You’ve thought about investing in rental properties …
… but the fear of making a huge six-figure mistake holds you back?
You’re not alone.
That “what if I buy a disaster?” feeling is real, especially for beginners.
Imagine walking into a casino and putting $100,000 on red. That’s how some people view real estate investing – as pure luck.
(And let’s be honest, those who dive in without learning the ropes probably aren’t much luckier!)
Successful real estate investing is about strategy, not gambling. By educating yourself and avoiding common pitfalls, you can weather almost any storm.
7 Expensive Mistakes (and How to Avoid Them!)
Let’s dive deeper into seven specific mistakes that many newbie rental property investors make:
[Here’s a handy PDF of the 7 major mistakes.]
Mistake #1: Relying on Appreciation
Don’t get caught up in the home price chase. Focus on the property’s ability to generate cash flow and build long-term wealth.
Appreciation is a bonus, not the main event. A hot market might make your property more valuable on paper, but it’s not the full story.
We can get so distracted by market appreciation that we forget the main goals of rental real estate: the cash flow, the principle paydown, and the ability to diversify your portfolio and create a stream of residual income that biases towards a dividend-style return.
Appreciation should be seen as the “icing on the cake.”
Mistake #2: Overleveraging
Leverage can be a powerful tool but be responsible. Don’t take on too much debt and risk losing everything if the market turns.
Leverage carries with it the ability to carry you both upwards AND downwards quickly. Be responsible with it. Don’t take the risk lightly.
And never, ever, EVER listen to any self-proclaimed real estate teacher who waxes poetic about the cash-on-cash return formula (CoCR); this is one of the ways that good people get led astray by bad teachers.
Mistake #3: Using the Wrong Formulas
Let’s talk more about the dangers of an over-reliance on cash-on-cash return, because it’s So. Darn. Important.
Many real estate investors are in love with this formula, and they encourage beginner investors to make decisions based on this formula. That’s a huge mistake.
This is why it’s so critical to be careful whom you learn from. The cash-on-cash return formula can make properties seem like better deals than they actually are, causing beginners to sink their hard-earned cash into a sub-par property.
Mistake #4: Using Magical, B.S. Accounting
Repeat after me: Math must be identity-agnostic.
How many times have you heard someone say: “If I do the work myself, then the cost is $0!”
*Facepalm.*
That’s an idea that’s repeated all the time among beginner rental property amateurs who haven’t done their homework.
It’s fine IF you decide that you want to temporarily handle the repair, maintenance and management tasks yourself, assuming you buy locally. But run the numbers as though that’s not the case.
Run the analysis as though you’re hiring out every task. Pay yourself a fair market rate. This means that when you’re ready to retire, you can hire a pro to do the repairs without compromising your returns.
Math must be identity-agnostic, meaning any person can occupy a given role (property manager, carpenter/handyperson) and the returns stay the same. Otherwise, you’re using B.S. accounting.
Mistake #5: Not Having a Strategy
How often have you heard someone say, “I’ll buy this property and live in it for awhile. Then I’ll rent it out. And I hope it’ll go up in value.”
That’s another way of saying, “I don’t have a strategy and I haven’t run any analysis. I’m crossing my fingers and hoping for the best.”
That’s how people make expensive mistakes.
If you’re thinking about buying a rental property, I have a few questions for you:
- What’s the projected cap rate under best, worst, and likely-case scenarios?
- What are your estimates for gross operating income, net operating income, and operating overhead?
- Can you name between three to five efficiencies that could help you boost the future NOI?
- In what other ways can you force appreciation on this property?
- How much are you anticipating for CapEx? Why?
- What’s the estimated remaining lifespan on the most expensive components, such as the siding, roofing and HVAC?
If you can’t answer these questions, you might be “playing” investor rather than “being” an investor.
Mistake #6: Using “Rental Property” to Justify a Personal Expense
Don’t trick yourself into buying a vacation home by calling it an investment. Analyze the property strictly on its ability to generate income.
That lakefront cottage might be your dream weekend getaway, but if it sits empty most of the year and costs a fortune to maintain, it won’t be doing your portfolio any favors.
Imagine that you want to buy a vacation property, such as a cute cottage on the lake.
Deep down, there’s a small part of you that feels guilty about making such an extravagant expense.
So you convince yourself that this is an investment property.
