When you are just getting started with your real estate investment portfolio, abundant information is both a great blessing and a frustrating curse. On one hand, extensive knowledge about investing strategies, tactics, and techniques is readily available, accessible, and even free. Just in the Szikov ecosystem, an aspiring real estate investor can:
- Read hundreds of articles written by expert contributors posted on the blog every month.
- Listen to excellent podcast interviews with expert guests every week.
- Attend informative webinars on a variety of subjects and strategies.
On the other hand, the availability of information on the various paths an investor could take to financial independence can wreak havoc on your ability to focus and execute. In fact, many aspiring investors end up feeling so overwhelmed by the different options that they often fail to take any action at all. I’ve discussed aspects of this phenomenon in a previous article on the Shiny Strategy Syndrome.
So today, I plan to lay a clear path for you to achieve a singular goal: Purchase your first investment property. If you really want to accomplish that goal, there are four critical areas to master. Over the next few months, you must concentrate your efforts to study and execute the strategies and tactics, as well as build the skills and relationships that are necessary to make a wise investment.
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1. Self Analysis
In the temple of Apollo in Delphi (Ancient Greece), there was an aphorism inscribed on the forecourt. It read: “Know thyself.” That’s the first critical area you want to master because it affects everything else. Here are a few questions to help you think through self-analysis:
- Why are you looking to invest? Or put differently, what do you hope to accomplish from your investing efforts? Avoid generalisms like “achieve financial freedom” or “get rich,” and be specific instead: “Build an income stream of ‘X’ within ‘X’ years” or “Quit my job by February 1 of Year ‘X.’”
- What does investing success look like for you? It could be that success looks like a lump sum profit at the end of house flip. Or it could be a certain amount of positive cash flow each month. No wrong answers — you just need to get clear on what victory looks like for you. You don’t want to be winning at checkers when you’re actually playing chess.
- In that vein, what’s your risk tolerance? If you are adventurous by nature, you might not mind a riskier strategy that would leave the most conservative amongst us sleepless at night.
- Are you willing and capable of taking on a project? If you have the resources (time, money, network of vendors) and the inclination for a rehab project, you would consider deals that those of us who are unable or unwilling would pass on.
- Finally, what’s your investment timeframe — long or short-term?
Action Plan: Take a day to ask yourself the self-analysis questions and get clear on what type of an investor you are and what investing strategy is best suited for your goals.
2. Deal Analysis
Now we are getting into the fundamentals of real estate investing. Just as it’s critical to know yourself, you also must know how to size up a deal. Let me tell you a story to explain exactly what I mean by that. When I was attending middle school in Albania, I could’ve sworn that our math program was lifted straight out of a Chinese torture workbook. For instance, when we were learning the concept of the square root, our teacher would make us figure out the square root of large and complicated numbers by hand. The crazy part was we HAD calculators! The teacher would say that we needed to understand the underlying concept, not just get a result.
I see a lot of aspiring investors ask questions about tools. What spreadsheet template should I use? What about the BP calculators? In a way, that’s like asking what brand of pens Hemingway used to write.
Don’t get me wrong: Tools are great. They make our life easier and help us save time. But as an aspiring investor, you must know the underlying concepts like the back of your hand. Let’s take the income statement on a rental property.
First, you start with the annual incoming rent (monthly rent x 12), and you adjust for the vacancy (5-8%). The resulting number is your gross rent. Then you subtract your operating expenses: property taxes, insurance, HOA dues, maintenance and management, leasing fees, and any utilities (if applicable). The resulting number is your net operating income (NOI a.k.a income if the property was free and clear). If you divide the NOI into the purchase price of the property, you get the capitalization rate (cap rate for short). Now you have to account for the mortgage, so you subtract the annual debt service (principal and interest payments x 12).
The resulting number is your (hopefully positive) cash flow before taxes. Now let’s calculate your total investment into the deal:
Down Payment + Loan Closing Costs + Out of Pocket Improvements to the Property
If you divide your cash flow before taxes into your total investment, you get your cash on cash return.
