We’ve all heard the expression, “Those who fail to plan, plan to fail.” In real estate, this saying certainly holds true. It’s essential that you develop a workable plan and start building a team of experts before you get started, so that you start off on the path to success. For those of you just getting started, you’re wondering where to begin. And the answer is, with taking a good, hard look at your financial affairs in order to develop an accurate, comprehensive financial report card.
Step #1: Preparing Your Financial Report Card
You can’t move forward until you determine where you are right now. Unfortunately, this basic premise is overlooked by many investors, and it’s a crucial foundation for success.
Start creating your financial statement by developing an income statement that lists your monthly income and expenses. Most of us are checkbook-driven; we put our paychecks into our checking accounts, pay bills with that income throughout the month, and, if we’re lucky, we have enough income each month to pay those bills. The income statement will show you your monthly financial activity.
Next, you’ll create a balance sheet, which lists your assets and liabilities.
Your assets, as you’ll recall, are the things that generate wealth for you, such as investments, savings accounts, stocks, 401(k) plans, mutual funds, real estate, or a business that you own. Your liabilities are all the things that take money away from you, which might include your credit cards, the remaining balance on your car loan, or the mortgage on your home. Your balance sheet will give you a picture of your current wealth. (For more tools on creating your financial statement visit www.corporatedirect.com/loopholes-of-real-estate.)
Your personal financial statement will bring your financial goals into sharp relief. You’ll see where your debt is concentrated or how to pay it down, and you might see where you could bolster your asset column. (Here’s a list of 29 small business financial resources.)It may lead you to form a plan to decrease expenses or increase income. Some decide to downsize their homes in order to free up some money for investment, while others may opt to rent out their existing home and move to a smaller home to generate cash flow, increase passive income and decrease expenses. Only you can decide how to address your financial situation. Seeing your assets and liabilities in black and white will open up a lot of possibilities you hadn’t considered before.
But unless you plan to increase your working hours, ask for a raise, or seek a better-paying job, your income options will be limited. The only real way to significantly improve your income will be to increase your passive or portfolio income.
Step #2: Setting Your Real Estate Goals
Passive income is the suggested method for growing wealth. It is not only the fastest method, but is also the easiest, because it means other people’s money, time, and energy are working for you.
If you’re like most people, your financial report card reveals that zero percent of your income is passive. So your first step is to determine what percentage of your income you’d like to make passive. Start with where you’d like to be one year from now, as well as a longer-term goal of five years from now. What would a reasonable monthly passive income goal be? $1,000? $5,000? $10,000? More than that?
Remember that your goals are dependent on what you’re willing to do to make them happen. Know that you can also recalibrate your goals down the road as you learn more and determine what works and what doesn’t.
A lot of people, once they’ve made up their minds to invest in real estate, decide to jump right in and figure things out as they go along. Some people learn best by doing and making the occasional mistake, while others do what they can to head off those mistakes by completely educating themselves first and consulting with advisors and investors. Everyone is different, and you should do whatever is most comfortable for you.
Essentially you’ll want to determine something specific—how much you want to save, how much of an initial investment you plan to make, what you’ll do with that initial investment, and over what period of time.
For example, maybe you’ve decided that within six months, you want to save $10,000, which you’ll then turn around and invest into a piece of rental property by the end of one year. If this is doable for you, it’s a worthy goal. From there, perhaps, you might decide that within ten years you want to have five rental properties.
Beyond that, you have other decisions to make: What kind of properties you’ll invest in, where, and what to do with them.
The following are your numerous real estate options:
- Single-family homes
- 4 plexes
- Trailer parks
- Commercial office space
- Commercial industrial space
- Storefront retail
Each of these has its own choices as well—apartment complexes vary in size, so are you interested in 20-unit complexes, 100, or more? Starter-market or high-end gated communities? High-rise office, strip-mall retail… your choices are plentiful.
Then you must decide where you want your properties to be. Are you looking for properties nearby in your town, in a neighboring town, in another state, near water, urban, rural?
Now, what will you do with the property? You could:
- Buy foreclosures cheaply, without intending to earn immediate cash flow from them,
- Fix and flip, intending to purchase cheaply, refurbish, and resell for a profit,
- Buy and hold, capitalizing on appreciation, or
- Buy, hold, and rent, earning both appreciation and cash flow.
The Rich Dad strategy is buying and renting, which maximizes short- and long-term income potential.
3. The Wisdom of Investment Specialization
Because the real estate world offers so many options, it’s a good idea to focus on a particular area of specialization. For instance, you might become an expert in buying, holding, and renting small, one and two-bedroom apartment buildings in a particular area of town. Perhaps you used to live in an apartment in that area years ago and understand the needs of that community and that type of resident. Each geographic area has its own unique dynamic, its own zoning regulations and its own distinctive resident, so it’s a good idea to focus on one particular area. As you become an expert in one investment area, you will be more apt to learn another area quickly.
Another word of advice: Start small. You will make mistakes, so make them early on, with low-risk, low-end properties in which there isn’t as much at stake for you.
4. Stick With Your Game Plan
One final point about why it’s a good idea to stick to the same game plan when you’re investing in real estate: When you assemble your team of advisors, one of them will be your real estate agent. He or she will be an expert in one particular sector—the one you’re investing in—but most likely won’t be an expert in other sectors. For example, he or she might specialize in duplexes, but not strip malls.
So by sticking with one sector, you can retain the same team of advisors without having to seek others. And as far as your team is concerned, it’s best to find them, understand their strengths and use them as your investment vehicle. This leverages experience. When you’re ready to broaden your investment horizons, you can seek new team members.