Chapter Five
The Investor Mentality
Some sophisticated real estate investors are big believers in the Law of Attraction—the idea that people can attract good and bad things into their lives by virtue of their positive and negative thoughts. Others will tell you that success comes strictly from hard work and honesty, and still others will tell you that in real estate, as in life, what goes around comes around. When I hear investors debating these ideas, I think of that song, Funny the Way It Is, by the Dave Matthews Band. That song reminds me that life is complicated; and people have different opinions because they've had different life experiences. What all these philosophical positions have in common is the idea that if people are successful in real estate, it is because they set out to be successful.
This is what investment insiders call the “investor mentality”—and it is essential to building a successful portfolio. Strategic investors do not wander into grey areas and they certainly never break the law; they would never be associated with people who do. They maintain healthy relationships in their personal and professional lives because they value the people they've chosen to hang out with. They put little stock in good luck, but are big believers in hard work.
I've always enjoyed philosophical discussions about real estate investment because I think they help investors take a critical look at where their businesses are and whether their present focus still fits their long-term goals. A long-term perspective is important for those who want to make a plan for where they want their businesses to go. In sum, successful real estate investors run businesses that follow proven systems. They learn how to let economic fundamentals guide their business decisions and are careful to make decisions based on market information rather than emotion. They invest for long-term wealth creation and for future financial security. Does this mean real estate investment, done right, is a sure thing? Obviously not.
Success is a Habit—Beware of the Sasquatch!
This notion of successful real estate investment as the thinking person's business is essential to what I teach. You do not need to know everything there is to know about real estate investment before you buy your first revenue property. You can, however, learn almost everything you need to know to protect your downside and increase your chances of an upside. Success is a habit—and habits begin when you decide what you will do.
I have often heard that investors haven't bought because they are stuck in analysis paralysis. That tells me that they are getting in the way of their chosen investment system. Strategic investors know that there is never a perfect property. Beginners without a system to guide their analysis are often stymied by the search for one perfect, risk-free, no pain opportunity. This is what I like to call the Sasquatch—because while many have heard about it, but no one has seen the beast in real life.
The really good news is that both the knowledge and the mentality required to be successful in real estate investment can be obtained. Then, once the knowledge and strategies are known, they can be practised until they become habits.
The truth is that real estate investing is a serious business, and without successful habits, you risk a lot of money, pain and potential bankruptcy. With good habits you can position yourself and your family for long-term financial success. That is why you must either do it right, or don't do it at all. As you develop your habits you also start honing your intuition for deals and the skills to close them. In other words your investor mentality begins to take shape. In the beginning you should aim to use a proven system and research, mostly gleaned from other sources, to:
Overcome Self-Doubt
To be a real estate investor, one must learn how to overcome self-doubt or defeat a lack of confidence, both of which are toxic to the evolution of the investor mentality. One cannot make success a habit if you never put smart investment strategies into practice. But confidence, in and of itself, is not enough! You must have confidence not only in yourself (many people have that), but in the direction you are taking (cash flow real estate investing) and confidence in your system.
According to Peter Kinch, one of the country's leading mortgage-education professionals, confidence, credibility and integrity (CCI) are the factors that separate those who want to be sophisticated real estate investors from those who really are successful investors. Peter is the author of the bestselling book, The Canadian Real Estate Action Plan: Proven Investment Strategies to Kick Start and Build Your Portfolio, and he has discovered that one group wants while the other group acts.
I offer that information with one major word of warning: there is a difference between having confidence in your system and making decisions based on ego. The kind of false confidence that's based on ego has been the downfall of many an investor. As success begins to be created, some ego-boosted investors forget about the system that got them there. They start to believe that it's all about them and that they are smarter than the market. This is when portfolios begin to go off the rails. Once the ego kicks in, decisions are no longer based on the due diligence and analysis that helped create their success. Instead, decisions now follow an I-know-better thought process. Let's be frank. Real confidence is not self-delusion.
The Credibility Factor
The confidence component is easy to understand. Real estate investors apply their own initiative, skills and team members to every business problem they encounter, and they use that combination to build a solid investment portfolio. The actions they take today directly affect their financial security tomorrow.
Entrepreneurs obviously need a certain amount of self-assurance, and the best kind of self assurance comes from knowing what they're talking about. Credibility comes from their expertise, their experience and their track record. That is what makes individuals credible as real estate investors. Their actions are in direct contrast to the Big Talkers (who talk a lot so that they don't have to answer questions). In the end, credibility is a measurable commodity, which is directly driven by an investor's track record in real estate as well as their consistency in the following actions. Credible real estate investors:
Live with Integrity
How you run your life, your business and your investments is a choice. By operating from a place of integrity, you act consistently from a foundation of honesty, empathy and respect. Integrity is a lynchpin that binds a sophisticated investor's business together. With it, the business is strong and can weather winds and storms. Without it, the business and its owner's reputation can crumble into nothing.
Your integrity is directly affected by the integrity of those around you. You can live your life with 100 per cent integrity. But if the partners, mentors, team members or friends in your life do not share that commitment to doing the right thing, people outside your circle will begin to assume that you are the same as the company you keep. That may not seem fair, but it is how the real world works.
