Take A Disciplined Investment Approach

This month in Wall Street Your Real Estate we’re examining Rule #5 Take A Disciplined Investment Approach.  If you’re just now joining us for Wall Street Your Real Estate, The New Rules For Investing in Real Estate, you may want to view our previous posts:

 

 

If you’re a design or renovation junkie and feel like you’re in the wrong place, you won’t want to miss our latest post about choosing paint colors on The 1898 House Home Renovation Blog Series.  We’re all about the rules here and in that post we’ve highlighted our Five Rules For Paint Colors here.  If you’re here for Wall Street Your Real Estate then enjoy Rule Number 5:

RULE #5 TAKE A DISCIPLINED INVESTMENT APPROACH

It’s easy to get caught up in the hype of a hot market or jump at a property that seems like a good deal in a down market, but in order to be a long term winner in the real estate market you need to maintain discipline.  This discipline isn’t just important at purchase and sale:  it’s critical throughout the ownership process.  Disciplined real estate investors set purchase numbers and sales target numbers, keep a budget for their maintenance costs, make plans for capital improvements, stay informed about the tax code, shop carefully for loans, understand management fees, and carefully track expenses.  In this blog post we’ll discuss the various ways you can be a disciplined investor.

In order to excel at being a disciplined real estate investor you need to be patient,  willing to wait for the right opportunity, and adjust pricing only when absolutely necessary.  It’s critical to learn the market and find a trusted local advisor who can help.  Together you should be able to set a realistic target purchase price and later, a target sale price for a property.  You need to set a cap on the price you’re willing to pay for a property and walk away if the price exceeds that cap.  You need to do the same for a sale price when you’re selling.  In some instances, market conditions will dictate re-examining your targets but discipline means staying calm, gathering enough information, and waiting until you absolutely know you have to adjust.  

An undisciplined investor gets nervous and operates out of a fear and scarcity mentality.  They justify paying above their target by telling themselves that they’ll never find another property this great.  They accept an offer below their sale target price, because they’re afraid they won’t find another buyer.  Undisciplined investors are impulsive, reactive, and act on emotion.  This type of investor is the perfect prey for unscrupulous real estate advisors who use scare tactics to close deals.  These are often the high flash and little substance advisors who dominate their clients and manipulate them into changing strategy.  Fear and scarcity are powerful motivators in any marketplace, but even more so where the product is unique and the stakes are high.  If you tend toward this fear mentality, investing in real estate is not something you should do alone.  Find a friend or family member who can be a neutral third party and keep you honest if your advisor is pressuring you or if you’re pressuring yourself.  Even if you’re naturally more of a big picture investor and just can’t handle the details, you can still invest if you have the right people on your team. 

Another area where discipline pays off is in record keeping and understanding the tax code.  At a minimum, you need to understand the basic write offs for your investment property, such as utilities, repairs, maintenance, cleaning, costs of rental, attorney’s fees, management fees, taxes, and the basics of 1031 exchanges.  You also need to understand depreciation and capital gains taxes, both short and long term.  If you’re almost asleep reading this – and let’s face it, I’m getting drowsy – set up a meeting with your accountant and get all the information you need.  Then download an app like Quickbooks or Mint that can help you keep track of expenses.  Be disciplined in tracking all of your write offs every month and don’t wait until the end of the year to recreate everything for your accountant.  By carefully tracking your expenses and understanding the ramifications of the tax code on your transactions, you’ll maximize your investment dollars.

Discipline is critical in other areas of real estate such as understanding the types of loans and details of loan costs.  Loans are very complex in terms of variable loan closing costs, points, interest rates, and penalties.  There are significant differences between purchase money mortgages, refinances, home equity loans, and loans against your stock portfolio.  There are also major differences between loans for primary residences, second homes, commercial properties, and investment properties.  You should discipline yourself to compare all of the details of available loans and know the actual amount for which you qualify before shopping for any property.  Make sure you’re comparing apples to apples since so many aspects of loans vary.

An undisciplined investor may jump at a home equity loan or stock portfolio loan as the easiest, fastest and cheapest loan.  These loans are desirable for those reasons, but they typically offer variable interest rates which are risky and not desirable in a rising interest rate market.  In addition, a portfolio loan is dependent on the amount of money in your stock portfolio.  If the stock market declines and your investments decline, you may be asked to pay down part of that loan.  This can deplete your cash reserves at a time you need them the most.  Home equity or portfolio loans can be useful tools if you need quick money to buy a property, but they can be risky and very costly over time.  A disciplined investor might use one of these tools, but they would only do it if they know they can refinance into a less costly, more conservative long term loan.

Operating costs are another area where discipline is key.  Basic operating costs for a residential rental property may include items such as utilities, management fees, homeowner association fees, maintenance, repairs, advertising costs, taxes, insurance, permits, loan interest, short term rental fees, and landscaping.  These costs all narrow your profit margin.  Make sure you understand all of your costs, review them periodically, and maximize any opportunity to control them.  

You’ll also want to recognize where spending more money on operating costs may save you in the long run.  For example (my Dad was famous for this one) you can save money doing your own repairs but if you venture into areas where you’re not skilled it can cost more for a professional to repair or it can cheapen your property.  You might spend more to replace your roof but that cost can be depreciated on your taxes, reduce your utility bills, and make your property more valuable in the long run.  Finally, you may save money with self-management, but if your property isn’t competitive with management companies’ properties you might have high vacancy rates and lower rental rates which will reduce your income.  To maximize long term profits, you need to understand exactly how much you save and compare that to the value of spending money on your investment property.

Being disciplined with your real estate can be the difference between a paying hobby and a profitable investment.  Taking the time to understand the costs of purchase, sale, and operating is all time well spent.  Recognizing when spending more money may save you in the long run is another form of discipline that will maximize your profit.  Making sure you are patient, calm, and ready to act on your terms will help you in real estate and in life.  If you need help understanding any of these areas of costs or expenditures, find a trusted advisor who has the knowledge you need to understand the details.

Next month, join us as we examine Wall Street Your Real Estate, Rule #6 – Set Realistic Expectations.

Read More