10 Rules for Successful Real Estate Investing | PREI 002
In this episode Marco discussed his 10 Rules for Successful Real Estate Investing.
After many years of successes and failures, Marco came up with the following rules of successful real estate investing. These are the same rules he follows today and shares with investor clients at Norada Real Estate Investments.
This is an important and foundational subject so be sure to listen. You can also read the original article here: 10 Rules of Successful Real Estate Investing
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10 Rules for Successful Real Estate Investing
Welcome the Passive Real Estate Investing. I’m your host, Marco Santarelli. This is our second episode of our exciting new show. This is the show where busy people like you learn how to build substantial passive income while creating wealth for the long term. If you’re new and you missed the first show, I encourage you to go back and listen to that introduction. We cover passive real estate investing, what it is, how that compares to active real estate investing. It lays a good foundation of what the show is about and where we’re going as well as an introduction about myself.
Today we’re going to talk about the ten rules for successful real estate investing. I find this to be very foundational and very important. After many years of successes and failures through acquisitions, dealing with tenants, managing myself, working with property managers, market ups, market downs, seeing speculation in the market, speculating myself, getting caught up in that whole frenzy back in the early 2000s and then riding down a deflating bubble, I’ve learned many, many things.
Over the course of those years, I’ve come up with these rules for successful real estate investing. These are the same rules I follow today and they’re the same rules that we share with clients at Norada Real Estate Investments, a company that I own and manage that sells turnkey investment properties nationwide here in the US.
The first is educate yourself. This is critically important and probably the most important rule. Knowledge is the new currency. If you don’t educate yourself, then you are doomed to follow other people’s advice. That applies to almost everything, whether you’re talking about equities and the stock market or real estate or anything else for that matter.
I like what Robert Kiyosaki talks about. He breaks education down into three categories. There’s academic education, and this is what we all go to school to learn, the important stuff, the basics, what teachers teach us. This foundation is the reading, writing, learning and learning about the functions in the world.
Beyond that, there’s professional education. This is what we learn to help become successful within our careers. This is usually the stuff we learn in college or trade schools or maybe even on the job. It’s information that we use for our profession. A good example would be attorneys or CPAs or dentists or trades people, like a machinist. This is information and skills that we need to be successful at work, at our job.
The third kind of education is what we call financial education. This is the type of education that teaches us what we should be doing with our money to be successful. In today’s world, financial education is crucial, especially with the world, economy and recession or depression. However, our school systems don’t teach us about financial education and so most people have never really been taught what they need to know in order to take control of their financial lives.
It surprises me that some people get out of high school and they don’t even know how to balance a checkbook. Financial education is crucial. This all comes down to educating yourself, knowing about money, knowing about assets, understanding income and expenses, understanding the different types of assets and asset classes and how they can benefit you financially.
If you don’t know the difference between different assets and how to evaluate good deals from bad deals, then you’re really going down a path where you’re being led by other people’s advice and you don’t know if that’s good or bad advice. Educating yourself basically takes you from being a good investor to becoming a great investor. That knowledge will help provide you a passive stream of income for you and your family for the rest of your life.
The second rule for successful real estate investing is setting investment goals. Before you shut yourself off and stop listening here, this is not about goal setting. I’m not going to talk to you about how to set goals. I just want to tell you that setting a goal is very important. Having a goal is much different than a wish, and many people wish to be rich. That doesn’t that they will.
If you set clear and specific investment goals, that really becomes your roadmap and then eventually becomes your action plan to becoming financially independent. You are statistically far more likely to achieve financial independence by writing down specific and detailed goals than not doing anything at all. This has been proven time and time and time again.
In fact, when I was sixteen years old, which goes back a number of years, I remember purchasing Tony Robbins’ first program. It was on audio cassette. Yes, cassette. Not CD. I remember playing those tapes over and over and over again. One thing that was pretty consistent, especially early on in that program, was thinking about what you want, visualizing what your ideal life would look like and then writing down what those goals are.
What is it you’re trying achieve? Make them very crystal clear and then define them even further into what you’re going to do to achieve it. Break it down to step by step by step. It’s just like that saying, “How do you eat an elephant?” The answer is one bite at a time. If you break it down into a granular enough list, you can take that first step and then once you’ve taken the first step, you can easily take the second step and third and so on.
