Buy and Hope Investing

For the first 7 years I owned real estate, I never planned for anything except how to purchase my next property.  Every time I closed escrow, I would just introduced myself to the tenants and tell them where to start sending their rent checks.

If they had a complaint that a window was broken or a garbage disposal didn’t work, I offered them a concerned facial expression and a promise to “get right on that”.  Occasionally, I might remember that maintenance request a month later.  Sometimes the tenant would call and remind me, other times they would just live with the broken window.  Either of these outcomes seemed to have little downside to me personally, so it became my default management style.

I was focused on acquisition and figured that after I came up with the minimum down payment and closing costs, the time for investing was done.  The concept of reinvestment was foreign to me.

Usually, first time landlords come into the experience with a little information from a guru or a book, maybe a few success stories to embolden us, but no management plan once we take control of the property.  We just jump in and hope for the best.

I think this is because we all know a guy, that’s not as smart as we think we are, that’s killing it in real estate.  If he can do it, it must be easy, right?

This attitude toward planning happens in no other field that I can think of where the financial stakes are as high.  If you were to open a restaurant, or a dry cleaner, or a daycare, you wouldn’t just show up on opening day and think things are going to fall into place.

You would do massive research to prepare for opening day.  You would carve out a niche, write a business plan, find a perfect location, hire employees, and come up with a marketing plan.

Apartment investors fail to plan because they think all the hard work is done after they find a sweet deal.  This is far from true.  An acceptable return on investment will not come to those who fail to plan and reinvest.  Buying an apartment building is rarely enough to make you rich one day.

To quote Warren Buffett’s best pal, Charlie Munger, “The big money is not in the buying and selling … but in the waiting.”

Creating wealth in real estate doesn’t happen when you buy, and it doesn’t happen when you sell.  Wealth accumulates over years of ownership which requires you to effectively manage property over a long period of time.  I’ve heard many real estate gurus teach that you get rich by finding great deals at below market prices.  It’s just not what I’ve found to be true.  That may work if you are fixing and flipping, but not if you’re a long term investor.

For the “Buy and Hold” investors, it’s the “Hold” part that makes you rich.  And the better you manage the property, the better your returns will be now and over the life of the investment.

Don’t misunderstand, I think you should try to get the best price on the property, I just reject the idea that this is how long term wealth is created.

For starters, if you are planning to buy multifamily apartment buildings, focus as much attention on your management plan as you do on your acquisition plan.

My management plan was “collect the rent, pay the bills, avoid costly repairs”.  If that’s all you plan to do, you’ll probably see better returns from other asset classes (like the stock market).  I suffered through many years of negative cash flow because of this thinking.

Instead, I recommend that you plan to take property management seriously.  Find high ROI ways to add value to the property.  Approach the apartment the way you would a business.  Plan to optimize the net income of each property by investing in capital improvements that will increase your rent roll and lower your operating expenses in the long run.

Here are some of the things I do before I close escrow on a new property (in no particular order):

1. I make a list of all the capital improvement projects I want to undertake.  I rank them in order of highest to lowest return on investment.
2. I start asking contractors and handymen to give estimates on the capital improvements.  This will help me to refine my ROI calculations.
3. I start interviewing people to fill the position of property supervisor (or property manager if you’re the hands-off type).
4. I review all the tenant leases and determine who needs rent increases.  I plan to sign new leases with all the tenants as soon as the old leases expire.
5. I plan to have a discussion with the new tenants about deferred maintenance.  I ask them if there are any outstanding issues that need to be corrected.  I have someone come to fix these issues within days of the conversation.  This will establish my reputation as a professional and I will have less resistance (unhappiness) when I increase rents.

You may not get rich overnight, but real estate investing is about taking the long view.  If you bought the apartment at a fair price and made some improvements, you’ll have strong positive cash flow within 1 or 2 years.  But in 20 years, you’ll have unshakable financial stability that can be found in very few asset classes.  Your friends, that are fully invested in the stock market, may do well with their investments, but they will always have the risk of losing 50% of their principle in a single market downturn.  Meanwhile, you’ll have a stable source of tax advantaged cash-flow and steady appreciation, without the same emotional market swings.

Spend time honing your property management skills.  It’s the true path to riches for buy and hold apartment investors.