Only Play When The Odds Favor You
There are two ways to make money in real estate. You can work hard, or you can work smart. Hard work is great, but sweat alone won’t save a bad deal. Winners stack the odds before they sign.
Rule number one is simple. If the odds aren’t on your side, don’t play. Be picky. Learn to analyze a deal realistically, and get comfortable walking away. It doesn’t matter how many deals you pass on. All that matters is the ones you do.
The biggest trap is betting on market direction. Every market goes up, down or sideways, and nobody knows which way it’s headed next. If a property only works because you hope rents will rise, it doesn’t work. What happens if rents stay flat for five years? How long can you feed a negative cash flow out of your own pocket? The deal has to work today, on today’s numbers.
Make Your Profit Going In
Rule two goes with rule one. Your profit should be locked in the day you buy, in one of three forms:
- Cash, when you buy below market value and resell for more.
- Positive cash flow, when rents cover the mortgage and every expense with money left over.
- Equity, when you pay less than true market value, or when modest repairs push the value way up.
If you can’t point to at least one of those on closing day, you’re not investing. You’re gambling.
Keep Each Deal In Its Own Box
Rule three is to limit your financial and legal exposure. Every deal should stand on its own, so one bad property can’t drag down all your good ones. Today a lot of investors hold each property in its own LLC, set up by a real estate attorney. That helps keep trouble at one property from reaching the others.
But know the limits. Most lenders that loan to an LLC will want your personal guarantee, and once you sign it, the LLC won’t shield you from that loan. Read it closely before you sign. And moving a property that already has a mortgage into an LLC can trip the loan’s due-on-sale clause, so talk to your lender and attorney first.
Use Leverage, But Respect It
Leverage is the great multiplier. Say you buy a $100,000 bargain property and sell it a year later for a $30,000 profit. Pay all cash and you made 30 percent. Put $10,000 down, finance the rest, and you made 300 percent on your money.
Leverage multiplies losses just as fast as gains, and plenty of investors learned that the hard way when values fell. Borrow only on deals that cash flow from day one, so the property pays the loan, not you.
Work smart, follow these four rules, and you’ll win a lot more often than you lose.
