I like to think that if I had a good mentor early on, or if a site like BiggerPockets.com existed, that I might had avoided some of the early mistakes I made in RE Investing. However, sometimes I’m grateful for the mistakes, or else I wouldn’t have the same perspective on growth vs. risk.
If you learn better from other's mistakes, then hopefully I can share 3 points that you can learn from and do differently in your journey.
Mistake 1 – Buying with higher percent down.
I was 20 when I purchased my first Single Family Rental in 2009. I saved up for 20% down from the proceeds of a painting business I was running.
At the time, nobody told me that if I purchased the property as an owner occupied home instead of going to the bank and letting them know my plans were pure investment, that I would have been able to purchase the home for as little as 5% down. I could have lived in the home for a while and then rented it out, therefore allowing me to save cash to purchase home number 2 faster.
Mistake 2 – Focusing on shorter term loans vs. 30 year loans.
Seems more responsible to go with a shorter term loan right? That was my thought in my first 3 purchases. Save some money by having a lower rate and get the home paid off quickly. I also was afraid that if I had too much cash flow, I might spend it, so better to have it locked up in the property!
What I didn’t realize is that I was screwing up my Debt to Income ratio. Because with the shorter term loan, I had higher monthly payment obligations. Therefore making it harder for me to take on more “good debt” because my credit was tapped out quicker. If the goal is to pay the property off quicker, just opt for a longer payment schedule and make additional payments to principal. The interest rate might be 0.5% higher, but the benefits of having flexibility and more access to credit far outweigh.
Mistake 3 – Focusing on Cashflow vs. Appreciation
If you are not thoughtful with your strategy, you may find yourself following the herd. Many times the conventional wisdom will tell you to compare your real estate holdings to a more conventional type of investing such as stocks or bonds. We then get caught up in comparing cash flow returns to dividends distributed. Thus making us think that the real estate game is all about cash flow.
Cash flow is certainly important. But not always most important early on in a real estate journey.
Because I know very few people who have saved up enough “cash flow” to buy an apartment building. (I actually know nobody who has done this).
Just like most things in life, there are different phases or levels. Someone in their 20’s doesn’t invest in the stock market the same way that someone in their 60’s does. However a lot of real estate investing knowledge comes from older mentors who have more of a “cashflow” strategy.
My argument is that younger investors should aim only to be cashflow positive, then focus more effort on appreciation. Appreciation, either organically as an area increases in value, or forced appreciation through improvements to the property, will lead to much faster growth.
Just like my mistakes above, I purchased my first two homes that were in low growth areas with declining population. They also didn’t have much room for forced appreciation via improvements. . . Sure I could have remodeled them to make them nicer, but the neighborhood would not have supported higher values.
The cashflow was good on both of these first two homes, however my appreciation pretty much matched inflation. Thus not allowing me to leverage or trade up these properties into anything substantial for several years. Vs. a high appreciating Duplex that I was able to sell after just 18 months to afford a down payment on a 24 unit apartment building.
Growth early on will lead to more cashflow in the end.