5 Common Real Estate Investing Mistakes & How to Avoid Them

May 30, 2023

Based on our extensive real estate investing experience...

Real estate investing has gained significant popularity as a path to wealth creation and financial independence. While the focus is often on the potential rewards it’s equally important to acknowledge the mistakes that can hinder success. Having personally experienced some of these pitfalls during my own ten-year journey as a real estate investor, I believe it’s crucial to shed light on these missteps so others can benefit. In this article, we’ll explore five significant mistakes commonly made by real estate investors and provide actionable strategies for avoiding them.

1) Avoid the Three Major Killers: Cash Flow, Debt, and Liquidity

During the Great Recession, countless investors were brought down by the trifecta of no cash flow, bad debt, and lack of liquidity. These factors are inherently intertwined and should be addressed collectively to lay a strong foundation for success. Positive cash flow is the lifeblood of any investment, while negative cash flow leaves you vulnerable, akin to navigating a leaky boat hoping it won’t sink before reaching your destination.

Bad debt, often in the form of short-term or variable debt, can wreak havoc if not carefully managed, as demonstrated by the hardship faced by single-family homeowners and investors during the recession, as well as some commercial investors today who didn’t anticipate the interest rate rise in 2022. Finally, liquidity plays a critical role in dealing with unforeseen circumstances such as unexpected repairs, rising taxes, or tenant issues. Ensuring you have adequate reserves and access to credit lines is key to weathering storms and avoiding forced sales at inopportune times.

2) Broaden Your Investment Horizon: Going Beyond Your Backyard

While it may be tempting to limit your investments to properties in your local area, adopting a more expansive mindset can unlock superior opportunities and diversification. The belief that real estate investments must be confined to one’s immediate surroundings is akin to insisting on investing solely in hometown-based companies when venturing into the stock market. Coastal markets, for instance, often lack cash flow due to inflated property values, while regions like the Southeast, Southwest, and Midwest can be more attractive due to their balance of cash flow and price stability. That is why institutional investors focus on these regions. Personally, I have found success by targeting markets with cash flow potential, alongside robust population and job growth. Overcoming the fear of venturing into out-of-state investments is crucial for attaining higher risk-adjusted returns. I will address how to do this in a future post.

3) Don’t Overemphasize Cash Flow

While cash flow is undeniably important, solely fixating on this aspect when evaluating potential properties can be shortsighted. Very high cash flow can signal higher risk (i.e., neighborhoods with crime challenges). It’s vital to adopt a long-term perspective and consider the holistic risk-adjusted return over a 5–10 year period, taking into account both cash flow and appreciation. Appreciation, over an extended period, tends to contribute more substantially to total returns compared to cash flow. Consequently, investing in high-growth markets and desirable neighborhoods often proves more rewarding than focusing solely on properties or regions with high cash flow. Striking a balance between these factors is key to optimizing your investment portfolio.

4) Embrace Return on Equity (ROE) as a Key Metric

One of the most prevalent mistakes I’ve observed among real estate investors is disregarding the concept of return on equity (ROE). As properties appreciate and equity accumulates through loan paydown and improvements, it’s critical to evaluate the return on your invested equity regularly. Paradoxically, as your equity grows, the overall performance of your investment can decline.

Consider this example: in 2017, I purchased a home near Tampa, Florida for $120,000, with a $25,000 (20%) down payment. Initially, the property generated $300 per month in cash flow, resulting in an annualized ROE of 14% ($3,600/$25,000). Fast forward to 2023, and the property’s value has soared to $250,000, yielding $155,000 in equity. However, the cash flow has increased only slightly to $400 per month, resulting in a meager 3% return ($4,800/$155,000).

I would be better off taking this “lazy equity” and explore opportunities for higher returns, such as selling, exchanging, or utilizing a home equity line of credit (HELOC) to invest elsewhere. Continuously recycling capital and optimizing your ROE should be a core strategy, mirroring the approach of successful Monopoly players who steadily trade up from property to houses and hotels. If you are still in growth mode of your #investing plan, make sure your equity is working hard for you.

5) Valuing Your Time: Evaluating Return on Time (ROT) Invested

A common oversight among real estate investors is failing to factor in the value of their own time when assessing investment returns. While it may be tempting to declare victory after a profitable rehab project or successful short-term rental endeavor, it’s crucial to calculate a fair wage for the time you invested. Are you just investing or are you actually taking on a second job? While this may be tolerable in the short term, it is unlikely to scale and ultimately impedes progress towards achieving financial independence.

Personally, I’ve shifted my investment strategy over time, transitioning from single-family properties to small multi-family units, and now focus on third-party syndications. Real estate syndications, where groups of investors collaborate to purchase or develop larger properties, offer a more hands-off approach. By carefully evaluating project sponsors and being comfortable relinquishing some control, you might be able to generate comparable or better returns with reduced personal involvement. If you are interested in learning about specific syndications that I recommend you can subscribe to my newsletter here. Striking a harmonious balance between return on equity (ROE) and return on time (ROT) is a recipe for success.

In summary, #realestateinvesting presents remarkable opportunities, but avoiding common mistakes is essential for long-term prosperity. By prioritizing positive cash flow, managing debt wisely, maintaining liquidity, diversifying markets, assessing holistic returns, optimizing return on equity (ROE), and valuing your own time, you can dramatically increase your chances of success. Through careful planning and a balanced approach, you can navigate the real estate investment landscape with confidence and unlock the potential for lasting success.