You probably know a story about someone who has failed at real estate investing. Foreclosures, lost properties, crushed financial futures, and years of hard work down the drain. If real estate investing is as amazing as I have been telling you, how does this happen?
If you know the reasons why some investors fail, you’ll know how to avoid them in your investment career.
Instead of being scared off because of others’ failures, learn from them. Understand the pitfalls in order to become a better and wiser investor yourself.
This is my list of the 6 most common snares that lead to some investors failing, and the lesson to learn from each of them.
1. RUSHING IN
People are impatient and ultimately lazy. They are excited by success stories and decide that real estate investing is the right path for them as well. “Financial freedom in ten years or less?? Hell yeah!!” So, they rush out and start buying rental properties before they know what they’re doing and before they’ve done the work to educate themselves. No analysis, no deep understanding of their market, no planning – just jumping at whatever opportunity presents itself.
And they end up jumping in way over their heads.
Lesson: TAKE YOUR TIME! Do not invest until you fully understand what you are doing. Real estate investing is not a get rich quick scheme.
2. POOR ANALYSIS AND BAD MATH
Numbers never lie, but it can be easy to run the wrong numbers! Not doing enough analysis and research is a very common mistake. A lot of investors review a property that rents for $1000/month with a mortgage of $750/month including taxes and insurance and they think: “Great! I’m going to make $250 per month in cash flow.” But, after property management, vacancies, repairs & maintenance, and all other expenses they end up losing $250 a month. You have no chance of getting the right cash flow from a property if you have the wrong math going in.
Lesson: Educate yourself and research. Make sure you know how to run your numbers correctly. Always run your numbers conservatively by factoring expenses higher than you expect.
An unfortunate, but common issue in real estate investing is under-capitalization – or not having money to cover an expense. Sometimes it’s the result of over-leveraging. An investor simply buys too many properties, too quickly, with too much debt and at too low of margins. Sometimes it’s the result of poor planning. The investor may simply go spend all their money on other things, not leaving themselves enough of a cash buffer to cover a major repair. Whichever the reason may be, they leave themselves in a dangerous and precarious position of not having enough cash on hand.
All of the sudden an HVAC system goes out at one property. A major plumbing leak happens at another. A tenant stops paying and they have to go through a lengthy eviction process. A tenant leaves a property in shambles and they lose months of rent as well as having to renovate the property. Everything big thing that could go wrong does go wrong in a short period of time. If you don’t have enough to cover all those costs and continue to pay the mortgage you can lose everything.
Lesson: Under-capitalization is the Achilles heel of all business ventures that are in their infancy. Make sure you have cash reserves for the worst case scenario. Be prepared and don’t leave yourself without a safety net.
A lot of real estate investors are speculators, meaning they are investing based on the hopes of their investment gaining value by a certain time. There are multiple ways investors speculate in the market. All forms of speculating are just theme and variation of the same investment strategy:
An investor purchases a building or land with the hopes that at some point in the future (usually years) it will be worth multiple times what they paid. At the time of purchase they might lose some money every month in the beginning, but they are speculating on their long-term bet paying off and making up for the early losses many times over.
People have made a TON of money doing this. But many people have also LOST everything when their speculations don’t pan out. Sometimes they lose everything because the uptick they were planning on took a lot longer than expected and they didn’t have enough money to get through the losses at the beginning. In other cases they placed the wrong bet and the uptick never happened. In some extreme cases, the market actually went down below their original purchase.
Lesson: Speculating is a true risk/reward investment. Although potentially lucrative, it is equally, if not more-so, dangerous and risky. It is a very high stakes game that should only be played by the people with very deep pockets and incredibly sophisticated forecasting systems. That is why I only invest in properties that are performing well now and avoid speculating.
5. THEY DON’T TREAT IT LIKE A BUSINESS
Some investors fail simply because they don’t treat real estate investing like a business.
This is most common for people who choose to self-manage their properties. There is a lot of room for error in property management. Many don’t have good (if any) screening processes for tenants. Or they aren’t strict on rent collections. Or slack on any other number of huge list of things that a property manager is responsible for.
Even if they have hired property managers, there are many ways to fail by not treating their business like a business. They could have been lax on hiring the members of their investment team. Or maybe they didn’t implement any systems to watch over and track their investments. Without proper oversight it’s easy for things run very poorly. If this goes on too long, it may be too expensive to get it back on track.
Lesson: Real estate investing can require very minimal time and be a very passive investment once all your systems are in place. Take the time to establish solid systems and a solid team.
6. THEY DON’T HAVE A BIG ENOUGH “WHY”
Many investors simply don’t have a big enough motivator to invest the time and effort to get their real estate investments going properly. I have said several times, but it bears repeating: This is not a get rich quick scheme. Real estate investing takes time to learn. Tradeoffs have to be made to save up to invest. The early returns will be very small. Without having a big “why” many investors end up failing because they stop caring and stop putting in the effort.
You have to have something driving you to continue working toward your goal year after year.
Another reason not having big enough why causes investors to fail is simply because they never get started.
Lesson: You MUST know your WHY
SUMMING IT ALL UP
If you haven’t recognized the theme of all the failures, it usually falls back to a failure of the person. It’s not that real estate investing is inherently risky. The risk in real estate is diminished greatly with proper education or planning on the part of the investor.
Risk comes from not knowing what you are doing. Take as much time as is required to educate yourself so that you really know what you are doing. And finally, know why you’re doing it.