Summary: Over the last four years, Leti and I have built up a substantial passive income stream from real estate. This has given us the freedom to work in clinical medicine the way and the amount that we choose, but it’s important to point out that our success was built on the foundation of real estate investing mistakes. My mistakes. Fortunately, we’ve both learned from these mistakes, and this has enabled us to avoid many of the hiccups that slow down newbie investors. I’m sharing these stories with the hopes that it will help our readers avoid similar mistakes.
[Disclaimer: We are not accountants, lawyers or financial advisors, so please consult your own team of professionals about the topics covered in this article.]
I first started “investing” in real estate in 2001. At that time I had just started working as a management consultant and, for the first time in my life, at age 29, I had some money to invest.
I partnered with a close friend of mine because we believed that by pooling our money together we could grow our portfolio more quickly.
Our first property was a college rental. It was a three-bedroom, three-bath house near a large university. We bought the property for $104,000 with no money down. Back in those days, and up until the 2008 crash, you could purchase properties with no money down.
This property yielded only a small amount of cashflow, about $100 a month after expenses. While the margin was small, we’d make a little cashflow each month, and we’d only go negative if there were unexpected expenses. As it turns out, this was the last property we bought together that cashflowed.
Even though I had read books about investing and knew about the merits of investing for cashflow, the allure of “getting rich quickly” with a speculative gamble was too strong. So it didn’t take much to convince me to jump on the next opportunity that came up: flipping vacant lots in Florida.
This opportunity was a lot sexier.
Leading up to the 2008 crash, developers were buying up large plots of waterfront lots, putting in utilities and subdividing the lots.
Some of these developments were so large that you could easily see them using a satellite map view (see pic).
One of the ones we invested in had over 15,000 empty lots. Even to this day, most of the lots sit empty with only a house or two in one city block worth of lots.
The first deal was a home run. We bought a vacant lot for $150,000 for no money down, and sold it one year later for $350,000. This was quickly followed by another smaller win that netted us another $100,000.
If you were wondering, this is what it feels like to ride the wave of a real estate bubble. It was fun while it lasted.
After these two quick wins, we bought four more vacant lots, and I was clearly hooked. This led me to buy (on my own) two high-end condos in downtown Seattle. This was in addition to a condo that I already owned just one block away.
At this point, I was flying high…or at least I thought I was. Then came the crash of 2008.
The following are the stories of what transpired after the crash with each of the properties described above and the lessons I learned from the experience.
Before I dive into the stories, I do want to point out that Leti didn’t have anything to do with any of these. I made these real estate investing mistakes all by myself.
Vacant lot flipping
In the years between 2003 and 2006, I bought a total of six vacant lots. Two I sold for a profit as described above, and the other four I was stuck with…for a while it turns out.
Immediately after the crash, my properties weren’t even worth the money I paid in property taxes each year. Something I bought for $150,000 was worth less than $5,000.
If you were ever wondering, this is what a real estate crash feels like.
I ended up having to hold onto these properties for the next 10-15 years and sold all of them at a considerable loss (see table).
In order to sell Lot 2, for example, I had to come out of pocket $10,000 because the remaining mortgage was more than the sales price.
These losses don’t include all of the property tax payments, homeowner dues and mortgage interest that I paid over the years.
The other thing that isn’t illustrated in the table is how difficult it was to refinance a loan after the crash.
For example, we got a 3/1 ARM for Lot 2, and I was facing a large balloon payment of a little over $125,000 in 2009, right after the crash. Unfortunately, I couldn’t refinance because all of the banks had completely shut down their loan programs for vacant lots.
I played chicken with the bank and threatened foreclosure. The bank came back and agreed to a loan repayment program where I would pay off the $125,000 loan in 12 months.
As you can imagine, this required quite a few extra shifts to pay for this mistake!
While I learned a lot of lessons from this experience, the biggest one for me is to never speculate.
Speculation isn’t investing, it’s gambling. If we buy something now, market appreciation is never the primary goal. If it happens, it’s just a bonus.
Instead, we invest for cashflow and immediate/forced appreciation. Cashflow allows us to hold on to a property indefinitely, even if the market value drops. What you don’t want to do is to be in a situation where you’re coming out of pocket every month in order to cover expenses. This is exactly what happened to me on my next real estate investment mistake (see below).
Immediate and forced appreciation are types of appreciation you can control. Immediate appreciation is buying a property at a discount. Forced appreciation is raising the value of the property by increasing the income that it generates. It’s part of the Fast FIRE System and how we achieved financial freedom in 3 years. It’s also what we teach in our Zero to Freedom course.
High priced condos
Just before the market crash, I purchased two condos in downtown Seattle. These were about a block away from another high-priced condo that I already owned.
My original plan was to live in one of the new ones and sell my old condo. Unfortunately, by the time I was ready to move, it was just after the crash and the value of the old condo I was trying to sell had dropped significantly. Therefore, I decided to rent the two new condos.
This was just the beginning of my problems.
