Ep 84: The cold hard truth about real estate – it takes money to make money

The most common question that I get is from somebody asking for advice on breaking into self-storage space, usually telling me they have $X in savings and want to buy a facility for $Y. The truth is that there’s a ton of nuance to it based on where you are in your career, but I always lead with three questions:

  1. How much cash do you have in terms of liquid net worth?
  2. Are you from a wealthy family? Can your parents write a $1M check to bail you out if they need to?
  3. Do you have wealthy friends who you can sell on the deal?

If you don’t have access to a ton of cash, you have no business in real estate until you have more in the bank. That’s how you go broke. But again, there’s nuance. Frankly, if I gave myself advice back in 2013, I would have probably advised myself not to do our first deal. That deal has made me over a million dollars and made a ton for investors, so it sounds ridiculous right now. But I’m at a different phase in my career right now, and my risk tolerance is focused on protecting the downside.

So if you have your eyes on a $1M facility, how much cash do you need? I would approach this by syndicating a deal with wealthy people and aiming to capitalize $1.2M, which provides cash for closing costs, cost segregation, capital expenditures, etc. over the purchase price. I would aim for around $500K-$600K of debt on the deal, which is a lower rate because debt is really expensive right now. It’s hard to find real estate that will produce positive cash flows if you borrow a ton of money, and you can end up spending more on debt than your property even produces.

There are three primary mistakes rookies make, and they’re often the first thing I warn them about when they’re looking at their first deal:

  1. Not keeping enough cash in reserves
    • The #1 rule of real estate is to not run out of cash, because then it’s game over. You need money to account for surprises to keep you in the game.
  2. Taking on too much leverage
    • With a possible recession on the horizon, buying a property with 80-90% leverage gives you a really low margin for error when operating, and is an easy way to end up underwater.
  3. Not accounting for the cost of doing business
    • On top of the purchase price, you need to be able to comfortably cover closing costs, insurance, appraisals, and maintenance, which can balloon the amount of cash needed for your deal.

It’s a popular saying that real estate investors are cash-poor but asset-rich, meaning they have a high net worth but little liquid cash. That’s true to a degree, my net worth is around 75% tied up in real estate, but I still have cash. I have several million dollars on hand for reserves, and my partner and I have over $10M in accessible liquidity that can be used if needed. By having cash on hand, we’re able to pounce on new opportunities as they pop up.

So what do you do if you want to get into commercial real estate but don’t have millions of dollars? I got into real estate after being in a small business that shot out $300K+ every year for a few years, and for 90% of people right now I would tell them to forget about real estate and to go do something else. Most real estate investors with ultra-high net worths started with small business entrepreneurship, and you can make a ton of money in your business and put it into real estate. Real estate is a great way to grow wealth, but it’s not the way to create wealth from scratch.

If real estate is in your focus, start small until you have the cash. Step away from your computer, step away from influencers, and focus on making cash. It sucks to hear it, but to get commercial real estate property on your own you would need at least $500K of liquidity, and you’re best off not rushing things and putting yourself into a tough spot financially.

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I started the Sweaty Startup in December of 2018 because I believe the Shark Tank and Tech Crunch culture is ruining the real spirit of low-risk entrepreneurship.