“I’ll rent out the cottage when I’m not there,” you tell yourself. “The rent will cover the expenses. Then I can stay there, three weeks a year, for free. And it might go up in value. So really, it’s a good investment”
Whoa there, buddy. Hold the phone.
Let’s go back to the fundamental question that all rental property investors need to ask: what is the cap rate on this property?
If you can’t answer that question, then you’re not viewing this as an investment. Let’s be honest.
It’s fine to buy a vacation home for personal enjoyment, as long as you admit that’s what you’re doing. And it’s great to monetize something that you purchased for personal enjoyment.
But that’s not an investment property. It’s a personal purchase that you’re monetizing.
Mistake #7: Choosing the Wrong Mentors
Learn from experienced and credible real estate investors. Be wary of “gurus” promising unrealistic returns with risky strategies.
There’s a lot of noise in the real estate education space, so vet your sources carefully. Look for mentors with a solid track record and a focus on long-term, sustainable investing practices.
Be careful whom you learn from.
Every investor has their own strategy, philosophy and perspective. Following the wrong teacher can lead you down the wrong path. And that can create a six-figure (or more) mistake.
It’s not tenants destroying your place or a flood that’s going to ruin you – it’s the moment you exchange $100,000 for the wrong set of keys.
The most important element of successful real estate investing is choosing the right property.
If you educate yourself, conduct due diligence, and buy a property in which the numbers work, you can weather almost any storm that nature, crappy tenants, or bad luck throws at you.
If you choose the wrong property, almost no amount of good management can salvage the deal.
Is real estate investing worth the effort? Is the effort-to-reward ratio worthwhile?
I discussed this in a YouTube livestream last week.
Short answer? Yes, and here’s why:
When you get into real estate investing, you’re starting a new business. Once you have everything up and running, the income is residual.
But like any business in an industry that’s new to you, it’s going to take time to educate yourself.
Sure, you can shortcut that time with the right courses, mentors, and community, but it’s still time spent on education that’s on top of your full-time job and life + family commitments.
Ask yourself: is getting educated worth a couple hours a week?
If you’ve been working a soul-sucking job for a long time and desperately want to escape, it’s easy for the “escape urge” to overwhelm your patience and cause you to look for a quick exit.
But successful investing is about the long game.
If you impatiently dive in and buy your first rental with no idea what you’re doing, you’ll make mistakes.
But if you look at this long-term (for example, if you have a five-year goal of buying your first one to two rental properties), it’s clear that this educational phase is perfect for preparation — education pairs well with saving up for a downpayment.
My favorite things about real estate investing are …
Returns that bias toward income —
When you invest in index funds, your dividends are generally low.
The primary way to draw from your portfolio is to liquidate part of it.
As a real estate investor, your returns are biased towards the “dividends,” more so than the appreciation. It’s the income portion of your portfolio.
Hedging against inflation —
Real estate tends to perform incredibly well during inflationary periods, because investors look to tangible assets to store their cash in.
Competitive returns as compared to index funds —
Real estate is a hybrid between investing and entrepreneurship. You can add value to the deal through strong management and tight systems, which can bolster your returns.
Hedging against overexposure to the stock market —
A good portfolio is diverse. None of us know what’s going to happen with the stock market, crypto, or the real estate market. A strong portfolio won’t be sunk by one asset class going down. (The cliche notion of FIRE through an index fund portfolio alone has always made me uncomfortable.)
Control over management and operations —
It’s up to you how you run this real estate business, which means that you have the power to create better returns.
For example, if there’s a laundry room that’s being under-utilized, you can turn it into a bathroom, and then the rental value of that property rises.
Or you can use a partition wall to section off an underutilized portion of a living room, converting a 2-bedroom unit into a 3-bedroom.
With index funds, you have no power, control, or autonomy. You simply accept the returns that are driven by corporate management.
Control over ethical decisions —
When you buy index funds, you’re implicitly backing the decisions of the companies tracked by that fund.
When you’re running a rental real estate business, you get to be the landlord you want to see in the world. Be a role model landlord, and lead by example.
You get to be the human connection for your tenants, and offer them a level of customer service and care that they never could have accessed if they’d rented from a Wall Street hedge fund.
Ultimately, you have to weigh all these things for yourself. Just because real estate investing is right for my lifestyle and financial independence goals doesn’t mean it’s right for you.
If you’re thinking about it, you can learn a TON on this page. Check it out.
— Paula
