Investing is a Business, Not a Hobby!

I often see first-time investors make the tragic mistake of using emotion to get in the way of them making money in real estate. After I purchased my third rental property in Phoenix, AZ, I was approached by a woman who said to me, "Why on Earth would you buy a property in Phoenix, it's so hot there, who would live there?" To which I responded, "About 1.5 million people." I then explained to her that Phoenix has a much lower cost of living than Los Angeles and is the #1 state that Californians move to is Arizona since it's so much more affordable. I tried to explain to her that where I want to live has no relevance to where I purchase a rental property, so long as the rental market is hot there and the property makes me money.

Owning investment real estate is a business, and it should get treated like one. If you want to buy an investment in a particular area simply because you have a family member who lives there, or because the weather is nice, or because the trees are prettier there, then you are in for some costly and painful lessons.

The property you are buying needs to make sense FINANCIALLY. First, start by looking at the demographics, job market, the housing market, and rental market of a particular geographic area. Then zoom in on the statistics and data of the neighborhood where you are looking. Examples would be how close the neighborhood is to freeways and shopping, school district ratings, and perhaps the crime rate. Finally, zoom all the way in on the specific house you are looking at purchasing. Look at the age of the property, condition, possible rent vs. purchase price, cash flow, amount of money needed for initial fix-up, possible ROI, and quality of tenants you will attract. If this property isn't going to produce a significant return on your investment and pay you cash flow every month, then toss it out.

Now you're starting to look at this as a business!

The IRS considers owning investment real estate a business, so shouldn't you? Each year during tax season, you must fill out a "Schedule E" on your tax return for each property, documenting every single expense and total income produced. The IRS allows you to deduct certain expenses on your property, including but not limited to the insurance, property taxes, mortgage interest, repairs, and even travel. Those that keep detailed summaries of every penny spent are usually those that benefit most from the generous tax rules provided by Uncle Sam. Make sure you hire a CPA or tax professional who understands the tax deductions for rental property owners or even better owns real estate of their own.

There are three key factors that you must implement into your rental property business to ensure you are successful:

1. Good Employees
2. Organized Systems and Processes
3. Cash Flow
4. 
   

GOOD EMPLOYEES:

In the business of owning rental real estate, your "employees" can consist of the realtor or broker representing you, your mortgage lender, the property manager, your CPA, your insurance agent, contractors, and sometimes even an attorney when necessary.

People are good in nature. However, to show you their good side, you must hold them accountable for their actions. Your employee's performance will reflect your management skills, so if you are not a good manager, you will have a bad business. If you hire the right people and have good relationships with them, they will enjoy working for you and strive to do their best. If you hire the right people and have poor relationships with them, their performance will reflect it. Ultimately, you need to make sure your employees take care of your customer (the tenant). If the customer is not taken care of, your business will suffer.

ORGANIZED SYSTEMS AND PROCESSES:

Your rental property must always be a priority. You do not need to spend very much time over 12 months on a rental property, but when a tenant moves out, you need to know what to demand of your property manager. It only takes about 20 minutes a month per property to review your property management statement, account for any maintenance and repairs, and make sure it matches your bank account. However, if you let it sit for eight months, it will create a mess. Setting up an excel spreadsheet is a great way to keep organized records of your monthly and yearly income and expenses on each property. You should also set up a separate checking account to make it easier to manage.

CASH FLOW:

Your business needs to pay you; it shouldn't be the other way around. A successful business does not eat into your cash flow regularly. One of the biggest mistakes most people make is they don't factor in maintenance and vacancy upfront. It's not a matter of "if," it's a matter of "when" the property will go vacant and need repairs. A good rule of thumb is to factor in 8% of the monthly rent for maintenance and 8% of the monthly rent for a vacancy for an A-Class Property (Learn the Property Classes). Of course, this number will vary depending on the area you are buying in, the age of the property, etc. but this is a safe number to stick to. With the incredibly low-interest rates of today, it's possible to generate unprecedented Cash-on-Cash Returns of 10%-15% a year on rental property. Don't think of Cash Flow as the means to get you rich. Think of it as the glue that holds the deal together long enough to experience appreciation in the future.

I love living in Southern California, but currently, I am not in a place to invest due to the high purchase price, and I'm okay with that because I get to experience the best of both worlds. My out of state rentals pay me handsomely, and I get to live 15 minutes from the beach. My favorite quote to use when telling first-time investors to look at Real Estate like a business is, "Live where you want, but invest where the numbers make sense." There's no more straightforward way of saying that when it comes to Real Estate investing, it's all about the numbers, and when you treat your real estate like a business, and it will pay you like one.