3 Real Estate Investment Rules You Dare Not Break

Almost anyone can make money in an appreciating market. The real skill is making money in a flat or down market like we find ourselves in right now. In this article I am going to share with you the only three things you need to know to make money in real estate in both good times and bad. Knowing these three rules and abiding by them will allow you to sleep well at night even as those around you lie awake in panic.

Rule No. 1 – Invest, Don’t Speculate

Perhaps the costliest mistake novice investors make is thinking they are investing when what they are actually doing is speculating. Speculation is risky because it leaves a lot to chance. Investing, on the other hand, involves having a well-thought out plan that is as close to foolproof as possible.

How can you tell if you are investing or speculating? If the only way you are making money in real estate is when the price increases – then you are speculating. If you follow Rule No. 2, outlined below, you will be certain that you are investing, not speculating on something you can’t control.

Rule No. 2 – Don’t Pay for Real Estate Yourself

Don’t put yourself at risk. Don’t use any of your job income to support negative cash flow from a property, even if your accountant says you can use it as a tax write-off. This is risky. What happens if you lose your job? Not only will you lose your own home, you’ll also lose all your investment property. Before you buy an investment property, determine if you will be able to collect enough money from your tenant to meet the mortgage – plus ALL the expenses of maintaining the property. If you determine that you cannot collect enough rent to cover the mortgage, property taxes, homeowner’s insurance, utilities, repairs and vacancy allowance -- don’t buy it!

By following Rule No. 2 you are better protected from market downturns and can confidently hang on until the market eventually comes back up again because you know that your renter is the one covering the expenses – not you. Imagine, for example, that you have purchased a $200,000 property and your rental income covers all your expenses. Let’s say that the property value falls to $150,000 and stays there for the next 30 years. Did you really lose money? No, you did not. At the end of that period you will own the house free and clear with $150,000 you didn’t have before – courtesy of your renter who has, in effect, given you a free savings account.

Once you sign the mortgage papers and lock in your terms, you are guaranteed one thing – you know what the loan balance will be year after year. So it really doesn’t matter how much your total price is as long as somebody else’s is paying for it and the income covers ALL the expenses.

Rule No. 3 – Don’t Buy Based on Emotion

Rule No. 3 is to keep your emotions -– mainly greed and fear-–in check. This is perhaps the trickiest of the three rules because even seasoned investors get tripped up by it. If you are an emotional investor you can get sucked into the fear of not getting into the market; being left behind; watching your deal slip away; thinking you will die broke, worrying that the market will collapse or leave you behind.

I too have been guilty of losing money on an investment property because I could not rein in my fear. It happened with one of the first investment properties that I ever bought; a $10,000 foreclosure that had emotion written all over it if I had only been willing to listen. I ignored the obvious when renovation quotes came in 30 percent higher than I had budgeted. I remained unconcerned that the property was located in a low-income, high-crime rate area too. I let my emotions and my need to “do the deal” over rule common sense. I lost more than $30,000 on that property – a very expensive lesson.

But I learned an important lesson: Before you sign on the dotted line ask yourself if you have followed Rule No. 1, Rule No. 2 and Rule No. 3. Once you are certain that you have done so, commit yourself to the deal and sleep like a baby.

Paul M. Hecht is an author, investor, real estate agent, investment coach and host of the radio program The Real Estate Investment and Success Show. He is the author of Everyday Real Estate Millionaires: How Average People Really Do It.