Your goals can include the number of properties you want to acquire this year, over the next few years, the annual cash flow that they need to generate, the types of properties, maybe the locations of where those properties are going to be. That’s up to you. The more specific you are, the better off you’ll be. Of course, reading them on a regular basis. Ideally, read them daily. If not, at least review them once a week.
The third rule is never speculate. Always invest with a long term perspective in mind. Don’t chase after appreciation, especially short term gains. Now, if you’re flipping property, that’s just baked into the cake. When you buy a property and you flip it, usually it’s going to happen within three to five months. Any gains are going to be short term gains.
When you’re building a long term real estate portfolio for cash flow, for long term equity growth or wealth, you don’t chase after appreciation. You should buy in markets that make sense, that generate cash flow from the day you buy that property, that will appreciate over time but you’re not investing for the sole purpose of chasing after that appreciation.
When you hear about a market being hot, you shouldn’t be jumping into that market just because the last two, three years have had high percentages of appreciation or maybe double digit appreciation. That doesn’t make sense. That’s certainly not sustainable and thousands, if not, tens of thousands of investors got caught with their pants down back in 2006, 2007, investing in the bubble markets of Florida, California, Arizona, Nevada.
They got to the point where they jumped on the equity train, rode it up for a short period of time, they thought it would go on forever. Nothing ever goes on forever. At some point, the market’s going to turn and come down and they found themselves upside down on these properties where they owed more than the property was worth and they had to give them up, short sale them, get foreclosed on. That’s not the smart way to invest.
My primary criteria is cash flow, my second criteria is the equity in the property and my third criteria is appreciation potential. We can’t predict or know what a market’s going to do over the next three to five years. That’s very difficult. It’s a little easier to forecast what the market will do over the next six to twelve months. Again, that’s not what drives my decision and it’s not what really should be driving your decision.
Only invest in prudent value place. This is kind of like the Warren Buffett principle, invest in value place where the numbers make sense right from the beginning so you know you’re going to be getting a rate of return from the first day you close escrow on that property. From there, equity will grow. Equity will happen, appreciation will happen over time. Your property will appreciate in lockstep with inflation.
Number four, invest for cash flow. Now, I just touched upon this but it’s worth emphasizing that you should always, and I emphasize always, buy investment properties with positive cash flow. There are rare exceptions where a small negative cash flow or break even cash flow make sense. I’m not going to get into that today. That’s an entirely new topic.
Cash flow is the glue that keeps your investment together. It covers all your expenses, your future expense, covers your debt service and leaves cash leftover at the end of the month that you will take as income. It allows your property to gain equity over time as that loan is amortized, it’s paid down and the property appreciates.
Also, when you invest for cash flow, you have a rate of return. You invest a certain amount of money, let’s say $10,000 on a $50,000 property or $20,000 on a $100,000 property. These are just hypothetical examples here. I’m using 20% down. The cash flow that you get every year from those properties is a direct cash on cash return on that money or cash invested.
That is where you can start to build your passive income that ultimately, when you build it up, will replace your current income from your job or work or whatever you do. When you get to that point, now you have enough passive income to allow you to financially retire. That doesn’t mean you have to stop doing what you’re doing if you love it, but it allows you to do whatever you choose to do.
Number five, be market agnostic. What does that mean? It means you’re not married or tied to any particular market. The US is a very large country and it’s made up of about 400 local real estate markets, or what some people call MSAs, metropolitan statistical areas. There’s no such thing as a national real estate market. It doesn’t exist. Show me a national real estate market, you can’t. It just doesn’t exist.
What you need to understand is that each market moves up and down independently of one another due to local factors. Its local economy, the health of the housing market, the supply and demand, the inventory. If you recognize that, you will see that there are times when it make sense to invest in a particular market and of course there are times when it doesn’t.
Just because it makes sense to invest in a market like, let’s say, Kansas City today because the numbers are strong, there’s high rates of return, the economy is solid, doesn’t mean that it may also makes sense to invest in other markets like San Francisco for example, which is highly inflated, or a market like maybe Detroit, not to pick on any particular cities, where it is suffering economically, it’s a city that has filed for bankruptcy.
