Starting Out in Real Estate Later in Life? Here Are 3 Deals to Avoid

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What’s on your bucket list? Have you ever dreamed of buying an antique car? Or better yet, inheriting one? An old roadster or classic convertible would fit the bill for me.

I never dreamed I’d have the opportunity to drive my dream car. But recently, through a friend at church, I found myself with the keys to his neighbor’s 1971 Mercedes convertible for a day. My surprised wife and I took it for a spin on the Blue Ridge Parkway to explore the fall colors. Another item off my bucket list! And right in the midst of COVID.

Seriously, this was a lot of fun. And dreaming about it in the days leading up to it was half the fun. I found myself calculating what it might take to permanently park this baby (or one like it) in my garage.

Then I drove it for about four hours. We had a great time. But the trouble started before we turned the key when we looked for a place to set our hot coffees. I guess they didn’t obsess over coffee 50 years ago. No worries.

Then we tried the radio. AM Jam. And what was that burning oil smell? Oh, and the seatbelt had this special way of latching. And…

You get the picture. We loved the time on the Parkway that day, but my desire to drop more than the price of my first house to get this car evaporated like the dew on the grass that morning.

Related: 3 Investments To Insulate Your Real Estate Portfolio From a Market Downturn

Sometimes our bucket list items are like that. And sometimes our investments can be, too. If you’re jumping in the real estate game later in life, I’m guessing you’ve got jitters thinking about what you’ll be investing in. I still have those myself, and I’m entering my third decade as a full-time real investor this month.

I’m not writing to tell you what to invest in. Or what to avoid. (Necessarily.) But I want to give you a few thoughts on what I and some others have found helpful when starting later in life.

How to Invest Later in Life

I spoke to one of our newer investors this week. He and his wife, successful professionals, are nearing retirement and they have burgeoning 401(k)s to show for it. They are in the process of converting their retirement plans to self-directed IRAs. Time to celebrate!

Or not.

Converting from a corporate retirement plan to a self-directed plan can introduce a whole new level of risk to investors. It sure did for me when I made the switch a few decades ago. There are at least three types of investors who would be better off not switching from a traditional managed retirement plan.

1. If you’re a fan of the Social Security system and believe the government will take care of you, you probably don’t care about any retirement plan. Your 7.65% (really 15.3%) investment (see item “FICA” on your paystub) will certainly be invested safely for you by our government, right?
2. If you chase crazy investment schemes and double or nothing opportunities, you would honestly be better off letting a professional manage your money. Sure, I know about the guy who made millions off the crazy invention in his uncle’s attic. But that is certainly the exception, not the rule.
3. If you think your plan administrator can do a better job picking investment options (typically bond funds or mutual funds) than you, then you probably don’t need the flexibility offered by a self-directed IRA. (Honestly, many investors would be far wealthier with this option. Especially those in the second category above.)

When I sold my company for a few million dollars before my 34^th birthday, I considered myself a full-time investor. Laughable! I was a full-time speculator. I didn’t know the difference. I was willfully ignorant.

Related: This One Factor Makes Growing Your Wealth Almost Guaranteed

I knew about the guidelines for diversifying my portfolio and carefully allocating assets between this and that. But I was an entrepreneur. And I treated my investments as an entrepreneurial investor. This was a big mistake (for me, at least). These so-called investments were little more than speculations. I learned this from Warren Buffett years later, and oh, how I wish I could have known before I blew through countless dollars.

Investing: When your principal is generally safe, and you have a chance to make a return.

Speculating: When your principal is not at all safe, and you have a chance to make a return.

Recall the wise words of Paul Samuelson, the first U.S. Nobel Peace Prize winner in Economics: “Investing should be more like watching paint dry, or watching grass grow. If you want excitement, take $800 and go to Las Vegas.”

And now repeat after me class: Low risk leads to low return. High risk leads to _____.

Your mind wanted to fill in the blank with “high” didn’t it? But that is wrong. The right fill-in for high-risk should be it leads to “the possibility of high or low return. Or even zero return.”

If you’re starting later in life, and you have cash on hand, be very careful about speculating. It is probably OK to speculate with a small portion of your investable capital. Some investment managers recommend 10%. But if you play double or nothing with all of your investment capital, you will eventually land on nothing. Then what will you have left to invest?

I hear a few of you saying, “Paul, wait! Clickbait! You said you’d tell us what deals to avoid as an older investor!”

OK, OK already. But I did say I’m not inclined to narrowly tell you what to avoid. It’s always about the asset type because investors make money in many asset types I wouldn’t touch with a thirty-nine-and-a-half-foot pole. It’s more about the risk level within the asset. I’m guessing a few people even made money in malls and retail in 2020 (though I’m not sure how).

If you want to dive deeper on this topic, I highly recommend a few books that have really helped me:

• The Hands-Off Investor by Brian Burke. BiggerPockets published this excellent guide to vetting real estate syndicators and deals. It will provide valuable insights on passively investing in syndications.
• Mastering the Market Cycle: Getting the Odds on Your Side by Howard Marks. This book, more than any other, helped clarify the natural and unavoidably cyclical nature of every market cycle. And perhaps as important, how to invest appropriately at these various points.

