The psychology of an investor is what separates the good, from the bad, from the lucky. As Warren Buffet famously said – “Know your circle of competence, and stick within it. The size of that circle is not very important; knowing its boundaries, however, is vital.”
Real estate investors biggest mistake
The biggest challenge I see many real estate investors face is the “failure fallacy”. Investors who need to keep their foot on the gas because they believe that they are failing if they do not continue to acquire new properties constantly. This sense of “failure” ignores the reality of an investor’s resources, experience, risk tolerances and growth. As an investor-focused mortgage broker I have observed this relentless drive to be many real estate investor’s greatest strength, as well as their greatest weakness.
A mindset shift for investors to build a real estate portfolio
I want you to think of Real Estate investing like race car driving, both require great focus, training, preparation, and involve a team. In both pursuits, the consequences of emotional decision making are high and not having a plan often results in failure.
The three stages of the real estate race
When racing you have three choices, press the gas pedal (accelerating), do nothing (coasting) or press the brake (slowing down). Every racetrack is different and a racer must create a strategy specific to the track they are on.
There will be straight stretches where acceleration to extremely high speeds is possible, great progress can be made quickly and easily. A driver cannot become complacent because after every straightaway is some sort of corner and failing to brake in time will result in a crash. An aggressive racer may be tempted to switch between accelerating and braking sharply but this is a flawed strategy as each driver has limited resources. Running out of gas or blowing a tire can end a race as decisively as a fiery crash. To maximize resources a driver may coast at times, sometimes the best action is no action. With experience comes the ability to transition between stages effortlessly.
Straight stretches in the real estate market
If you press the gas pedal down and don’t let go you will certainly speed ahead of your competitors but will almost certainly crash well before the race is over. Real estate investing is no different. Any investor who recklessly acquires properties constantly over long periods of time is likely to become a cautionary tale.
A hot market is your straight stretch. This is often a period of growth where investors see strong periods of growth. It is critical that you keep your ego in check as you will be making great progress. Having a clearly defined long term goal and financing your properties correctly will help you stay on track.
As you roar through real estate you should be checking your instruments
- Are you maintaining proper cash reserves? Temporarily you may reduce your reserves to acquire properties but the longer you operate with reduced contingency funds the more likely you get into financial trouble. I suggest having a minimum of two months of property expenses as a reserve fund.
- Are your assets performing as expected? Not every deal will be a winner but it is important to honestly assess your real estate portfolio as you grow. Understanding how each investment moves you towards your long term goals makes assessing the success of an investment far easier.
- Is your engine running too hot? As you grow your portfolio you will have periods where you have high levels of debt and relatively low amounts of equity (debt relative to the value of your properties). Heightened periods of risk are ok as long as they are calculated. What you need to avoid is the cycle of getting used the risk and then pushing further. If you are investing for long term wealth I suggest a “slow is steady, steady is fast” approach. Building a house of cards is the fast track to a fiery crash.
What to consider when “accelerating” your real estate investments
As an investor, you should be prioritizing value over price. Price is what many investors focus on but is only one piece of the criteria you should be evaluating when considering a purchase. Remember that during strong markets many properties will look like great investments. As an investor you must ignore the noise and stick to your core investing philosophy.
Cashflow, a critical factor for real estate investors
I wanted to focus on value but do not forget to consider a property’s cashflow as well as your overall financial health. Cashflow is your long term insurance against rising rates, vacancy and property repairs. Many investors are ignoring cash flow for more speculative markets.
Often investment “experts” will say this is the wrong way to invest, I disagree. I believe that for investors with large amounts of liquidity and a surplus of disposable income this may be a valid strategy to consider. If your goal is to diversify your assets into real estate with a long time horizon cash flow may be a low priority assuming you have significantly more income than you need or a large pool of liquid assets. Alternatively, if an investor does not have significant liquid assets or an excess of income they must be extremely concerned with cash flow.
A great investment property at a bad time could still cause financial harm (loss of liquidity, higher debt levels ect). Click here to learn about the two types of real estate value you should focus on as an investor.
Cashflow analysis
If you need help analyzing investment properties let me know and I can share with you a cashflow analysis tool that breaks down all of the expenses of a property as well as the multiple profit streams of a property.
What’s next? When to park your real estate portfolio and when to hit the brakes!
Part two – I will be covering when to “coast” as a real estate investor. There are periods of time where your best plan of attack is to simply build up your cash reserves, to pay off your debts and to plan. I will explore how to determine if this is the best step for you to consider.
Part three – I will explore when an investor should “brake”. How to determine if you need to deleverage, sell poorly performing properties or to rebalance you portfolio.
I hope this helps with your real estate investing, let me know if you have any questions!