In sum, credible business people who act with integrity are the kind of people who can act with confidence because they have a well-developed habit of saying what they mean and then doing what they promise. People who act with integrity gain a reputation for being credible and that reputation, combined with proven actions, leads to confidence. Remember to build your investment business on all three: confidence, credibility and integrity. Acting together you get the business equivalent of a three-legged stool. Take away one or two of those legs and you're doomed to fail.
Fear is Not the Enemy
So how does someone who is new to this business overcome self-doubt and a lack of confidence? What about investors who find themselves plagued by self-doubt as they encounter turbulence for the first time or are confronted with wave after wave of what appears to be very bad news about the economy?
First, understand that fear is not your enemy. Fear keeps us from stepping off ledges when blindfolded and from jumping into choppy waters when we are not wearing a life jacket. What would make those two activities okay—and maybe even fun? Information and the tools to protect yourself and reduce the risk of harm.
The same logic applies to real estate investment. Fear is solidly and deeply rooted in the unknown. You do not borrow large amounts of money without knowing how it will be paid back. Applying that logic to other aspects of the real estate investment business, you also don't hire a lawyer to write a joint-venture agreement if she's never written one before. Similarly, you don't let tenants move into a rental property before their applications are properly vetted.
Do you see where I'm going? Having a system that forces you to ask the right questions, no matter what scenario you are entering, is critical to building confidence. Even long-term, successful and strategic investors have moments of self-doubt and few people will be able to eliminate negative thoughts entirely. This is why the investor mentality, and the system that supports it, are paramount.
The system helps the investor, whether she is new or experienced, to ask the right questions and get the answers she needs to hear. Instead of letting self-doubt hold them back, the investor mentality will propel them—and their portfolios—forward.
In reality, fear dissipates as proper information is gathered. Because the strategic investor is guided by a system, he knows what information to look for and where to find it. He also knows that gathering ineffective or irrelevant information bogs down the decision-making process, adds to analysis paralysis and compounds the problems caused by fear and hesitation. That's right: quality information strengthens the investor mentality and your CCI index!
Balance Risk and Reward: The Role of Due Diligence
No amount of confidence, even when accompanied by credibility and integrity, can erase the fact that all types of investments have risks as well as potential rewards. Someone with an investor mentality recognizes those risks, analyzes them without emotion and then works to mitigate them. Unsophisticated investors get themselves in trouble by blindly (or willfully) taking actions that ignore the risks. Others err when they fail to take action because they freeze in the face of perceived risks. Strategic investors know that it is critical to complete detailed due diligence on all aspects of their business. They work through their fear because their system tells them what they need to do, and their investor mentality keeps them on track for success.
The System
Real estate, when done correctly, can provide long-term financial results along with the occasional home-run profit that accrues from equity appreciation. Investors who manage their business without a system to guide them will find themselves chasing the short-term money while ignoring the long-term wins. With bases loaded, a walk delivers a run. Striking out while attempting to hit a grand slam delivers nada.
The system I use to keep those bases loaded is called the Authentic Canadian Real Estate (ACRE) system. Designed to focus on cash flow and yield, ACRE also positions investors to take advantage of any potential home-run opportunities. That has worked well for so many Canadian investors because it addresses and mitigates risks by forcing investors, rookie and veteran alike, to think before they act. Because they know what a real estate portfolio based on long-term sustainable wealth looks like, they take the specific action. These investors:
- choose a region, then a neighbourhood and then a property;
- decide who they need on their team before they hire;
- carefully vet tenants before they move in; and
- line up joint-venture partners before they have a property deal in the works.
This business-like approach teaches investors to respect risk. In baseball, a home-run king's record often features an enormous number of strikeouts, too. The same applies in real estate. If investors always focus on large potential equity appreciation, their chances of losing increase dramatically. Instead of positioning their portfolios to survive a market downturn, these non-strategic investors risk all of their future wealth by relying on a giant value increase as their only profit centre!
This sophisticated strategy views investment success as a habit, not luck. Keep hitting singles and doubles and, every once in a while, you'll pop one over the fence.
In sum, sophisticated investors follow a system that values checklists, consistent action and teamwork. This strategy respects the fact that a proven system is organic and matures along with the investor (because everyone gets better with practice). At its core, this system-based approach allows for geographic adjustments without compromising its basic structure. What works for an investor in downtown Toronto will not necessarily work for an investor in Fort McMurray or Halifax—but the fundamentals used to decide what properties to buy will never change!
Of Death and Taxes
The sophisticated investor's focus on long-term wealth also yields tax advantages because he pays strategic attention to the taxable difference between income and capital gains. Investors who chase after the big hits (where an increase in value is the only profit potential) will find themselves unable to claim capital gains for tax purposes. This income will be taxed at the highest rate possible. Remember: people who make a profit pay taxes. But it is not how much money you make in a deal—it is how much you keep that matters.
Instead of riding a speculative roller coaster and surviving its peaks and valleys of profit and loss, sophisticated investors follow a sustainable system that saves them time, grief and money. They let the system do most of the work!