There’s a time to invest in every market, depending on where that market is in its real estate cycle. The numbers have to make sense, the market has to make sense. That’s what it means to be market agnostic. You’re only choosing markets that make sense the day you’re looking at it or that year. Only invest in market when it makes sense to do so, not because you live there or because you bought properties there before.
Maybe it made sense to buy properties in a particular market three years ago, that’s the case with a market like Phoenix, Arizona. In Phoenix, it actually made sense to invest about three, four years ago. Market values or property values were very low. The rent to value ratios were very attractive. But that market heated up again. Now, that market is maybe not overpriced but it’s highly priced and the rates or return aren’t there.
There is an element of timing here. You don’t want to buck the trend. The important thing is just to stay agnostic, don’t marry yourself to any particular markets, select the markets that make sense, don’t attach yourself emotionally.
Number six, take a top down approach. Most investors start by analyzing properties with little to no regard of its location. This really is a big mistake if you don’t consider the investment in light of the market and the neighborhood that it’s in. You can’t just detach a property from the lot that it sits on, in the neighborhood that it sits in, and move it to another location if, later, after you’ve purchased this property, realize, “Well, that wasn’t such a good decision. I don’t like this neighborhood or maybe the economics of this area aren’t so good. There’s just a lot of crime.”
It just doesn’t work that way. They’re joined hip to hip. The best approach is to first choose your city or town based on the health of its housing market and the health of the local economy. Things that we look at are unemployment, such as unemployment trends, jobs and job growth, population growth, is there positive migration, maybe negative migration out of that area. Look at different factors at a macro level, the big picture within that metropolitan area.
From there, you would narrow things down to the best neighborhoods or areas within that metropolitan area or that city. Here you would look at things such as amenities in the area. To me, that’s a big factor, the amenities in the area, because that’s what draws interest or makes an area attractive to your particular tenant demographic. Schools, the quality of schools. Crime and crime rates. Renter demand, this is a big one. Some of the best places to get this information is from local property managers.
You narrow it down from the big picture, the city, down to best areas and neighborhoods. Then finally you start looking at candidates, different properties or deals within those different neighborhoods you’ve identified. Now, if you do this backwards, if you start with a property, at least look at the neighborhood that it’s in and do some research and due diligence on the entire market that property and neighborhood sit in.
You may have found a cherry property, but if you don’t like the neighborhood it’s in and the market that it’s in, if it’s a depressed market, in decline, there’s people moving out of that neighborhood or you’ve just got other issues going on, then you can quickly forget about that property. As good as it looks on paper, or maybe as good as it looks walking through it or looking at photos, you can quickly dismiss that property as a good candidate because it’s not a good deal.
Number seven is also a strategy, not just a rule. That is diversify across markets. It’s important to focus on one market at a time and to accumulate three to five income properties per market. This is a general rule of thumb for me. This is not hard or chiseled in stone, but it’s a guideline or a measuring stick to just give you a reference point.
For me, diversifying across different markets means accumulating three to five income properties per market and then moving to another market that is geographically different than the previous one. That typically means focusing on another state. You would diversify your portfolio by accumulating properties in one market after another that are geographically different. My rule of thumb is three to five per market, but then I also have another cap of three to five markets.
If you’ve accumulated, let’s say, five properties per market across five different markets, now you’re at 25 properties. Now, you can go back and start accumulating more properties in one of those markets that are the best prospect at that time.
Now, what if there are better markets out there than some of the ones you’re in years down the road? You can still diversify across markets. You can sell through a tax deferred exchange, which we’ll cover in another episode, out of those markets and move that equity tax-free into other markets that make more sense at that point in time. That could be years down the road, just depends on how quickly you’re building up your portfolio.
The important thing to understand here is that every real estate market is local and each housing market moves independently from one another. What I mean by local is every driver in a market, every fundamental factor that changes that market, that drives people to move into that market, that builds more demand and increases property values, changes from market to market.
Diversifying across multiple states helps reduce your risk should one market decline for any reason, whether it’s increased on employment or increased taxes, whatever the case is. This is just a way to diversify within the asset class of real estate and minimize your risk.
