When I was in high school, I had a job at the pro audio and music store in my small town. People would occasionally come in and jokingly ask, "What do you have for free?" The owner of the store always had a clever, one-word response: "Advice."
I've been frequently asked on podcast interviews what advice I have for other real estate investors. Depending on the context of the interview, it's not always the same thing. But, I recently talked about a mistake I see other investors (both seasoned and new) make quite often, and it was the basis of my advice for other real estate investors:
Know Your CapEx Budget! Don't Ever Go Into A Deal Under Capitalized.
When you are under capitalized, you are not only taking greater risk, but you are also cutting off your property's maximum potential. Fortunately, this is not a lesson I have had to learn first hand, but I have seen many others make this mistake as they get caught up in the thrill of a deal. It's easy to fall into the trap of finding a property with below-market rents, and believing the answer is as simple as raising rents as leases renew. Though receiving advice is often times free, taking the advice often times is not.
CAPEX IS REQUIRED TO UNLOCK VALUE
Ever heard the phrase, "You need to spend money to make money?" I would agree, but with a slight variation to the statement: "You need to invest money to make money."
Once you acquire a property, your objectives to unlock value are clear: 1) increase income, and 2) reduce expenses. The combination of these two things will maximize your Net Operating Income, and force the appreciation of your income property. However, achieving these two objectives are going to require an investment. For example, implementing water conservation and converting lights to LEDs are great ways to reduce the monthly utility bills, but you have to be willing to make the investment to purchase and install them. So, make sure you are well-capitalized, so you can unlock the properties maximum potential value.
OPTIMIZE YOUR CAPEX
When approaching a deal, you definitely want to consider how you can optimize your CapEx investments. You will get the greatest return on the CapEx investments that result in increased income or reduced expenses. For example, if residents are willing to pay $50 more per month for a unit with newer appliances, and the appliance package costs $1,200, that's a 50% return in the first year ($50x12 months, divided by $1,200). You will not get as strong of a return on investments made to address deferred maintenance, but you still must plan for known issues in your CapEx budget and prioritize accordingly.
BE PREPARED FOR THE UNEXPECTED
It's the unexpected things that pop up, which will get you into trouble. This is where I see other investors go wrong most often. Regardless of how good your due diligence was, things are destined to break, and these are sometimes big ticket items. It can be a real setback, if you don't have cash set aside to address them. This can lead to outstanding payables—and even worse—a mechanics' liens.
Things don't necessarily need to break to take you by surprise either. The City can inspect your property and require you to address things immediately. They don't bother to ask whether you have the money to carry out their instructions. They typically just give you 30-days to complete the work. This happened to me once: The City required me to re-plaster the pool. This would normally be a few thousand dollars. But, once we began the work, there were multiple things we had to do in parallel, which turned into about $15,000 of CapEx I wasn't planning to invest. Fortunately, I didn't stress over it, because I had a buffer line item in my CapEx budget. I recommend building in an additional 10-15% into your CapEx budget for the unexpected.
Regardless, make sure to have your CapEx budget nailed down before you close, and set a little aside for the unexpected. Your lender might even be willing to finance a portion, or even all of it, which can increase your return exponentially.
ABOUT THE AUTHOR
Mark Walker has been an active real estate investor since 2004, so he brought a wealth of knowledge with him when he founded Luxmana Investments in 2011.
Though he started out as a part-time investor—holding a full-time job in high tech—he fully transitioned into his passion of real estate investing in 2015.
Mark now dedicates most of his time helping new and experienced investors build wealth through residential, multifamily and commercial real estate.
Learn more about Mark and Luxmana Investments at www.luxmana.com.