6 Questions Every First Time Real Estate Investor Should Ask
Investing in real estate can be hard enough, even with the best of circumstances. Asking and finding solutions to these questions will put you on the right path to accomplishing your investment goals.
What outcome do you want to achieve with your real estate investment(s)?
In the famous story of “Alice’s Adventures in Wonderland,” by Lewis Carroll, Alice comes upon the Cheshire cat whom she asks where she should go. When she replies to the cat asking where she wants to go that it doesn’t matter, the Cheshire cat simply replies with those famous words, “Then it really doesn’t matter, does it. Like in this story if you don’t know where you want to go the any road is bound to get you there. Start working today with your ultimate goal in mind. Your long-term goals will influence your short-term decision making. For example, are you investing in your property(s) with a long term or short-term strategy? Are you going to hold them for 5 years or 30 years? The answers to these questions have massive implications in terms of how you manage your property.
For example, if your goal is to hold a property for 30 years and then cash out for retirement, you might consider locking in a 30-year mortgage. In addition, you will have a more strategic long-term approach to maintenance of the property. You can compare this to investing in an IRA account which cannot be touched until after retirement. Your end goal will cause you to think longer term and execute different strategies as opposed to a short-term strategy such as “flipping” a house, whereby you fix up the property and sell it for a quick profit.
Let’s frame this up by thinking about re-shingling the roof. If you are thinking in terms of a 30-year investment, you would use a more expensive, high-quality shingle that will last 30+ years, rather than buying a cheap, low-grade shingle that will have a shorter lifespan. If you plan to sell in 5 years, you are not worried about the shape the shingles will be in 30 years from today.
Your vision and the outcome you hope to achieve influences everything else you do, from maintenance, to capital improvements, to your mortgage. Set your goals, build a crystal clear mental vision of your success, and then create your plan for today with the future in your mind’s eye.
What experience do you have in the industry?
Owning a rental property involves many disciplines. The more experienced you are in these disciplines, the more profitable you will be and the faster it will happen.
Investing in real estate is like football. To succeed you need a strong and driven team. Hiring the right professionals to be on your team will make the difference between success and failure. It’s the same process someone goes through when starting a business. A smart entrepreneur seeks to build a team which includes an accountant, attorney, banker, IT person, and an insurance agent as the foundational members of their team. These are the minimum team members any business owner must have.
Establish a discovery process that will help you determine who will be a necessary and good fit for your team. Interview each professional and find individuals who understand the industry and your goals, have the ability to help you meet those goals, and can help you avoid the common pitfalls of owning rentals.
If you decide to include a rental property management company on your team, ask questions about their policies and be aware of their accounting practices and how it could adversely affect you and your investment goals. For example, a property owner named Jeff used a rental management company whose accounting practices left him in a lurch. Jeff was in the process of trying to sell his rental property, and the potential buyer wanted to know if the property was profitable. In reviewing the accounting statement for the previous year, the prospective buyer noted an $11,000 miscellaneous maintenance expense listed and was concerned whether that was a one-time or recurring expense. Unfortunately, when Jeff asked his property manager to itemize this miscellaneous expense, the property management company’s records were so vague that no one had any idea what the expense was for or why it had been assessed causing the buyer to walk away from the deal.
How much time do you expect to spend on this investment over the first 12 months? Over the next 5 years?
Owning a rental property can be time consuming, and without a property manager, it WILL be absolutely time consuming. Many experienced investors suggest doubling the time you project spending on your future investment, and if you are still willing to put in that amount of time, the investment makes sense. The rental business isn’t a “get rich quick” scheme. It takes work, training, teamwork, and more to make it a profitable investment in your portfolio.
Of course, there are ways to reduce the projected time spent managing both the property and its tenants, but it requires you to build systems and automations to streamline the processes. For example, some landlords drive around and pick up rent. While this method certainly works and pressures tenants to pay right away, this method is extremely time consuming and costly. A more efficient way is to train the tenants that when rent is due, the consequences of paying late are clearly laid out and will be enforced. Another possibility is that you can have a system set up where an automatic payment is taken out on the first of the month. With the aid of an attorney, the ramifications of late rent can be written out clearly in the lease and have legal consequences.
Does your real estate agent have experience in rental properties?
Your real estate agent must have experience in rental properties, not just selling homes. As with any major decision or investment, it is best to seek council from an experienced expert who can give you an objective opinion before you spend any money. If your real estate agent understands rental properties, they will be one more resource from whom you can draw knowledge and mentorship.
However, I would not recommend using a real estate agent to source your first tenant. While they are technically licensed to provide this service, they will likely be less focused on renting your unit for a $400 commission when they may have properties for sale with a $10,000 commission at stake. You must be proactive in finding that first tenant as vacancies cost you money.
How much cash will you have on hand for unexpected vacancies in the first year?
You should never depend solely upon the rent to pay the mortgage. You need to have a reserve, so that if the tenant leaves or does not pay rent for any reason, you can still cover at the very least two months of the mortgage. Each day the property sits vacant costs you money in lost rent and utilities. Protect your investment, and make sure you have alternative options.
How familiar are you with your area’s housing laws and regulations?
You must read the laws and regulations of your state pertaining to rental property. Familiarize yourself with Federal and State Fair Housing Law as well as HUD (US Department of Housing and Urban Development) regulations on certain areas of concern such as lead based paint and other environmental hazards. This is certainly not glamorous or exciting work, but it’s better than dealing with government officials when they bust you for a HUD violation, causing you to lose both profit and potential tenants.