Why Real Estate Investors Struggle to Create Real Wealth
I want to share with you stories of 2 men I met with last year who both wanted to start investing in commercial real estate.
What’s interesting, is that both men were successful doctors.
Both were very busy. Both married with kids.
Both wanted to create passive income that could one day replace their active income – so they’d be able to stop working if they wanted.
Both started investing in residential real estate. They each thought that investing in single family homes would eventually generate enough passive cash flow that they could one day replace their jobs as doctors.
What they both realized, after we sat down, was that they were generating less than $100/month from their single family homes.
For ease of calculations, both had to invest roughly 25% of the purchase price of the house- meaning $100,000 cash to buy these homes.
In exchange for their $100,000- they were yielding less than 2% cash on cash ($100/month x 12 months = $1,200. $1,200/$100,000 = 1.2% return
I too started investing in residential houses as a way to make money in real estate. My plan was the fix up and flip or rent out. So, my returns were higher, but required a tremendous amount of energy and time to find and fix up the houses.
Both these men were too busy to be playing the fixer upper game.
But, they wanted to create wealth investing in real estate.
They’d heard of investing in apartment buildings and retail properties- but didn’t know where to start.
They found me, through my website (at separate times last year) and set up a time to meet).
To protect their privacy, I’ve changed their names- Ron and Donald.
While, both men were driven and wanted to invest in CRE, one was committed, and one was interested in it.
This didn’t become evident to me, until several meetings in. In my experience, there are a lot of people who like the idea of owning an apartment building. They have visions of driving by their retail property with friends or co-workers, saying- ya, I own that building there.
But, there’s a lot of work that goes into buying a CRE property. Wanting it, is step 1. The next step is to create a plan to make it reality.
I met Donald first in January. He was focused, studied, came with great questions and was playing the long game.
I explained that it could take months to find the right property. But it would be worth it, because that 1 property could generate 5-10k/month in passive cash flow.
Ron, on the other hand, was more impatient. I sensed he was frustrated with his job and wanted to start investing asap.
When I asked Ron, what his budget was, he told me he could buy a property up to $5M. Donald- he too had a budget of up to $5M.
When I dug in and started asking deep financial questions of Ron, he mentioned he’d have to raise most of the money from friends and family to invest. Which was fine- but, I asked how much equity he would be comfortable raising for his first commercial purchase.
That’s fine- but we should be looking at properties between $1.5-2M.
(Some new investors are thrown off at how forthright I am about the money. In CRE, money is important and you get those conversations out on the table in the first 30-45 minutes.)
Donald, on the other hand had saved up $1.5M+/- to invest- so we could look at $5M commercial deals.
Next, came return expectations.
How much do you expect to earn on your properties? Remember, for some reason, each of these men was ok earning 1.2%/year on their single-family homes.
All of a sudden, we go to investing in CRE, and you’ll see how the expectations change.
Ron ‘I’d like 10% cash on cash returns’.
Shane- ‘Ok. How did you come up with 10%? Have you seen any CRE properties that generate that? And, are you ok finding value add properties, with high vacancy, requiring capital and likely larger down payments to stabilize? Because, the market here is 4.5-5% cap rates’ (meaning if you buy all cash- that is the return you’ll receive).
Ron- ‘Well, I want to invest in what you (Shane) invest in’.
Shane- ‘I see. Well, here are 2 deals I’m working on now. One is expected to pay 50% out in 18 months and the other, 35% in 16 months. Both require full time effort on my part and because I have a development partner with experience, I feel comfortable doing these types of deals’.
Ron- ‘I’m not sure, I don’t like the location. Can you really get those types of returns’?
Shane- ‘Ron, level with me. What do you really want to invest in? Why are looking to invest in CRE now’?
Ron- ‘I have friends who’ve made millions because they got started buying multifamily and I feel I’m falling behind. I want to get into a property right away and start creating wealth’.
Shane- ‘I understand that. But, CRE is not get rich quick. It takes time to find the right property. Time to understand and learn your market. Then time to execute. But, all that is worth it, when you get the right deal. One property can pay you $10k/month passively.’
Ron- ‘That’s what I want’.
Shane- ‘Then, we need to start at the foundation and design a plan to get you there’.
Ron- ‘Ok, I’m busy now, but maybe next week or the week after’.
