours of work a month, at most.

I'd also add that it's most important to chose the location based on running the numbers, not whether I like the look of the property or the neighborhood (though I don't look in the worst neighborhoods). Every time I see a house, I use a spreadsheet to calculate low and high income estimates by (1) calculate the expected mortgage using a conservative interest rate, (2) add 2% (of the sale price) to cover taxes and insurance, (3) add 10% property management fee to the conservative estimate, and (4) find high and low rent prices for similar properties on Craigslist.

[Ari]

I live in Massachusetts where housing costs are extremely high. You just can't make $$ on the single families or duplexes here because the price/rent ratio is so high.

[Apex]

@Ari,

In that case the triplexes are probably a good fit for you. You appear to be making your assessments based on what works in your area but the thing is, all real estate is local.

As Jonathan said its all about the numbers. If the numbers don't work for SFH in your area then clearly you cannot do that. The numbers do work for SFH in most areas of the country, at least right now they.