Confession, they say, is good for the soul. So I confess: I repeatedly made a VERY serious mistake in my real estate career—one that in some ways, I will literally never recover from. I kick myself about it all the time, because I think that even as I was doing it, I KNEW it was wrong.
Ok, enough of the striptease.
The worst thing I ever did was live as if ALL of the money I was making (and, some months, on MORE than the money I was making) was there to be spent. If I could go back in time and change one thing about my business life, it would simply be this: I always live on 80% of my income, instead of 100-110%.
Now, to give this some perspective, let me remind you of what I was doing early in my real estate career.
My first 40 or 50 properties were single family homes that I bought and fixed with private money, refinanced (usually with $5,000-$10,000 cash out), lease/optioned with $100-$200 a month cash flow, and eventually sold for a $20,000-$30,000 profit, generating another $10,000-$20,000 cash after the mortgage payoff.
I didn’t start wholesaling properties until around 1994, and not seriously until about 1996. Given that I’d keep 25-35 houses in portfolio at any given time, my income often looked like this:
January (post-Christmas “I don’t have the rent” month): $2,000
February (now with 5 vacancies due to January) $2,000
March (refi one house): $12,200 ($10K of it borrowed)
April (back to nearly full occupancy) $2,500
May (1 tenant buys house) $17,500
June (school’s out, moving time) $1,900
July (2 tenants buy houses) $27,000
August (now short 2 houses) $2,300
October (buy another house) $2,200
November (refi) $13,700 ($11,500 borrowed)
That’s some serious income for a 24 year old, right?
Well, first, let’s remember that $21,500 of it wasn’t really “income”—it was cash-out proceeds (remember those?) from mortgage loans had to paid back. So, in a sense, I was borrowing out equity a year or 2 ahead of the sale of the property. It would have become income later, anyway, but I was using refinancing to push some of NEXT years’ income into this year.
Second, recall the rule of thumb that rental properties actually cost 20%-40% of their gross rents to manage, maintain, carry during vacancies, repair, etc. I was not, of course, putting this money into a reserve account, where it belonged—I was spending it and then paying for repairs and maintenance with a credit card, which I’d pay off after the next refi or sale of a property.
So, a more realistic evaluation of my actual profit—taking out the borrowed money and ignoring the reserves that that really ‘belonged’ to the houses—would have my spendable income at $36,000.
So, what happened each month is that whatever I brought in, I spent. In the months when I refied or sold a house, I caught up on all my credit card bills, plus took a vacation or bought furniture or a pig (which probably ranks in the top 10 mistakes I’ve made all by itself) or clothes or whatever. In months when my “cash flow” was less than $3,000, I ran up credit card bills and made minimum payments. And when tax time came, I had no money to pay the bill unless it coincided with a refinance or sale of a property.
Now, I recognize that if my current self could go back and tell my younger self this, my younger self would say:
- You’ve got to be kidding, I’m barely surviving now on $87,000 a year. How can I spend 20% less and still pay my bills?
- I deserve the treats in the months when I have money, because I only have it a few months a year (this would be my younger self lying, since I just put the “treats” on credit cards when I didn’t have cash)
- I don’t need cash reserves for the properties because 1) they’re fixed up by the time I refinance them and so don’t need work and 2) my tenants take care of all the repairs and maintenance anyway. Plus, I can’t afford to put aside reserves; see #1.
- I can’t budget, because my income is too variable. There’s no way out of this.
By the time I began wholesale in the mid-90s, I had managed to rack up over $30,000 in credit card debt, no savings (except the equity in the properties), and a bad, bad habit of spending any money that came into my possession.
The main change that wholesaling created in my life was that I had more of that money to spend. For tax reasons, I did start exchanging my lease/option properties instead of selling them outright, which kept some of that cash out of my hands. And since my speaking business lost about $10,000 a year for the first few years, some of that wholesaling cash went away there. But the primary effect was to put a six-figure income into the hands of someone with no financial self-discipline at all.
It took another 4 or 5 years for me to realize that these habits were going to force me to spend the rest of my life living (big) paycheck to (big) paycheck, and by that time, the process of cleaning up my financial life was daunting, to say the least. I had started yet another business (promoting conferences) by then, and it was also a money-loser some years. 4 years later, I’m sorry to say that, while my credit card and unsecured debt is practically gone, I’m still not where I’d like to be in terms of reserves, paid off properties, and other “safety nets”.
My great regret is that I did not deal with this early on, when good habits might have been easier to develop and before “creeping decimalism” made a sizeable monthly credit card bill $90,000 instead of $9,000.
My wish for you is that you do the hard part—budgeting, spending less than you make, and developing reserves—NOW. Believe it or not, denying yourself a latte or HBO now is a whole lot easier than denying yourself a new car or vacation later.
A real estate investor with a high income, lots of equity, and reasonable cash reserves is in a good financial shape indeed. If you want to be bullet-proof later, don’t make my mistakes now. Trust me, you’ll thank me someday.