“I’ll do a few side deals and when I have enough cash flow to sustain myself, I’ll go off on my own full time”. How many times have you heard this? While doing deals on the side is great in theory, the execution is significantly more challenging than most people can imagine. Successfully acquiring and managing real estate is a full-time job. When you’re doing your first few deals you have more at risk; you’re signing full recourse on the debt, managing investors’ money (likely friends and family), and the deals are critical to building your track record.
While doing side deals is tough, it’s not impossible, and it provides the unique opportunity to maintain your full-time job while getting a taste for the entrepreneurial life. My good buddy Vadim, of Urbanist Capital, just closed on his 7th deal in Western MA, while working full-time for an NYC-based investment firm. In this post, Vadim shares some of the realities of doing side deals.
Take it away Vadim:
What does it really take to start a real estate investment portfolio while keeping a full time job? Having run one for over five years now, I can tell you the requirements change quickly as you ramp up. What you need with your first purchase seems antiquated and naive by your fifth. Here is what I needed. I hope this helps some of you.
Let no one tell you otherwise: owning residential real estate is a full time job. My first purchase was a two family house in the greater Boston metro area, where I lived at the time. It had two long-time Section VIII tenants which made life both easier and harder. On the one hand, subsidized tenants stay longer which means less turnover and less leasing costs and downtime. On the other hand they make collecting rent harder, increase your repair costs and increase your chances for evictions. Tenant relations become more important. For me, having a large cash reserve would have proven invaluable, had I had one.
Evictions in the American Northeast tend to take 6 months of downtime and cost around $1,000. Be prepared for this. If you can’t weather that storm and keep up with your mortgage payments and other bills then you aren’t yet ready. A boiler can break. A roof can leak. A pipe can burst and flood the basement. Any of those can set you back anywhere between $5,000 to 20,000 dollars. If you don’t have an emergency loan line or the world’s lumpiest mattress, you aren’t yet ready.
Lastly, make sure you find a great and (most importantly) honest contractor to step in every time a toilet clogs or an outlet fails. How do you find a good contractor? You overpay six others for poor work. How do you find an honest one? You get ripped off by four others. Asking friends, mentors and other contractors – once you have them – speeds up that trial and error process significantly but make no mistake about it, there will be plenty of error.
SECOND AND THIRD PURCHASES
So you’ve righted the ship on the first one. You fixed the illegal plumbing the previous owner put in that wasn’t spotted until a routine inspection for a leaky sink. You put in a sump pump to keep the basement from flooding and you managed to find tenants that pay you mostly on time. If you aren’t sure you’ve gotten a handle on house number one or you have no more hair from tearing it out at the steady stream of repair bills, maybe wait on more purchases.
The second and third properties are like second and third children. While you may think you’ve learned the lessons from the first one, in fact you’ve never dealt with two of them at the same time. One is screaming to watch Finding Nemo for the fourth time today while the other can’t stop soiling its diapers. It’s the same with rental properties. Have you ever had a boiler and a roof go at the same time only to have those tenants stop paying you since they are now cold and damp? Your boss will start wondering whether you have a medical condition with how many times you’ll sneak away to the bathroom to call your contractor or tenant or inspector or therapist.
Again, a pile of backup money solves many sleepless nights but you can’t throw cash at every problem. That can quickly turn your retirement plan into alimony payments for a kid you never had. Attention to detail is key. Get some mentors and listen to them. If they tell you to buy the more expensive furnace, do it. If they say fix the roof before it leaks, do it. There are few things more expensive than doing a job twice.
