Why is it that s many of us with the entrepreneurial mindset tend to learn best through the medium of pain? Was it indeed a fundamental truth that Mark Twain voiced when he said "a man who carries a cat by the tail learns something that he can learn in no other way"?
Starting another year and looking back on the good and bad of yesteryear, I decided to try an interesting thought experiment:
If Dr. Emmet Brown from "Back to the Future" were to be so kind as to lend me his time machine, and I had the opportunity to go back and spend 10 minutes with the Lou Gimbutis of 2004, I would not be lacking for words of wisdom with which to fill that 10 minutes. I would find myself somewhat more open minded, a tad more energetic, and excited as a kid at Christmas over my new quick-turn real estate toy (I still am on the last count). I'd find my younger self about to embark upon a remarkable journey, and about to make some colossal mistakes in the process. Here are 10 things I'd cover with myself that would make life a heck of a lot easier over the 30 or so deals that I'd be about to do.
•1. Cash Reserves: If Dr. Brown gave me only ten minutes with my former self, I would spend eight of them hammering cash reserves. Yes, it is that important. As you're building your financial tower, a neglected foundation of solid cash reserves can very quickly and very easily cause the other two pillars of strength it contains, cashflow and equity, to come crashing to the ground with uncanny ease.
At the height of my momentum, I was responsible for making payments on 13 single family houses. To some, that may not sound like very many. To a 28 year old young guy, with very little cash reserves, who'd never made more than $27,000 in a single year in his life; it can be pretty stressful. Every month on the first, I was responsible for making 13 house payments (more like 15, counting second mortgages). After the first of the month, it'd be time to sweat bullets over the 6 or so people who did not have their money there on the first like it was supposed to be. Of course they all had good excuses. I've yet to hear a tenant say "Well, I just really didn't feel like paying you this month". Their excuses; however, carry alarmingly little weight with the institutions or individuals responsible for receiving my underlying payment(s), a fact which meant that I needed to make payments out of pocket, and collect from my tenant/buyers as I was able. This is an exercise, I can assure you, engineered to elevate the blood pressure, and shorten the lifespan of the unsuspecting, cash-poor investor.
•2. Buying houses isn't "cool": Ok. Maybe it is cool. There are few absolutes in life. However, what I'm referring to is the over-eagerness some of us have to get our first few deals under our belt. Now granted, an "itchy trigger finger" is easier to cure than the old "butt print in the recliner", but it is no less of a liability for its being the lesser of two evils.
I moved out of an apartment and into my first single family house in 2003. I was now a "homeowner". Within a year, I bought my first investment property. To me, buying property was "cool". The newness hadn't worn off yet. I could stick my chest out a little farther than before. Therefore, I overlooked a number of factors which I should have considered more carefully. My first house was in a bad neighborhood. My first investment property was across the street (almost literally, it was across and one house over). This was also a gross violation of rule number 9. The house continued to punish me for three years, until someone was kind enough to set it on fire in 2007 (no, it was not me). No one was hurt, and I suspect the firestarters in question were the tenants that I had just evicted, thereby ensuring that all occupants were safely out of harm's way.
•3. Lease-Options don't cash out: Ok, you got me again. Some of them do. Before the subprime shakeout of 2008, mortgage meltdown, or whatever term history wills stamp upon the fruit of the stupidity that ran rampant within the mortgage "boom", the nationwide statistic for lease/option tenant/buyers who actually exercised their option was somewhat less than 5%.
My limited experience tends to confirm this. Over my career spanning maybe 20 or 25 tenant/buyers, only one of them has ever cashed me out.
One time and one time only, did the vehicle of lease-options take me to that magical place where equity, through alchemical means unknown; may be transmuted into cash without the simultaneous creation of an equivalent debt. I had bought the house 3 years ago, and was on my third tenant/buyer. All things considered, I worked pretty darned hard for that check.
The problem I ran into was the impression, gleaned from a variety of real estate gurus, that a lease-option was as good as a sale, and that you will be cashed out at your inflated sales price some time in the not-too-distant future. That being the case, why worry about buying a house with very little equity, or where the monthly spread between your incoming and outgoing payments couldn't feed a 3rd-world orphan? You'll be rich when your new buyer exercises his or her option by getting a new loan, as they've sworn to you that they'll do once they've "tidied up their credit a bit".