End of story. Ron hasn’t been back since. Too much work. It wasn’t sexy enough.
Donald on the other hand, was different.
My first meeting with Donald he brought his wife. They were both on the same page and focused on their financial future. Both were polite and listened intensely. They had great questions and we started off by defining their goals and outcomes.
(I later learned, Donald brought his wife to vet me. To see if he could trust me. Funny- before I do business, I bring my wife to important meetings. Women seem to have a good 6th sense about people).
Over the next 3 months, Donald would tour properties and search online for opportunities. He’d send them to me and I’d run through the numbers and properties.
While 99/100 didn’t fit- he didn’t get discouraged.
When we finally found the right property in the right location- we made an offer.
If I recall, it didn’t have a list price, but the listing agent told me they wanted $5M.
So, we submitted an offer based on financial calculations we’d run and based on the risk profile of $4.5M.
They countered full price.
Meaning- Fu(* off.
Shane – “Donald, don’t worry. This can be part of the negotiating process. We made a reasonable offer. Be patient”.
The following week I follow up with the listing agent. We find out they thought they were getting a back up offer that never materialized.
Over the next 2 weeks we go back and forth and finally settle on a price that fit Donald’s return thresholds.
This was just the start of the process. Getting the property under contract is about 10% of the deal.
We still had to work through financing, a formal Purchase and Sale Agreement, due diligence and then finding a property manager to help manage.
But we broke down each part of the acquisition and found the right people to help.
At the end of the day, after a bit of bumpy closing, Donald was the proud owner of a class A retail property.
It won’t generate 10% cash on cash returns- but he also won’t have to worry about backfilling tenants because of the great location of the asset.
Donald was clear on his timelines and goals. He made good money and was fine with a solid 7-8% cash on cash return.
His tenants are paying off his mortgage and in 20 years, when it’s paid off, he’ll have an asset worth $5M (assuming the value doesn’t go up at all).
Now, Donald, with his 1 commercial property under his belt, is looking to syndicate his next deal. He’s got many friends, also doctors and business owners who want to invest in his real estate deals.
Most will never take the time to educate themselves on the real estate market like Donald.
So, they’re happy to give him their money plus a % of the deal for finding the property and closing it. In 3-5 years, I’m confident, if Donald keeps on his current path, he will be able to replace his active income. At that time, he can decide what he wants to do.
Ron on the other hand- was looking for the home run property. Hoping that I or someone else would find that for him.
I explained to Ron- the type of deal you’re looking for, is what every investors wants. It’s like finding a lotto ticket and asking someone hand it over to you.
No one is going to deliver that to you. The value is in finding the deals. You must be prepared to get out, make the calls, tour properties. Understand the game and the market.
Ron, unfortunately, wasn’t interested in learning the rules of the game.
He thought because he had some money, that he could become a commercial real estate mogul overnight. The reality is, there is more money chasing deals than there are good deals. Today, you must go out and find them.
You must be patient. And, when you find the right commercial property- be ready.
That means- you take the time to define your investing plan. This way, you’ll know what you’re looking for, so when you see it you jump on it.
If it takes you 6 months to learn your market and understand the commercial real estate game- wouldn’t it be worth it if 1 property could pay you $5k/month, 10k/month of 25k/month?
Both Ron and Donald went to school for 10+ years. Invested over $300,000+ to become doctors.
Donald, sought out someone with experience he could trust to help him find, fund and follow through on his first deal.
Donald understood that investing in CRE was playing the long game. That it would take time and energy to learn it. That investing in his first property was not a straight line- but with my help and surrounding himself with the right team, he could model a proven formula.
Today, Donald is cashing in cheques every month and having his mortgage paid down by tenants to the tune of more than $14k/month.
This is what’s so exciting about investing in CRE.
The opportunity to find 1 commercial property that can replace your income.
But, it doesn’t happen overnight.
It takes time, energy, patience and money. It requires dedication.
This isn’t like buying stocks. There’s a reason the wealthy own most of the CRE in the world. Because they understand how valuable it is and have the patience to wait for the right the properties.
For every 1 Donald, there are 10-100 Ron’s. I believe Ron could eventually transition to Donald. But, it requires proper expectations. A commitment to mastering the fundamentals.
Time will tell.
Meanwhile, Donald and I are looking for his next CRE property.