“Life is like a box of chocolates, you never know what you’re going to get.” said Forest Gump in the movie. In a similar manner there were certain items that surprised me when I first started investing in real estate, which I want to share with you today. While some were learning opportunities, others were positive surprises.
There are always challenges. In the 2020-2022 period, the market was very competitive and it was challenging to get deals. Now there is less competition; however, deal flow has slowed down and deals on the table are marginal.
Surprisingly in either markets we came across investors willing to overpay. Are they wrong in overpaying? Not necessarily as it boils down to their investing goals. For example, I may be willing to pay up to certain price if my primary goal is cash flow. However, for a 1031 exchange investor whose goal is to shield tax liabilities and who is more focused on long term appreciation, a higher valuation may make more sense than mine. A third may be buying cash and holding the property forever. Different investment goals, lead to different investment decisions and valuations.
Real estate goes through cycles. During periods of volatility or overbidding, it is important to stay focused on your investing objectives. It is also ok to take a step back and reassess if you should pivot.
There are always surprises. Unexpected events, exogenous (market, geopolitical, natural disasters) or endogenous (property fire) almost always happen. While it is impossible to forecast everything that could go wrong, it is important to think through the key risks upfront and determine how they are mitigated – whether how you as an active operator will mitigate those or as a passive investor understand how the sponsor mitigates those. Building in adequate cushion upfront via adequate operating and capex reserves and starting at a strong break-even occupancy for example, provides that needed cushion to weather unexpected storms.
Returns can be glamorous but misleading. It is important to understand the risk adjusted returns of a deal and how returns are derived. More specifically, from a risk-adjusted analysis basis, one needs to determine the risk level of a deal.
A new development deal for example carries higher risk because a lot could go wrong until the vertical construction is completed. Therefore, investors willing to take that level of risk should be compensated accordingly. Does it mean that that deal is better than a stabilized Class A deal with single digit returns? Not necessarily.
In addition, understanding the underlying assumptions applied to derive projected returns is equally important as such assumptions can impact the output significantly. Unrealistic assumptions can make a deal look very pretty in the beginning and very painful in the end (unfortunately now the market is going through some pain and capital calls on many deals that were aggressively underwritten in the past couple of years).
Passive cash flow and building your net worth is real. Real estate is real. Over time your investment income can replace your W2 income. However, it is important to understand that real estate is a long term play and like all good things in life, it does take time. I started investing back in 2017 and have since reached a level where my investments now cover basic living expenses. This did not happen overnight and required consistency and persistence. With patience, prudent investment approach, and time, the impact can be exponential, even if it would not feel like that for several years.
To help illustrate the point I also shared sample calculations in a prior article, which represents one of many ways to showcase the powerful impact of real estate investing. The power of inflation only compounds such effect.
I would be interested to hear what your surprises have been when you started your real estate journey and how you learned or benefited from those.
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Disclaimer: The information presented does not constitute legal, accounting, tax, or individually tailored investment advice. Past results do not represent or guarantee future performance.