So, I’ve already said I would avoid speculations—at least with a majority of your investable capital. I believe true wealth is owning assets that throw off income. Speculations are often assets that have no income. They are dependent on the whims of buyers and sellers. And they frequently rise and fall with the mood on Wall Street, a CEO scandal, or a war in the Middle East.

So, when investing for the long-term, be careful of assets that depend on the whims of the market for their profit. That’s not to say you shouldn’t flip houses in predictable markets. But if the current crazy appreciation must continue for you to succeed, I would question that deal.

Investments to Avoid

I would also avoid paying retail for stabilized deals since we appear to be at (or near) the top of the market. Let’s break this concept down into its three most important components.

1. Top of the market: Howard Marks tells us the worst time to invest is near market tops. This is when the risk is highest because it’s likely the value will go down soon. And this high risk is compounded by the fact that you must often outbid other buyers to get it, thereby creating a minimal margin of safety.
2. Paying retail: Our firm usually invests in off-market, mom-and-pop-owned deals with significant upside. These assets are very hard to find, and it’s taken our partners’ acquisition teams many years and millions of dollars to hone these skills. But if you don’t have this advantage, you may be forced into a position of buying regular on-market deals at the regular high price or investing with those who have these skills.
3. Stabilized deals: I love investing in deals with significant upside (assets currently operating far below their potential). Mom-and-pop operators typically don’t have the knowledge, the resources, or the desire to maximize income and therefore optimize value. This can be an enormous advantage for a professional operator. When the market softens, it is likely that a deal like this would have a wonderful margin of safety. If you can’t get access to an unstabilized deal, you may be at a significant disadvantage.

What else?

Declining Markets

I would also avoid deals in declining markets. You’ve heard that a rising tide elevates all boats, and that’s what has happened for the past decade. It’s also true that a falling tide lowers all boats. Investing for the long-term in a city experiencing population or income decline is often a losing proposition.

Overbuilt Markets

I would avoid investing in overbuilt markets. As an example, there has been a self-storage construction boom for the past number of years in many large metros. Investing in a ground-up storage project where several others are built down the street can be a tough sled for all involved. I know from personal experience.

We love investing in self-storage in out-of-the-way locations with little competition. We recently invested in a small-town, unstabilized, mom-and-pop self-storage deal that churned a 500%-plus return on equity to investors. I have the case study detailing this if you want to see it.

Government Overreach

Consider avoiding states with onerous government overreach. States like California, New York, and Illinois are widely promoting anti-landlord policies, and some of these locations also have some of the most overpriced assets. Be careful.

Aggressive Underwriting

Avoid assets that depend on aggressive underwriting. Operators showing revenue increase projections while costs are level or decreasing should be forced to prove their assumptions. Cap rate compression (asset appreciation from market forces often outside your control) should always be suspect.

Risky Debt

Avoid risky debt. Risky debt may come in the form of high loan-to-value ratios, adjustable rates, and short terms, among other things. Look for a high DSCR (debt service coverage ratio) to ensure a strong margin of safety between the net operating cash flow and the debt payments each month.

Bankers like a minimum DSCR of 1.25 or 1.30 (a 25-30% margin of safety). Our firm likes to see a much higher number.

Declining Asset Types

I would avoid investing in declining asset types. We all know how retail, malls, hospitality, and other asset classes have fared in the past few years—and particularly during the pandemic. The exception is a complete repositioning into a new usage, like an old department store into self-storage.

AJ Osborne was interviewed on the BiggerPockets Podcast in July 2018 and told his story of acquiring a Super Kmart in Reno. He sold off the parking lot to apartment developers, cut the building in half, and converted it to an awesome self-storage facility. Net cash in the deal: about $2.5 million. Debt: $5 million. I was on the phone with AJ in December of that year when he received a $25 million offer on that property at 40% occupancy (it was still being leased up at the time). You can learn how AJ did this in his awesome new book on self-storage.

Gut Check

And lastly, avoid investments that don’t pass the gut check. What do I mean by this? We were designed with a brilliant but hard-to-quantify ability to sniff out bad actors and bad deals. I can’t explain how we can do this exactly. Our brains (and hearts) can pick up on thousands of non-verbal cues that we can’t often comprehend cognitively. Scientists have found that our hearts give off massive electrical signals that are received by others’ minds. So while we can’t explain these things, we all know that we’ve experienced this.

And guys, if you’re married, that little knowing feeling often sounds like the voice of your wife. (Think about it. I’m only half-joking!)

Good Investments for Those Starting Out Later in Life

So, what should I invest in?

The BiggerPockets editor-in-the-sky told me to write on what to avoid. But in case any of you feel less than satisfied, you can check out this post about investing over 40. And if you’re feeling depressed about getting started late—or losing a lot and restarting like I did—join the big club. (I hosted a podcast called “How to Lose Money” for years.) But don’t stay there!

Realize that one of the greatest and wealthiest investors of all time wasn’t a billionaire ‘til his 50s. Who is that? Mr. Buffett himself.

Check it out…

Are you starting late? If so, let us know what you’re investing in. Or if you know of great investments for us late-blooming investors, we’d love to hear about them.

Join the discussion in the comment section below.

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.