First, the rents were considerably less than the mortgage. So when you included all of the other expenses, I had to come out of pocket several thousands of dollars just to support each condo. This, when added to the money I was paying on vacant lots in Florida, was financially crushing. Because I was so underwater with each of my properties, I ended up having to work 26 hospitalist shifts a month just to stay afloat.
Second, the condos were in a building with a rental cap. I knew this at the time of purchase, but I figured I would be able to come up with a solution. While I did end up figuring out ways to rent out the units for several years (by filing for financial hardship with the condo homeowner association (HOA) board, for example), eventually I ran out of options and had at least one condo sit empty for significant periods of time.
Because of the above problems, I decided to sell the properties to get myself out of my mess. Unfortunately, the building was brand new when I bought it and had several construction defects, which resulted in multiple lawsuits between the condo HOA and the developer. Whenever there is a lawsuit involving a building, nobody buying into that building can obtain a loan or insurance, which makes it very difficult to sell.
After about five years of stress and working extra shifts, I was finally able to sell both condos at a loss.
There were a lot of lessons I learned from my Seattle condos.
First, if you are buying a rental, you don’t want it to be upside down (cashflow negative). With high-priced homes or condos, the numbers rarely work. When this happens, you have no choice but to work to cover the shortage.
Second, be wary of HOAs and rules. They can change rules on you at any point. This nearly happened to my primary residence when they nearly instituted a rental cap. If this had happened, all three condos in Seattle would be under a rental cap.
Third, be wary of new construction. If a building has construction defects, a lawsuit can tie up your property for years, and you may have to foot the bill to repair the defect.
College town rental
This was my very first investment and in the end, probably the worst of all of my investments.
As mentioned above, I purchased this property with a friend in 2001. My friend took responsibility for managing this property because it was located where he went to college. Things started out as expected. For the first several years, the rents covered the expenses and the property cashflowed a small amount every year.
After a few years, I didn’t pay much attention to the property, figuring it was operating either slightly positive or net neutral.
Over the years, I would occasionally hear about issues. One year, some students punched holes in the walls. Other years, I also heard about some periods of vacancy.
It wasn’t until 14 years later that I finally understood the sheer magnitude of the problems with the property.
As the table shows, the property lost nearly $58,000 over the last 10 years (my friend didn’t have records for the first six years, but I was told that the property was essentially break-even).
And when you add the nearly $70,000 of interest we paid on the loan and over $6,000 in property taxes, in total, we spent nearly $134,000 or 1.3 times the original purchase price of $104,000.
In other words, we could have purchased this property outright and still had money left over for a downpayment for another property.
I learned a lot of lessons on this one.
First, if you are going to partner, be sure to have clearly defined roles. In this case, we should have laid out the expectations and roles up front.
Second, with any investment, be sure to look at the numbers on a regular basis and make adjustments. Ideally, you operate your rentals like a business.
Third, if a problem arises, you need to address it immediately. You can’t ignore it. If it can’t be fixed or continues to be a problem (as it did with this property), you need to sell and cut your losses short. If we had recognized the problem sooner and sold the property, we could have avoided considerable losses.
Fourth, $100/month in cashflow isn’t nearly enough to cover unexpected expenses and vacancy. This is why we teach you how to maximize your cashflow in our Zero to Freedom course. We have students who are getting more than $600 per door in cashflow. That’s six times more than what I was making!
None of this is meant to discourage anyone from investing in real estate. We think if you have the right strategy (ours is called The Fast FIRE System), you establish smart buying criteria and you stick to your criteria, real estate is one of the best ways to build wealth and achieve financial freedom while you’re still young enough to enjoy it.
[Looking for another vital member of your team? Be sure to check out our Vendor Directory to find our vetted and recommended team members]
Once Leti got me on track and helped us focus on a single strategy, it’s been relatively smooth sailing. On top of that, Real Estate Professional Status has really forced me to be more disciplined to operate our rentals as a business. I have to put in my 750 minimum hours, so these hours are focused on growing and maintaining our business. If something comes up, I try to address it immediately. We look at our numbers regularly. This enables us to spot problems and adjust accordingly.
As a result, in a short period of time, we’ve been able to grow our real estate business with very few hiccups or mistakes.
[What were your worst real estate investing mistakes? What were the lessons learned? Please leave us your comments and, if you enjoyed this article, please remember to share it with your friends!]
Do you want to learn how to creatively grow your real estate portfolio and achieve financial freedom? Join the conversation! Follow our Semi-Retired MD Facebook page and join our Physicians (for MDs or DOs only) or Professionals group!
Semi-Retired M.D. and its owners, presenters, and employees are not in the business of providing personal, financial, tax, legal or investment advice and specifically disclaims any liability, loss or risk, which is incurred as a consequence, either directly or indirectly, by the use of any of the information contained in this blog. Semi-Retired M.D., its website, this blog and any online tools, if any, do NOT provide ANY legal, accounting, securities, investment, tax or other professional services advice and are not intended to be a substitute for meeting with professional advisors. If legal advice or other expert assistance is required, the services of competent, licensed and certified professionals should be sought. In addition, Semi-Retired M.D. does not endorse ANY specific investments, investment strategies, advisors, or financial service firms.