We all hear from friends and family that real estate is the best investment out there, but is that really the truth? In this article, I would like to share how that advice turned my first real estate investment into a disaster, highlight my five biggest mistakes in that first purchase, and how you can avoid these transgressions.
So what were my five biggest mistakes?
- Unfamiliar with the demographics of the market.
- Bad timing of the market.
- Lack of education.
- Terrible due diligence.
- Over fixing.
The list is much longer than these five mistakes, but I feel that these mistakes were the main culprits that led to me buying such a crappy investment.
Unfamiliar with the Market:
Most investors begin their investing by analyzing deals and selecting a market that is either close to their home or affordable (aka cheap). An investor’s first step is to focus on one or two markets, and gain an intimate knowledge on metrics, such as population growth, jobs, and number of major employers.
The market that I chose to buy my first commercial investment property had very unfavorable demographics. There was no job or population growth, the local government had no clear plan for the town’s growth, the cost of living was extremely high, limiting my pool of prospective tenants, and the tenant laws were unfavorable to landlords. I couldn’t have chosen a worse market!
Looking back, the only criteria that was positive was that the investment was about 30 minutes from my home! I thought it was less risky to buy a property in my backyard and manage it myself. I shattered that limiting belief with my first multifamily investment.
I never took into consideration what market cycle I was purchasing the deal in. To be honest, like most beginning investors, I had no clue about the four market cycles, and I paid dearly for my ignorance. Never believe a person that utters ignorance is bliss. In this case, ignorance is painful and costly. I purchased the asset at the very end of the hyper supply phase, and values were at the top of the market. I actually purchased the property at a rather decent cash on cash return and cap rate, but once the economy tanked, I lost several tenants and my returns vanished with my tenants. Click here to read about the four stages of a market: 4 Stages Of A Real Estate Market Cycle.
As an investor, it is imperative to know what phase of the cycle your city is in. If I had realized the cycle, I would have waited to purchase the asset at a discount or I would have elected not to go ahead with the purchase. Real estate is market specific, and one city may be in hyper supply while another city may be entering the expansion phase.
Lack of Education:
One of the biggest fears I hear from new investors and students expressed is: “I don’t know what I don’t know!” That can be down right scary and dangerous. I decided to invest in a commercial income producing asset with no experience, no team to guide me, and no plan to manage the asset. I had never written a commercial lease, and I did not know how to underwrite the deal accurately.
Once I understood my shortcomings, I decided to seek out a coach and learn the business from someone who already exhibited success and could teach me their framework. Although it was too late for this deal, it served me tremendously for my future deals. I chose multifamily real estate and focused on cash flowing assets that would help me achieve financial freedom.
Terrible Due Diligence:
Another example of what you don’t know you don’t know. I take full responsibility for my lack of due diligence (it was terrible), but my attorney and inspector were about as bad as I was.
This is where a top-notch team comes in and elevates your business. The building had so many violations, and yet I purchased the property without having the seller correct the violations. Let me list just a few for you:
- No commercial fire system.
- Water system was inoperable.
- Reports to Board of Health were incomplete.
- A couple of tenants had violations to their units, and did not have proper a C.O.
- Commercial space utilized as a residential apartment.
- Did not collect proper income/expense reports.
As you can see, it is a miracle that I did anything right on the deal. I learned the importance of due diligence, and created a three step due diligence framework for fellow investors: Due Diligence Framework. My wish is to spare first time investors the pain that I endured due to my lack of education and being surrounded by team members who displayed the same amount of incompetence.
This problem is a fix and flipper’s worst nightmare, but it also plagues the commercial investor. My investment was beset with a ton of deferred maintenance, and I was more than eager to turn an ugly duckling into a beautiful property. Who ever considered return on investment for capital invested? I undertook some major renovation, such as siding, roofs and paving the parking lot. It would have been nice if I had the ability to estimate the repairs needed so I could ask for a repair allowance. I did manage to get a small reduction in price, but it was meager in comparison to the money I spent in renovations.
Now with all of these colossal mistakes I committed on this deal, you would think that I would pack up and quit. I almost did, but my reason for investing in real estate was greater than my fear of failure and losing more money. It took me a couple of years to educate myself and meet Jake, but it was well worth the wait.
I also want you to realize that what most people may characterize as a mistake is in fact, a blessing in disguise. If I had never invested or tanked on this deal, I may have never invested in real estate. Or I may have never sought a mentor to teach me how to invest. The point is to never allow a setback to stop you from achieving your goals. In order to become successful, focus every day on your “why” for real estate, and when you eventually hit the bump in the road, you will not veer off course. You may slow down, but you will continue to grind it out as I did.
Investor's Action Task:
Know why you want to invest in real estate, dedicate the time to learn how to invest, seek out a coach or mentor to shorten your learning curve, and take action! Let me know if you have any real estate questions on how to begin your journey.