•4. Home warranties: How I wish I'd known about these puppies at the start of my investing career. I'm sure there are many good companies that provide them, but I use American Home Shield. My multi-property discount comes out to around $330 per year per property, which they will even break up and let me pay monthly for less than $28 (can you say, "Make your tenant pay for it"?).
Now, I can already hear some of you asking, "Can't I just use a lease-option that passes all major repairs on to my tenant/buyer and make them pay for it"? Sure you can. However, that can be a double-edged sword, as you will inevitably end up getting a house back with buckets under sinks and things duct-taped together, to avoid the tenant having to pony up and pay a contractor to fix it. AHS does not even inspect the house, and will do anything from re-plumb the house, to replacing the furnace if necessary; all for a $60 service call. How many unanticipated $2,500 furnaces does it take to make the warranty pay for itself? I've bought two out of pocket, and they worked fine when I tested them when I bought the house.
•5. Home inspections: I had two mentors when I got started in the business. One of them was an interpersonal and financial genius. The other, while also a brilliant guy, had as his claim to fame the fact that he had owned or worked in construction companies for the past 30 years. I'll bet Warren walked me through 30 houses, pointing out every potential problem, and teaching me what to watch out for. With that level of detailed instruction, it would surely be foolish to pay $300 for a home inspection before closing on a house, right? After all, I was now an "'expert". Wrong, wrong, wrong. I don't think I ever bought a house where I did not miss something of decent significance, and sometimes the errors ran into the thousands and thousands of dollars. I could not have reaped a better return on those skipped $300 investments with a jockey's eye for horseflesh, and a pocket full of four-leaf clovers stored in a rabbit's foot bag.
•6. Tenants are guilty until proven innocent: "But this is America", you may say; "Isn't everyone innocent until proven guilty"? Folks, EVERY time I have went against my training and better judgment and trusted a tenant, I've lived to regret it. The check is not in the mail. They are not moving out peaceably, so "you can just save yourself the hassle of evicting us". They are not "cleaning the house like new" on the way out. The milk of human kindness is a wonderful thing, but it quickly sours in your tenant's refrigerator.
•7. Listen to people who are smarter than you: Boy, did I have a hard time with this one. My mentor advised me against buying the first three investment properties that I ultimately ended up buying. "Easy for him to say", I rationalized, "he's got houses coming out of his ears, and I hardly have any!" I lived to regret each one. From time to time I'll be listening to an audio training cd (Ron Legrand, Lou Brown, etc . . .) from years ago, and for probably the 20th time I'll hear a piece of advice that, had I heeded it; would have saved me a good deal of time, money, and grief.
•8. Have an attorney prepare ALL of your forms and paperwork: I like to think of myself as a pretty smart guy. Starting with paperwork like Lou Brown's, there's no reason to go to the "extra expense" of paying an attorney to make sure that each transaction is watertight, is there?
Wrong, wrong, wrong again. On one joint-venture deal, I "saved" myself a couple of hundred bucks by taking a guru's joint venture agreement and customizing it for the transaction myself, rather than pay an attorney. When the "you know what" hit the fan during the exit strategy, it became painfully obvious that my paperwork was woefully inadequate for the task. That's not good news, as most courts, when dealing with issues of vagueness in contracts, decide against the person that drafted the contract (in other words, against me). Net cost to me for being the Smart Guy and doing my own paperwork: around $40,000. That, my friend, is a hard way to learn a lesson.
•9. Stay out of marginal neighborhoods: "But the deals look so good right on the other side of the tracks", you say. "You can hardly tell the difference between this house and the one on that other street that costs 20-30% more". Your tenants and buyers, my friend; will know the difference. They will not need any advanced real estate training, an appraisal, or a list of comparable sales. Good tenants and good buyers know where they do and don't want to live, and you will violate this rule at your peril. If you would not want your 15 year old daughter staying the night at a friend's house at this location, I strongly suggest that you keep looking.
As I leave you, I sincerely hope that these words of wisdom that I wish I could've shared with my former self will act as a dose of strong preventative medicine, the presence of which should save you many an Advil, and countless sleepless nights.
Lou Gimbutis, owner of Property Solutions, LLC, www.SoldCarolina.com, has been buying and selling houses full-time since 2004, first in Michigan, then after moving to NC in 2007. He serves as Director of Education for the Metrolina Real Estate Investor’s Association.