Summary: When you invest in real estate, you’re bound to make some mistakes. In this article, I explore what Kenji and I have learned over the years from making mistakes as we’ve built our cashflowing rental portfolio. From getting emotional about properties to not adequately managing our team, there are some doozies. If you want to learn from our errors and be a better investor yourself, this is the post for you!
Kenji and I recently filmed something we called the Backstage Pass to Our Rental Portfolio for some of our students. In it, we went through our past and present portfolio, discussed some of the biggest mistakes we’ve made along the way and what we learned from the experiences.
Since it was such useful content for us to create (it helped us reflect on our more frequent mistakes!) and for our students to hear, I wanted to share some of the conclusions of our training with you so you also get the opportunity to learn from our experiences.
#1. Do not get emotional about properties
Kenji and I like to say, “Fall in love with the numbers, not with the property.” But, we haven’t always followed our own mantra. As we walked through our top two worst performing properties, we could see that we were emotionally involved with them in different ways.
The property that both Kenji and I recognize as our biggest purchase mistake was a six-plex in Oklahoma City. This was a property we bought in 2018, rehabbed extensively, and then sold in 2019 for a slight loss. At the time of sale, it was cashflowing decently (9%) but we both had a sense that there were going to be more issues with it down the road, so we decided to sell it, roll over the lazy equity, and move on with a different property.
As we reflected on the purchase of the property, we remembered that during the purchase, Kenji had wanted to back out of it as we uncovered more and more structural problems, but I had insisted that we had told our agents that we were going to buy it, and we needed to go forward. I wasn’t emotionally involved with the property. I was emotionally involved with my agents and their feelings. That was the problem.
In contrast, as when we covered a duplex we had purchased in Arlington, WA, and then spent over $130,000 rehabbing, we noted that Kenji was emotionally involved with the property itself.
He loved the location, down the road from a park and across the street from a school. He loved the layout, two separate little cottages, on a single piece of land. He loved the work we did to improve the property and the ingenious ways we changed the floor layout of one of the cottages to more than double the size of a bathroom. Because of this, we overspent on our renovation. In the end, our cashflow was only 8%.
We ended up selling this property earlier this year for no net loss or gain, and we’re rolling it into a much larger property in Tacoma, so everything is going to work out fine. But, the point is, if we hadn’t been emotionally involved, we would have made better rehab decisions based on return on investment, not the potential of the property.
#2. Never neglect doing your due diligence
In only one case, have we not done adequate due diligence: our Oklahoma purchase.
We didn’t adequately research the neighborhood. We didn’t double-check on the rental estimates given to us per unit by the property manager. We relied on a property manager who was very closely linked to the agent without checking out other property management options. We didn’t get multiple bids from construction companies. Instead, we just relied on the one suggested by our agent. We were in a dual agency situation (the agent was representing both sides), but we didn’t act like it by double-checking all of the assumptions and comps.
We made lots and lots of errors in due diligence in this case. But, as an upside, we learned our lesson. And, we ended up learning a lot about the dangers of having team members who are linked together closely (inflated rents!) and the importance of being especially careful to get multiple opinions from different vendors when entering a new market.
In the end, one of the great outcomes from this experience is that it has kept us conscientious. Even when we don’t necessarily have to, that experience makes us think through whether we want to get second opinions especially when we are working with new vendors. You’ll see us plugging in our cash-on-cash calculator numbers during the due-diligence process multiple times, as more accurate information becomes available.
#3. Manage all members of your team closely
This one is our most frequently made error. I think we’ve made it because we’ve often spread ourselves too thin, and not given our rental portfolio the time it’s deserved.
When thinking through our deals over the years, there were several instances of us not managing contractors closely, not managing our property managers as much as we should have, and even not managing our structural engineer and keeping on top of his timelines in the case of our building project currently ongoing north of Seattle.
As a result, timelines have dragged on, costing us money. Time is money when you own rentals. Even a month or two of extra vacancy has a significant impact on your cash-on-cash return for the year. So managing your team members, making sure they stay on time, should be a high priority.
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One great result that has come out of this, is that Kenji and I now have a planning session for our rental business most weeks. We call this our “thinking time.” During it, we go through each of our properties, talk about what needs to be done in the next week, and any additional projects we could take on to increase income or decrease expenses and/or maintain the property at a better level for our tenants.
One of the side benefits of having thinking time is that it also counts as material participation hours for Kenji’s real estate professional status. So we not only improve our portfolio’s performance, but we make sure to cement our tax savings as well.
#4. Mistakes are a natural part of learning and there are positives in every “mistake”
As physicians, we’re trained that mistakes are bad. At worst, they can cost someone their life. There’s a reason so many of us walk around incredibly afraid of making mistakes.
In life, though, I think most of us realize mistakes are a natural part of learning. You had to fall down to learn to walk.
It’s no different in real estate. Certainly, you can avoid many mistakes by learning from mentors and from having an excellent support system of people who are also building their portfolios. But, sometimes, you’re going to make mistakes.
The key that we’ve learned over the years is when we make a mistake but we learn from it, and do things better the next time, we can give ourselves grace.
We also actively look for the good that comes out of every experience. Sometimes the good is fairly random.
For example, in the case of that duplex we over-rehabbed above, because we were visiting it to check out rehab progress on the day that an awesome property down the street was listed, we were able to walk down the street and lock that property up without a bidding war, for over $50,000 under price. That property is one of our best purchases and has nearly doubled in price because we bought it right, we’ve forced appreciation, and there has been some market appreciation.
Sometimes our mistakes are directly related to the good result later. For example, because we learned to get multiple property managers to weigh in on rents in any new market, we had three property managers give us rental comps on a 16-plex we were considering buying in OKC. We ended up walking away when the monthly rent varied from $500 per month on one end to $675 on the other. We had learned our lesson, and it kept us from making the same mistake in a bigger project.
Over the years, we’ve also had such a variety of challenges from dealing with lead paint to asbestos to foundation issues to poor construction team members to property managers who stop performing to difficult tenants, that we’ve run the whole gamut. These experiences have helped us be better able to teach our course and help our students no matter what situation they face.
#5. Real estate investing is an incredible way to build wealth, over time
I know we’ve said it before, but real estate is an incredible way to build wealth. There’s the cashflow, the forced appreciation, and the tax savings. This is all part of our Fast FIRE system.
But then there’s something we don’t talk about much: time.
When I reflect on our portfolio and how it’s changed over the years, part of what I see is that time is really the key ingredient. I see that the compounding growth of our money, the tax savings, and the natural growth of our portfolio as we harvest forced appreciation by turning properties over and 1031ing them to larger ones is what has really grown our wealth.
Many of our students look at the money they have now and where they want to be in 5 or 10 years and can’t see how it can happen. How can $100,000 in down payments this year turn into $100,000 in cashflow in five years? That’s because they don’t see the value of time and the way that it will contribute to their wealth if they diligently build their portfolio, year after year.
Bill Gates, Tony Robbins, and numerous other leaders have been quoted saying: “Most people overestimate what they can do in a year and underestimate what they can do in a decade.”
This holds true in real estate as well. Start with a single duplex and, if you’re diligent, focused, and keep at it each year, you’ll have an empire in a decade.
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