In a single paragraph, I outlined an income statement you can run on the back of an envelope. No fancy spreadsheets. If you are serious about real estate investing, deal analysis is a skill you have to master at that level.
Action Plan: Select 5-10 properties in your market and run income statements by hand on a legal pad.
Now let’s go another level deeper and look at property analysis since it feeds some of the critical data to the income statement. For instance, how do you know that the rent you’re using to analyze the property is correct? What if you overshot it by 10-15%?
The second skill you must build is the ability to read and draw correct conclusions from comparative market analyses. The “raw materials” for this analysis would come from your real estate agent in the form of a CMA. Then you have to determine where the property you are analyzing fits in the spectrum of prices. Is the property average in terms of condition and upgrades, or is it more of a premium property?
Essentially you are trying to determine the most comparable listings to the subject property and figure out the price accordingly. But the price is one part of the picture. Days on market are just as important. A property where the average rent is $1,500 and average days on market are 21 is very different from another where the average rent is $1,500 but the average days on market are 75. Rent estimates must be adjusted for the additional vacancy shown in the market analysis.
Action Plan: Take the 5-10 properties you selected, ask your real estate agent to produce rental market analyses for each, and determine the correct rental rate.
Finally, “boots on the ground” research should follow “computer research.” Drive the neighborhood and look at the subject property, as well as other comparable properties from your CMA. Are they truly comparable? Be objective and unbiased. Sometimes what you learn when you drive by is that the section of the neighborhood where a property is located is more or less desirable. There’s no way to get that information without first-hand knowledge.
3. Pre-Purchase Setup
Next, let’s setup the “framework” for purchase. In this area, we focus on the necessary resources and work on assembling a team to support you in the process.
First and foremost, let’s get your financial house in order. The first prerequisite to investing is becoming an investor. And by that, I mean “someone who’s in a position to invest.” A few questions to help you assess your situation:
- Do you have appropriate liquid emergency funds for 4-6 months of expenses set aside? In the event that you have trouble leasing out the property, could you pay the carrying costs without throwing your finances in a whirlwind?
- Do you have substantial high-interest credit card debt? Then the better investment to make first is in eradicating that debt. In so doing, you’re earning a guaranteed return of the interest rate on your cards.
- Are your expenses consistently lower than your income? Or put differently, are you able to save money on a consistent basis? I would recommend a recurring audit of your expenses to identify the ones you can cut so you can speed up the savings pace.
Action Plan: Assess your emergency funds, credit card debt, and monthly expenses this week. Take steps to build up the emergency fund, pay off high-interest debt (if necessary), or cut unnecessary expenses as fast as you can.
Second, let’s get you pre-approved for a mortgage. Most aspiring real estate investors plan on putting together portfolios of several properties. If that’s true, you should approach the selection of your loan officer as a key member of your team. I would make sure they have a good understanding of how to finance investment properties. Ask them:
- What’s their limit of how many financed properties an investor can have? The federal rules currently have the limit set to 10 financed properties. If a lender has a much lower limit (say 3 or 4), that’s a sign that their appetite for investment property loans isn’t as “healthy” as you would like.
- If you own multiple properties, will they use the income from those properties to offset the corresponding mortgages? What if the income from those properties isn’t on your tax return yet (because it’s a recent purchase)?
- What’s their normal turnaround time for a loan? Typically 3-4 weeks is what you want to hear.
Once you find a good loan officer who has the product (right interest rates and terms) and the process to finance investment properties, they can be your go-to person. They would have most of your paperwork on file from previous loans so you wouldn’t need to provide them over again.
Action Plan: Set up an appointment or phone call with 2-3 loan officers that specialize in investments (ask for referrals) and get pre-approved for your loan.
Third, let’s address capital. Do you currently have the necessary capital to purchase an investment property? The required down payment on single family homes is 20% and on small multifamily (2-4 units) is 25%. Plus, you should add the closing costs (3-4% of the purchase price) and any improvement costs that will be paid out of pocket.
