3 Things I Wish I Learned Sooner About Investing in Real Estate
I bought my first investment property in 2007 shortly after reading a book on real estate investing (which happened to be at the peak of the single family market before the crash, but we'll save that for the end). Since then, I have owned a handful of single family investment properties and a whole lot more apartment units. I've also learned numerous lessons - some due to bad decisions and some from near misses. Over the years there are a few key lessons that stick out.
The deal sponsor is more important than the numbers
While this may be completely apparent to some, I had a tendency to rely on the numbers - I mean, I have two degrees in math, so the numbers come naturally to me. I figured that the performance of an investment was all about knowing the numbers. I'd dive into the property financials looking for patterns and learning to recognize things that were out of place all in an effort to be certain that an investment opportunity would work out.
Gradually, however, I started realizing that more important than the numbers on the spreadsheet was the person responsible for those numbers. Anyone can put numbers into a spreadsheet, but an experienced underwriter knows the market well enough to ensure that their numbers are accurate. End of the day, the analysis tool used to determine deal-worthiness is only as good as the input. Garbage in, garbage out.
So my next step was to learn to verify the accuracy of the numbers that I put on the spreadsheet. Once again, I thought the answer was in the numbers and that the more accurate the numbers are, the better. Then we closed on our first property and I gained a whole new appreciation for how the numbers worked in real life and my newly updated goal was to try to make reality match our projections.
Although it took me a while to learn this lesson, I've now come to realize that more important than the person inputting the numbers is the person responsible for executing the business plan. It takes experience to know how to underwrite effectively and it takes even more experience to be able to turn those numbers into reality. That's why I have worked hard to develop relationships with people that have this type of experience and that's what gives me confidence in asking those in my network to invest with me in these deals.
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“Location undoubtedly helps drive value, but more than that, a supply-constrained area where people want to be helps lock in better returns during the ownership and long-term value.”
― Donald J. Trump
Though many would put this at the top of their list, the market (or city) you invest in is probably the next most important factor in apartment investing.
Like the first lesson, this one took significant time to really sink in. When I started looking for apartments in 2018, I quickly recognized that there was significant competition in the larger cities and the investment groups with experience were given preferential treatment by brokers and sellers alike (for good reason). Not only was there extra competition, the prices in the cities seemed extravagant.
So, naturally, I started looking in smaller cities where the competition wasn't nearly as fierce and the prices were much lower. In 2019, I purchased my first apartment investment and it was in a city with a population of about 300,000 - in doing so, we pooled together about $1.8 million from those in our network to make the purchase. The next few properties were all in similar sized cities where the market was a bit more friendly to up-and-comers. Looking back, though, while investing in the smaller markets may have been the best strategy to begin a career in apartment investing, it may not be the best strategy in the long-term.
While it's absolutely true that you can buy at more favorable prices in the smaller markets and generally get higher returns, there's also something to be said about the difference in competition in the smaller v. larger markets. The markets in high demand right now will likely still be in demand for the next several years - the same is true for the markets that are in low demand. When it comes time to sell a property, the same factors that lead to competition will ensure that there will be a steady stream of potential buyers for the investment property when it's time to sell, which reduces the overall risk in the investment.
There are many reasons that make a market desirable from an investment standpoint, and size is only one of them. While it's true that demand in cities like New York, Dallas, Houston, and Phoenix will not likely disappear overnight, we must also pay attention to the factors that create an imbalance in supply and demand. Cities with growing populations will tend to have increased demand and if the new construction does not keep up with the demand, there will necessarily be increases in housing costs, both in purchase prices and in rents, and these factors also bode extremely well for apartment investing.
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Buying real estate is like planting trees: plant now, enjoy for a lifetime
The best time to invest in real estate was 20 years ago. The next best time is NOW.
I mentioned previously that we bought my first investment property at the market peak - August 2007 to be exact. Luckily, we were able to take advantage of the lending environment and only had to put about 1% of the purchase price down (crazy, right?). One year later, the house was worth quite a bit less than when we had purchased it, but we had a fixed-rate mortgage and the income exceeded the monthly payments. When I added in the tax advantages due to the depreciation, we came out ahead by about $1000 per year. When we finally sold the property about 10 years later, we put over $100,000 in our bank account. Not bad for an initial $3,000 investment at the market peak. Now, there were many that didn't fare well during that crash, but the point is that you can make money in any point in the cycle if you are investing for the long-term.
One more quick story to illustrate this point. I recently had lunch witdh a gentleman that's about my dad's age. He mentioned that when he moved to Southern California in the early 1980s, he couldn't believe that anyone would pay $80,000 for a home in Santa Barbara. At the time of writing this blog post, a quick internet search shows that the current median home price in Santa Barbara today is about $2 million.
We don't know what the future will look like, but we do know that the value of real estate has steadily increased for centuries. There have been a few, relatively short periods in which real estate prices have gone down, but navigating price decreases in apartment investing is just a matter of keeping money in reserve and holding on to the asset for a little longer. Overall, investing in real estate has historically been a solid investment and will likely be a strong investment for many years to come.