FOURTH PURCHASE, ETC. UNTIL YOU QUIT YOUR DAY JOB
Go buy streamers and cake. Make a pot roast and order wine. Invite your friends to your ‘Going Away’ party… because you will never see them again. Having a full time job and (what can now without embarrassment be called) a portfolio of residential real estate investments is the same as having two full time jobs except that they happen at the same time. At this stage in the process sneaking off to the janitor’s closet does not suffice. You must now have a heart to heart with your boss. Cajole, reason or grovel for flexible time. Make it clear that you will stay his/her most productive (and loyal) employee but that sometimes your work day will start at noon since your morning will be spent in a court evicting a tenant, or in a basement overseeing plumbers, or at city hall paying yet another fine, or in the fetal position crying. His/her work will be done by end of business day which, for you, is now 10:15pm on a good day.
Absolutely essential to this stage of the game is realistic planning. No longer can you fool yourself into thinking rental properties are bonds that send you cash once a month. Nor are they gold lying in a vault. Rental properties are living breathing things that must be fed, clothed and cleaned. It’s time to put on your big boy pants and hire a property manager, even if that person is you.
Before you buy your fourth investment, plan out your budget to include all of the legal, custodial and emotional costs you now know it will require. Now add to those costs 7% – 10% of the revenue, depending on where you live, to pay a third party manager. Does the investment still cash flow? You are now adult enough to know that if the investment can’t support all of those things that will eventually and inevitably come then it is not worth buying. Save those nightmares for the rookies.
Even if you manage the building yourself you must budget in a manager’s salary. Then go ahead and pay yourself that. This is important for two reasons. First, it’s not a convenience, it’s a necessity. You earned that money by doing all that work. Ask anyone who has opened any other small business, be it a muffin shop or a bar. Chances are they set a salary or zero for themselves thinking, “Well, it’s my bar”. And for the first year or three, that’s exactly how much they took home: zero.
Second, if you can’t do the work, someone else must. That line item must be in the budget or else there goes all of your profit. You are not Habitat for Humanity; you cannot own buildings without making money on them.
Since it’s clear you’re undeterred by the waking nightmare of owning residential real estate and you’re thinking of scale, you must now think like the professionals do. Don’t plan in terms of 4 units, plan in terms of 400 units. Would you manage that volume for free? Could you? No. You must build in salaries for managers, repairmen, lawyers and all the other team members for whom you will be responsible and still come out with a profit on your investment. You don’t want to still be changing light bulbs by your 10th purchase.
Congratulations. You’ve now hit some small semblance of scale. You can quit your day job, apologize to your patient, understanding boss and embrace your new life with vigor. Your job has evolved from leasing apartments and staring at leaky faucets pretending to know plumbing 101 into managing your team, seeking efficiencies and plotting world domination.
Throughout your journey, there are some key tenets to bear in mind. First, keep it local, Jack (or Jill). When its 11pm and you have to drive to your property for the fifth time today, you don’t want that travel to take more than one hour or else that drive will be off a bridge.
Next, make sure your first property is small enough that you can make tons of mistakes and they won’t bankrupt you. You will most likely have sleepless nights and heavy losses at first. Make sure you are still alive to reach the end of the tunnel, there’s gold waiting for you.
Also, if you are thinking of doing this with other people – be it your wife, an investor, a partner, or even that one cousin that wears too much cologne – try the first one by yourself. It’s harder but it also is less risky. Imagine first finding out that your pipes burst and the bill is $12,000. Now imagine trying to explain that to your investor / neighbor / stinky cousin. It adds an extra level of anxiety that you are just not yet ready for. You haven’t built in the fail-safes and legal structures yet. You don’t yet have the experience to deal with both at the same time. And the last thing you want when you are just starting out is to have to smell your cousin’s cologne in a court of law.
Lastly, the worst mistake you can make is to under-budget and over extend. Don’t buy the second until the first is stable (not ‘almost’ stable). Don’t forget to ask your home inspector not just about what needs to be fixed right away but what will break in the next five to ten years. Then set aside a monthly savings budget (“capital expense reserve”) for those things so that when the roof slides off your house onto your confused neighbor’s lawn, you’ll be prepared.
Good luck. Now if you’ll excuse me, I have to get back to work. Some janitor is bound to open this mop closet any minute now.
Are you planning to do side deals while working full-time?