If you don’t have it yet, how far along are you? Based on your normal savings rate (money you save every month), how long will it take you to save the remainder? Once you have answers to those questions, your next action step is to focus exclusively on the capital accumulation for as long as it takes to achieve that goal.
A note of caution here: You might be tempted to revise your property criteria so you can purchase a property with less capital. Don’t do it! Decide in advance what quality of property you want to acquire and stick to that plan. Don’t sacrifice the quality to make the smaller capital work — you’ll thank me later.
If your current financial situation does not allow for a reasonable savings rate, then it’s time to look at alternatives. If capital is a scarce resource, perhaps you can make up for it by being flexible. For example, you could purchase the property as your primary residence with a much lower down payment and live in it for a year while you get it ready for rent, then lease it out.
Last but not least, let’s talk about a key member of the team — a real estate broker/agent who understands investments provides the data and information you need to make great decisions and adds value by connecting you with a network of trusted contractors.
If you ask 100 real estate agents if they can help you find an investment property, you will find that the overwhelming response will be “yes.” That’s especially true if your focus is on single family rentals. They say “yes” because in the end, you’re buying a house and they know how to sell you a house. The purpose for the purchase is secondary.
But you know it is NOT. That’s why you MUST spend the extra time to find a broker or agent who:
- Understands investment property fundamentals. Can they run a profit and loss on a prospective property? How many properties do they lease out each year? What were their average days on market for properties they leased out in the last 12 months? (Get proof!)
- Owns investment property in their own portfolio. It’s hard for someone who’s never owned investment property to understand and alleviate the concerns of a real estate investor.
- Focuses on long-term relationships with clients. You don’t want an agent whose goal is to collect a commission check on this transaction and never talk to you again. The incentives just wouldn’t be aligned. So ask them if they have investor clients that they’ve been working with for a number of years. Can they provide references and contact information so you can call them and find out about their experience first hand?
Action Plan: Set up an appointment or phone call with 2-3 real estate brokers/agents who specialize in investments (ask for referrals) and engage the best fit.
4. Tune Out Noise
Finally, we have come full circle. But there’s one more critical thing you must do if you want to reach your goal of owning your first investment property.
You have to make that goal your singular goal. In other words, you should tune out the noise and focus exclusively on achieving that goal. Over the next 60-90 days, stop reading blog posts and listening to podcasts. Stop learning for learning’s sake and just EXECUTE.
You probably feel the fear of missing out (FOMO) already. What if you miss out on that one blog post that will finally set you on a path to financial freedom? Or what about that nugget of wisdom from that guest on this week’s podcast episode?
Make a deal with yourself: You can act on those other strategies later. You can apply that wisdom AFTER you’ve executed on your singular goal.
Chris Sacca (venture capitalist on Shark Tank) said it best: “Ideas are cheap. Execution is everything.”
Execution is what sets you on a path to financial freedom.
Your 8-Step Action Plan Checklist
- Take a day to ask yourself the self-analysis questions and get clear on what type of an investor you are and what investing strategy is best suited for your goals.
- Assess your emergency funds, credit card debt, and monthly expenses this week. Take steps to build up the emergency fund, pay off high-interest debt (if necessary), or cut unnecessary expenses as fast as you can.
- If you don’t have sufficient capital to complete your first purchase, focus exclusively on the capital accumulation for as long as it takes to achieve that goal. Or pursue alternative routes (purchase as a primary residence and convert it to a rental).
- Set up an appointment or phone call with 2-3 loan officers who specialize in investments (ask for referrals) and get pre-approved for your loan.
- Set up an appointment or phone call with 2-3 real estate brokers/agents who specialize in investments (ask for referrals) and engage the best fit.
- Select 5-10 properties in your market and run income statements by hand on a legal pad.
- Take the 5-10 properties you selected, ask your real estate agent to produce rental market analyses for each, and determine the correct rental rate.
- Over the next 60-90 days, tune out the noise and stop reading articles and listening to podcasts. Execute on your singular goal.
On the quest for your first property, where are YOU within this action plan? Will you commit to taking action in the next 60-90 days?
Let us know your progress, pain points, and triumphs in the comments below!