What are some of the basic mistakes that investors make when it comes to investing in real estate? I cover that in this episode.
My name is Kenny Wolfe and I’ve been a real estate syndicator and investor for over eleven years; in this time, I’ve built a successful real estate investment firm, Wolfe Investments. If you’re new to the show, make sure to subscribe so you’re notified when a new episode comes out.
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What are some of the basic mistakes that investors make when it comes to investing in real estate? I cover that in this video.
Welcome to Real Estate Investing with Kenny Wolfe, the show with weekly topics designed to help you learn how to build your ideal life through real estate investing. My name is Kenny Wolfe and I've been a real estate syndicator and investor for almost 12 years now, and in this time, I've built a successful real estate investment firm, Wolfe Investments. If you're new to the show, make sure to subscribe so you're notified when a new episode comes out.
There are a lot of different types of real estate investment options out there, and investors make money in all of those different asset classes within real estate, but not every type of real estate asset is for all investors. Each real estate category has slight differences in what kinds of returns, operational intensity and tax ramifications that need to be understood by the investor. Some folks love student housing or government subsidized housing as investments. I personally think that conventional multi-family housing is a much better option, but again, the folks that love student housing or the subsidized housing think I'm crazy too. If you're new to real estate investing, you've really got to dig in and see what types of real estate speak to you. Before you do that though, you need to know what your financial goals are. Do you need more cashflow today and are you willing to give up some appreciation in the future?
Or do you need more appreciation today and can forego cash flow now so you can focus on growing your nest egg faster?
Once you know the types of returns you need to hit to reach your financial goals, then it's back to the drawing board on what types of real estate investments have a better chance of giving you the types of returns that you need. Say you need to grow your nest egg quickly, then investing in a stable cash flowing apartment building is probably not the way to go. You're going to get more cash flow and less appreciation, but what you need to find is the ugliest, the worst property on the block and take on the rehab and lease up challenge to create massive value. Now, there may be some increased risks and legwork to do, but that's where the big appreciation gains are to be had, or just the opposite.
Say you want to sit back and collect ACHs while you roll around in your big RV across the country--then a huge fixer upper in either a single family or multi-family are probably not the right investment for you. When you take on those big rehab plays, they are way more hands-on and time intensive than the stabilized assets. And to manage those big intensive plays of in investing in real estate, it'd be tough to manage those from poor Wi-Fi reception service at the Grand Canyon. I would even argue single-family rentals, as an asset class, are not for those who want truly passive income as they are very hands on. They can be great net worth builders, but one roof replacement and you have years of cash flow wiped out, and on top of that, in single fundamentals, you'll be dragged down into the day-to-day operations, which again, can be tough while you're on the beach out of the country.
Make sure to know thyself and what financial goals that you have. Then from there, work backwards to see which real estate investment vehicles have the best chance of getting you there. Loans are a huge part of real estate investing. Using leverage is one of the best pros to investing in real estate, there are no other better lending options than when you come to real estate loans. If done correctly, you can boost your returns and be tax efficient by using the correct type of loan. This is where real estate investors can get burned, though. Using leverage is a double-edged sword and can be an amazing tool to use or cause some serious pain. I have found that most lenders aren't out there to get you, but you as the investor have to be the responsible party and know what type of loan is best used for your business plan for that particular piece of real estate.
Say you're doing a major rehab at a property and because you're a smart real estate investor, you know that Fannie Mae can lend rehab dollars and Freddie Mac does not. In that instance, you should completely go the Fannie Mae route. Except, keep in mind that for Fannie Mae loans, there are massive prepayment penalties that are attached to those loans. Those massive prepayment penalties burn off over the years exponentially through your ownership, but it's really costly the first three years or so. If the goal is to rehab that property and then have the option to sell the asset, using a Fannie Mae loan isn't the right tool for this job. But, if you intend to keep the asset long term after the rehab, then there is an option to do a supplemental loan from Fannie Mae so you can pull out some of the value recreated post rehab.
Then again, if you want to buy a fixer upper that is a deep value add, then neither Fannie Mae, Freddie Mac nor HUD would even talk to you about that property. Those agencies require a property to be stabilized, and that means to them 90% occupancy for the past 90 days, at a minimum, to even lend on that asset. For those deep value add properties, you're really going to change out the tenants and demographic profile on those is either best to go to a local or regional bank or go to a bridge lender. The benefits on the bank lenders are that you'll secure a fixed interest rate, but they typically have lower leverage to hand out on each real estate investment. The benefits of going to our bridge lender is that they typically have higher leverage amounts, but they're going to have a floating rate loan.
The fix for those floating rate loans is to buy interest rate caps, which we've done on all of our bridge loans. It's been great. Both the banks and the bridge lenders typically have lower or no prepayment penalties tied to refinancing or paying off those loans. Again, you need to choose the right loan for the business plan you have for a particular real estate investment. I have loans from all the agencies, some banks and bridge lenders. These loans can be an awesome boost to your returns or really slow you down on your business plan. Make sure to pick the right tool for the right job. The deadliest sin any investor can make is to overpay for an asset. That is the one thing that is almost impossible to overcome, unless you get a big outside boost from the market. If that outside market help doesn't come bail you out, then there will be an enormous uphill battle to try and break even.
There are only so many levers we can pull as commercial real estate investors to drive up our own value of our assets. There is an eventual ceiling to rent and other income that we can introduce to an asset, and it's just the same on the operational expense side. Paying a fair price or getting a steal of a deal are ways to really stack the chips in your favor as a real estate investor or any investor for that matter. If you can acquire an asset for a fair price, then it hopefully means you're starting out with a stable asset. Then you can do your business plan of creating extra value at the property and have your refinance or exit in subsequent years with a lot less effort, compared to the overpay option. And in the off occasion, when you come across that steal of a deal, then jump on it and get after that business plan to increase the value of that asset.
By paying a price that is either fair on a good asset or coming across the rare completely mispriced asset by the market, you will heavily improve your odds of making a great return on your investment. The second you overpay for an asset, it'll be really tough sledding to get that asset to perform. Sometimes the best deals are the ones you walk away from because the basis in that property will be too high. To quote the great Warren Buffet, "price is what you pay and value is what you get." Keep that in mind when you're always investing in anything. Over the past few years, there have definitely been people that have overpaid for real estate assets, in my opinion, but the unforeseen massive rent growth has saved them and their investors hard earned cash. That's the way the market bounces sometimes, but to be the smarter investor, it's sometimes best to step back and see what happens should the market not bail those folks out.
Real estate investing can be a great addition to anyone's investment portfolio, but you do need to make sure you don't fall into the traps of picking the wrong type of real estate asset for you and your goals, the wrong type of loan for that investment and the worst mistake of all: overpaying for an asset. Now, don't let that dissuade you from investing in real estate, but do learn from others' mistakes and even your own to continually become an even better real estate investor.
This has been Real Estate Investing with Kenny Wolfe. Thanks so much for listening.