With an increasingly competitive market for multi-family deals, it’s equally important to understand the markers of a good deal as it is to know when to walk away from a bad one. Real estate investing is inherently involved and illiquid, and as such real estate mistakes can be costly. Being aware of common real estate investing mistakes and assessing opportunities effectively is essential to realizing the benefits of investing in real estate.
1. Don’t let emotion invade analysis
When filtering through real estate investment opportunities, it is easy to become emotionally attached to a deal based on first impressions. We all get excited about those seemingly homerun deals, however, emotion can reinforce confirmation bias, which leads to bad decision making. Confirmation bias in this context describes the thought process in which you selectively look at facts supporting your initial belief or emotion rather than taking an objective approach to evaluating an opportunity in full. When investing in real estate, confirmation bias can lead to overlooking or downplaying risk factors in your evaluation.
2. Don’t lean on market appreciation as a primary return driver
Due to the largely enthusiastic real estate market as of late, it is easy to feel as if profits are guaranteed by simply holding property while valuations continue to increase. This is a risky investing mindset. While buying into strong markets with positive momentum is good practice, investing in opportunities with value-add improvement potential or with solid cash flow can mitigate the risk of markets moving against you.
3. Don’t ignore the importance of building a quality team
Hiring or partnering with unvetted or unreliable team members can undermine more than just a single deal, it can jeopardize your entire investing operation. Hindsight is always 20/20, but consider several factors when building a team to avoid painful partnerships. First, evaluate your own strengths and weaknesses and determine the skills required by the opportunity type of your investments. Partnering with those who can supplement your skill or experience gaps will pay dividends when pursuing complex projects or investments. For example, significant value-add projects likely need experienced construction management or general contractor involvement; rv-parks or large apartment complexes require capable property management; pursuing a robust acquisition strategy demands trustworthy brokerage relationships and savvy financial analysis. Second, seek out partners confident and trustworthy enough to disagree with decisions even if they stand to benefit. A team based on trust and mutual benefit wins the long game and supports consistent and productive decision-making.
4. Don’t wing it – have a process
Dave Allred, one of Axia’s Managing Partners, realized early in his real estate investing career that he needed a system for efficiently and reliably evaluating deals. After suffering through is own initial learning experiences, he now leans on 10 guiding principles for preliminary evaluation of any opportunity:
- What is the ROI?
- What are the risk factors?
- What is the team’s track record?
- Do I trust the executive team?
- What are the tax benefits or consequences?
- What is the liquidity / how long until capital is returned?
- Does it fit my predetermined asset allocation determinations?
- Is it in line with my personal investment goals?
- Is there positive cashflow?
- Is the property recession resilient?
5. Don’t assume broker’s marketing or proformas are 100% accurate
Keep in mind that most often a broker’s pay is directly linked to the price at which a property sells. With this in mind, their proforma financials are incentivized to paint as rosy a picture as possible. The prudent approach to utilizing any broker prepared proforma is to pay close attention to their assumptions, take any projections with a grain of salt, and adjust your analysis accordingly.
6. Don’t go it alone
Top real estate investors are constantly learning from those around them. Whether relying on a formal team structure or engaging partners on an as-needed basis, it is difficult, if not impossible, to execute without support. Building a network of investing peers, and even competitors, as a resource for experience and guidance can help even the most seasoned investment professionals navigate the opportunity landscape. Investing in mentors, coaches, and your own real estate investing education all go hand in hand in successfully pursuing deals of any type.
7. Don’t focus ONLY on cash flow
In your long-term profit evaluations, it is important to consider each of the avenues which may ultimately contribute to profitability: cash flow, market/price appreciation, tax benefits, and principal reduction or equity increase. Understanding the difference between cash on cash and cash on equity and how you can maximize the velocity of invested cash by tapping into your property’s equity and rolling it forward to scale and create more opportunities for profit is an important concept.
8. Don’t let FOMO take the wheel
In a strong market it can seem as if everyone is able to achieve remarkable returns, and in turn get caught up in the fear of missing out (FOMO). FOMO can lead to a cascade of unproductive decision making, encouraging confirmation bias and greedy short-term thinking. Turn to history as your guide and study market trends and cycles rather than engaging in the emotional or fear-driven game of investing hot potato.
9. Don’t look to past performance as a predictor of future success
Evaluate each deal in its proper context and for its unique characteristics. For example, two 70-unit apartment deals, both built in the 1980s located down the street from each other, can look more or less the same from a quantitative perspective. Still, unique characteristics of each property’s deal structure can make them wildly different. Factors such as seller psychology and behavior, unique transaction contingencies, and the structure of any specific deal should all be considered.
Balancing risk across your portfolio is also a vital consideration with any investment. Diversification should apply not only to drivers of risk, but also your portfolio’s drivers of return. Most simply, effective diversification in real estate investing can be achieved by spreading exposure across asset types (multi-family, self-storage, rv parks, retail, industrial, etc.). Of course, there are a myriad of other factors to consider when it comes to diversification, but in general different real asset types will inherently have different risk and return profiles.
10. Don’t think small
How you approach life comes down largely to mindset, and this carries over into how you choose to invest. Starting smart does not have to mean starting small, investing in single-family homes. Multi-family investing has more risk and often more complexity, but that risk is manageable. Developing a solid process, building a competent and trustworthy team, and engaging your support network can all help get you up the curve faster to achieve your investing goals. While it can be daunting, there is often more opportunity for gain by thinking bigger!
This list of real estate investing mistakes is by no means exhaustive, however, being wary of these few common pitfalls can help save you time, energy, and money in your investing pursuits. This guidance came directly from our most recent Axia Partners monthly Experiential Investing webinar, in which our management team took a deep dive into these real estate mistakes and drew from personal experiences to answer questions from our community of investors. Become an Axia investor today, so you don’t have regrets tomorrow.