30 May Dirty Dozen: 12 Mistakes Experienced Investors Make
The mistakes that experienced investors make can be different that the mistakes that novices make. Below are 12 common mistakes I see from those who own multiple units.
1. Not raising rents. I was shocked when a landlord told me that his tenant in a particular house was only paying $250 a month for rent when the market rent for that area was about $750 a month. The landlord said he had never raised the rent in 20 years, and that he did not have the heart to raise the rent on anyone. No wonder his tenant had not moved out in 20 years! While it is your house and you can do with it as you wish, I recommend that landlords annually raise their rent at least in line with inflation (about 2 percent per year) or better yet, slightly above the inflation rate (say, 3 percent). Renting out a house for most is a business, not a charity. An investor should not harm their family’s financial well-being because they are reluctant to periodically raise the rent in line with market forces and inflation. If one is providing value to the tenant, such as in prompt repairs, periodic upgrades, or installation of safety features, then the tenant will be satisfied and pay the rent. One tip is to put the next year’s rent increase in the current year’s lease, so the tenant has a year to mentally prepare for it. Utility companies announce their rate increases a year in advance so people become accepting of it when the new rate starts.
2. Not tracking expenses. A good businessperson knows their numbers. What gets measured gets managed. If one does not know their numbers, they are not in a good position to identify inefficiencies, possible income opportunities, additional tax savings, or even potential embezzlement. The majority of people trying to sell an investment property give a pro forma statement (if that) to buyers instead of a TTM (Trailing Twelve Months actual income and expenses, also known as a T-12). If one is selling a property they’ve owned for at least a year, they should be able to easily produce a TTM to give certainty to a buyer. I knew a landlord who did not keep an eye on their monthly water bill as it ballooned higher due to a tenant’s constantly running toilet. That landlord ended up unnecessarily paying thousands of dollars for water.
3. Not inspecting the property before buying it. An experienced investor I knew purchased a $28,000 bank-owned house with the help of his agent yet without the help of a home inspector. A few weeks after the purchase, the agent called me for advice. She asked if he could give the house back to the bank and receive a refund for his $28,000. His contractors had walked off the job on day 1 because they deemed the house to be an unsound, unsafe structure. This structural issue would have easily been identified by a home inspector, yet the investor stopped using home inspectors years prior in order to save money. And my answer to the agent was no, a money-back guarantee is not included with the purchase of a foreclosure.
4. Putting too many properties in the same entity or owning everything in their name. One time an investor approached me with a problem. He had created a Limited Liability Company (LLC) and subsequently purchased 20 houses with it. Now he was in default on several of the loans, while he had equity in some properties. The problem was that the foreclosure actions were encumbering the title on all of the properties. I also know investors who own 20 to 40 houses, all in their own name. Some did it that way because of easier financing options; some did it because they did not trust lawyers; some did it because they never considered any form of asset protection; and some did it because that’s the way they have always done things. The challenge for someone with that many properties in their own name is that they leave their assets exposed, and they might even be more inviting to a potential creditor than one with sophisticated asset protection in place. Each person’s situation is different, so consulting an attorney and tax advisor are imperative, particularly at that level of units. I am not against owning investment real estate in one’s own name. I have LLCs and properties in my own name. One can enhance their insurance coverage to increase some of the protection they receive. My personal rule is not to have more than three properties in an entity at a time. Also, after a certain number of years or properties, I shut down some entities and open up new ones because of the tail of liability for properties that were sold in the past.
5. Commingling funds. I see it so often with investors and small business owners, whereby they only have one bank account and funnel everything in there. It’s hard to track income and expenses of individual assets when everything is jumbled together. Also, if one has an entity like an LLC for asset protection purposes yet they commingle the LLC funds with personal funds, there is potential for a creditor to pierce the corporate veil. I keep a separate bank account for each property, and I have a sub-account for the security deposits. I recommend that for each property, you have an Operating Account (for depositing rent and paying expenses), a Security Deposit Account (preferably which earns interest), and a Reserve Account (for placing anywhere from $1,000 to $5,000 for unexpected repair expenses like getting a new water heater). After filling up the Reserve Account, then you can take distributions from the monthly cash flow.
