I met with my friend’s wife this weekend to learn more about her thriving real estate business. She helped to confirm what I suspected to be the number one mistake that new investors make: they expect to make good returns by paying “retail” prices for real estate. By “retail” prices, I mean that they pay the same price for a property as someone would pay for their primary residence. It is very difficult (if not impossible) to make money in real estate by paying fair market value for investment properties, especially in today’s real estate market.
The real estate business is very much like any other in many ways. If you are buying and selling widgets on eBay and you buy your widgets for retail price at Wal-Mart, there is no way in hell you are going to make any money. You have to buy your widgets at a heavily discounted price in order to turn a profit. The same goes for real estate. If you are going to make money in real estate, you have to buy properties at a heavily discounted price.
Even if you use the cheapest kind of financing possible (i.e. an interest-only loan), it would still be difficult to make positive cash flow on a rental property. It would also be difficult to try to make upgrades to the property to sell it for a profit, if you paid fair market value for the property. The closing costs, holding costs, not to mention the cost of upgrades and repairs would erode your profit. Even if you paid cash for the property, it is may still be difficult to simply recover upgrade costs unless you made a major improvement such as adding a bedroom and/or bathroom.
The best way to mitigate risk when investing real estate is to make sure you pay as little as possible for investment properties. I’m talking about paying 65-70% on the dollar or less, not a discount of a mere 5-10% of fair market value. The less you pay, the more room for profit it will give you for recovering closing costs, holding costs, and the cost of repairing and upgrading the property. It also leaves room for positive cash flow if you plan on buying, holding, and renting (which is what my friend’s wife does). If you do ever decide to take the plunge and get into investing in real estate, be sure you are getting a steal on the properties you buy. Otherwise, you could very likely have a bad experience and will never invest in real estate ever again.
Of course, the big secret is how can you possibly manage to buy a home for 65% on the dollar. Perhaps that will be another article for another time, but there are many books and resources on the internet that will tell you how to do it. It is a matter of doing your research and acting on what you’ve learned. The biggest challenge (especially for an analytical person such as myself) is actually taking action after becoming educated with good information.