Number eight, use professional property management. Never manage your own properties unless you run your own management company. There’s only one other exception to this rule. Property management is a thankless job that requires a solid understanding of tenant-landlord laws, good marketing skills and really strong people skills to deal with tenant complaints and excuses. You do need thick skin.
Now, unless you enjoy it, you have the time, you have the knowledge and the experience from managing properties in the past, then go ahead, knock yourself out. That’s not something I want to do. My time’s valuable, your time’s valuable and it should be spent with your family, your career, looking for more property. It’s not something I want to spend my time doing in terms of it’s best use, highest and best use of time.
Property management should be left to a professional property managers. The fees they charge is money well spent. That’s usually around 10% of collected monthly rents, it could be as low as 9% or 8%. You can negotiate this sometimes. Even at 10%, believe me, it is money well spent. I’d rather spend 10% every month to have someone completely manage, oversee and deal with my properties, my assets.
I’ll keep in touch with them, I’ll manage my managers, but I’ll let them take care of anything in terms of communication, rent collection, turning over the property, leasing it up. As long as I get that check in the mail every month, that’s really what makes me happy. Use professional property management, highly recommended. There’s only few exceptions to that rule in my book.
Number nine, maintain control. Be a direct investor in real estate. Never own real estate through funds or partnerships or other paper based investments where you own shares and other securities of an entity you don’t control. You always want to be in control of your real estate investments. Don’t leave it to corporations or fund managers. You just don’t know what kind of fees they’re taking off the top, what decisions they’re making, you’re not involved in the process.
When you own your own rental real estate, you own it, you control it, you’re the boss, you call the shots, you hire the contractors and the people that you need, but really, you don’t even need to do that most of the time. With passive real estate investments, such as income producing real estate that are just leased and managed, you really just need to let the property manager handle everything. They’ll collect the rents every month, send you a check and you just stay in touch with them on what’s going on.If there’s any decisions that need to be made, you could make them with them, if needed. Maintain control.
There are just too many types of investments out there that are not real estate related and some that are where you really don’t have control. At the end of the day, it could be to your demise. Companies fail, equities and different paper assets get obliterated or they get knocked down because of poor earnings, whatever the case is. I’m just not a big fun of paper based assets. Own the property and maintain control.
Number ten, leverage your investment capital. Real estate is the only investment where you could borrow other people’s money to purchase and control income producing property. This really is an amazing thing because this allows you to leverage your investment capital into more property than purchasing just using all cash.
Let’s use my $100,000 example from before. If you had $100,000, which yes, I know is a lot of money. Instead of buying one property worth $100,000 all cash with that 100,000, what you could do and what I highly recommend you do, is put 20% down, which is $20,000, and purchase five of those $100,000 properties using that $100,000. Now, instead of having one property, you actually have five properties worth $100,000 each. Now, you’re controlling $500,000 worth of real estate instead of just the $100,000.
On top of that, you’re able to borrow money from lending institutions and banks at closed to historical low interest rates. That allows you to control a lot of real estate with a relatively small amount of down payment capital. You have tenants paying you every month. Effectively, they’re paying off your mortgage and buying that property for you. Leverage magnifies your overall rate of return and therefore accelerates your wealth creation.
This is great because you can’t do this with any other investment class. Now, some people will argue and say, “Hey, Marco. No, you can. You could get a margin account in stocks.” That’s true but the problem there is number one, you can only get 50% funds for buying stocks or securities. Number two, more often than not, those stocks don’t generate cash flow, with the exception of dividends of course. Number three is if your stocks, which are very volatile, happen to go down in value, you can have a margin call and you can have that stock brokerage that you’re with demand you make up the difference on whatever that floor or margin is on those securities. You may have to cough up some cash to make up the difference for what that security has dropped.
Leverage with real estate is powerful. It allows you to accelerate your wealth building and cash flow tremendously. I really think that is the best way to build your real estate portfolio the fastest manner possible.
That about wraps it up for this episode. Be sure to download our new free report, The Ultimate Guide to Passive Real Estate Investing. You can download that at PassiveRealEstateInvesting.com. While you’re there, you can submit any questions you’d like me to address in future episodes or send me some topic suggestions. You can do that through the contact form or if you like to leave a voicemail, you could do that right from our website as well. There’s a button on the far right, it says, “Submit voicemail.”
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