6. Not hiring a property manager. I am not against a person self-managing their properties to save money and maintain a high level of control. However, I have heard many tired landlords complain incessantly about tenant problems and how the landlord just can’t seem to go away on vacation. I had one investor in his mid-seventies who owns 40 houses complain about how he receives dozens of text messages and voicemails night and day from tenants. He also complained how his wife, adult children, and grandchildren bug him about spending more time with them. I suggested that he hire a licensed, professional property management firm to take over his properties (or at least some of them). I said that if he relinquished control to a reputable property manager, he would only have to receive one call a week or perhaps even once a month, from that manager. I added that I’m confident the property manager would give him a break on the fees. I noted that the property manager would justify their fee by probably increasing revenue and retention (perhaps by raising rents, introducing mobile or online rent payment processing, adding laundry and vending machines, and surcharges like pet rent). I told the investor that he was costing himself and his family quality time because he had fears about giving up control and losing money.
7. Not reviewing insurance periodically. I have known investors who filed an insurance claim only to find out that they had limited or no coverage. Also, I know investors who own many properties yet probably overpay for insurance because they have not adjusted their deductibles. When an investor starts out, oftentimes they pick cut-rate insurance to save money. As one’s equity increases and as one acquires more units, it makes sense to adjust coverage and the deductible. Too many investors automatically renew the policy they obtained years earlier. Every year in December my wife and I perform an insurance review of our portfolio, which includes consulting with our insurance agent and pricing out policies. Because my liquidity has increased, I raised my deductibles to save money because I can cover small unexpected repair expenses out of pocket that in my younger days would have been more difficult to pay.
8. Doing all the renovation work themselves. I know investors who insist on doing all the renovation work themselves and then complain about it. One investor I know has had apartments sit empty for years – yes, years – because they were too busy working on other units and would not hire a contractor. They could have hired a contractor for about $7,000 to complete one of the units within a month’s time, and then that apartment would have rented for around $1,000 a month. That would have produced $9,000 to $11,000 in revenue in the first year, more than paying for the contractor’s costs. There is nothing wrong with doing work yourself, yet it is a prudent business decision to leverage oneself in order to increase revenue for your business.
9. Only working in the business instead of working on the business. So many businesspersons become stuck working in their business that they do not allocate time to work on their business. It is important to make time to think strategically about one’s business. Do you do what you do today because that is the best way to achieve your clearly defined goal? Or do you do what you do today because that’s what you did yesterday? An investor friend who has 65 properties complained to me about being spread too thin with renovating houses and managing tenants while trying to also be a real estate agent. He ultimately made a strategic decision open up his own property management brokerage due to an unfulfilled need he sees in the marketplace. He also has put together a team of contractors, so he does not have to handle repairs and renovations personally. He kept his real estate license yet decided not to represent buyers and sellers. His income is higher, and he has more free time to pursue his highest aspirations.
10. Not taking advantage of tax savings. An investor I know owned a vacant lot for 25 years before selling it. They never added to the tax basis of the property, and so they must pay more in capital gains taxes because their basis is the original purchase price. They did not consult a tax advisor, and they did not annually declare their property taxes on the land as a personal itemized deduction on their Schedule A. I have seen too many investors use their accountant merely as a tax preparer once a year. My wife and I consult our accountant periodically throughout the year.
11. Letting properties deteriorate. So many investors I know let their properties wear down over time, to the point where a major renovation is needed because of deferred maintenance. Cutting short term costs is more expensive in the long run. One can collect more rent and reduce tenant turnover when a property is well maintained.
12. Not having an exit strategy. An investor came to me to express his frustration. Since 2008, he and his wife worked full-time jobs and bought 40 houses. In between driving trucks across the country, he renovated those houses and managed the tenants. With his wife pregnant with their first child, he was concerned that he couldn’t manage everything like before. He wanted time to be a great father and husband. I suggested that he either hire a property manager, or a contractor for the renovations, or quit his trucking job. He said he had plenty of income and liked renovations and managing his tenants directly, so he said he would quit his job. He has since done so and is a happier man. What are you doing this for? Who are you doing this for? Do you want to have freedom of time and money? Where do you want to be in 10 years? 25 years? 50 years?
If you own at least one investment property, you likely fall within the wealthiest two percent of the human population. If you own 10 or more properties, you probably are in the top one percent. It is a privilege to provide quality, affordable housing to others. You can do so without having to manage every tenant and fix every toilet. If you do not have a clear exit strategy, you may find yourself handling evictions and late night tenant calls. I urge experienced investors to take time to imagine where they want to be, and then take steps to get there.
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