Value the Due Diligence Process
Due diligence is considered useless work by many speculators, especially those swinging only for home runs. What they don't understand is that profits are always the product of the diligence process. I, too, used to think that it was my lawyer's and realtor's responsibility to make sure the property was right. Boy, was that a mistake! It cost me a bundle, not only because I was on the financial hook to fix the problem that my own due diligence should have revealed, but also because I overpaid for the property in the first place.
Those experiences taught me to value the due diligence process and helped me to develop a systematic approach. This includes a checklist that I use to this day (and have shared in the ACRE system). As outlined in earlier chapters of this book, ACRE's lasting strength lies with how it helps investors assemble the pieces of the whole. The due diligence portion is designed to force you to look carefully at each and every property. This keeps you from buying a property that eventually becomes more hassle than it is worth. As a matter of fact, successful investors use a system whether they are buying their first or their hundredth property.
Let's look at how easy this can be. Say you want to buy a piece of property. You know, through media stories, that a particular city is economically strong and marked for steady improvement. Still, you're bothered by the naysayers. They exist in all market conditions and your job is to learn how to get to the truth instead of reacting to opinion. Instead of allowing someone else's negative or positive comments to dictate your actions, you decide to investigate the situation yourself. You apply the ACRE program and start investigating. You then talk to others who are already investing in the region (a good place to find them is at the community forums at www.myREINspace.com), and they tell you they use 10 economic fundamentals to analyze the direction real estate values are poised to take in a target area.
Those 10 fundamentals are the foundation of Chapter One. To recap, they cover passive economic fundamentals (mortgage interest rates; changes in average incomes; increased in-migration/demand; the ripple effect; local, regional and provincial economic climate; transportation corridor expansion; and gentrification) and the active economic fundamentals (creating highest and best use; buy wholesale, sell retail; quality marketing). When you make these economic fundamentals part of your system, you confirm their role in the decisions you make. You do not need to have every fundamental work in your favour, but if the passive fundamentals are working against your business, expect trouble.
First Step: Information and Analysis
Sophisticated investors would consider analysis of these fundamentals as the foundation of their due diligence program and, in fact, their real estate investment business. They know that even when a majority of the 10 fundamentals overwhelmingly favours real estate investment in a particular area, this data only skims the surface of the buy and sell decisions they need to make. Once they identify a community or city where real estate investment appears to make sense, they drill deeper.
Knowing that a successful investor makes money when they buy the right investment property (and loses money when they buy the wrong one), they focus their due diligence on figuring out if a property works for their portfolio. Using REIN's All Properties Due Diligence Checklist, they then apply their investor mentality to find out the facts specific to the property.
You can quickly see that a review of the specific property comes second in line for strategic investors. Armed with solid data about the local economy and real estate market, the system helps them make sure they do not sugarcoat the property analysis. They are honest with themselves about deferred maintenance repairs, appliance purchases, renovation costs, taxes and what they can do to increase rent. They fill out a REIN Property Analyzer to ascertain whether monthly rent surpasses monthly expenses. If it does not create positive income (no matter how great the property looks), they go elsewhere. The investor mentality remains focused on annual cash flow and yield as opposed to acquiring a property that takes money out of their pockets every month with only the promise of a potential property value increase. In terms of portfolio growth, quality beats quantity—every time.
Second Step: More Due Diligence
As part of that focus on annual cash flow and yield, sophisticated investors continue to follow their system. The quality of the acquisition, rather than the speed with which it is acquired, is what matters most.
In addition to learning about when and where to buy, the savvy investors cultivate relationships as part of their due diligence. They get to know realtors who are knowledgeable about specific geographic regions and property styles, and are interested in working with investors. Many realtors prefer not to work with investors, but a select group understand that it is more profitable to work with people who buy properties more often than homeowners who buy and sell a property once every five years, on average.
Strategic investors also line up their proposed lenders in advance of finding the property and they analyze their sources of down payment (whether it's their own capital, joint-venture money or from a line of credit) and closing costs. This preliminary work takes the pressure off the transaction and allows them to act quickly when the proper deal is uncovered. The opposite is often true for the non-strategic investor. These individuals focus on the property first. When they find a property they want, they find themselves under substantial and unnecessary stress as they try to line up all of the pieces to make the deal come together. Too many wild cards exist in the purchase process to nail down after the property is found. No wonder non-strategic investors are often identified as struggling investors!
It must be said that roadblocks exist at nearly every turn in the real estate investment process. But few are real surprises. Sophisticated investors get used to encountering roadblocks and manage the obvious ones in advance. When confronted with the unexpected, they look behind the curtain to solve the problem so they can get on with their business. They find out how to fix partner credit or financing issues (and in the future, they check them out first!). They take the data generated by the property appraiser and complete their own cash flow analysis. They credit their system for helping them make sure a deal doesn't close until after they have all of the information they need to make an informed decision.
A sophisticated investor mentality demands that one take responsibility for one's own due diligence at every stage of the investment process. Landlord–tenant relationships are complicated. Lease-to-own and joint-venture deals require legally binding agreements the investor can turn to if lessees or money partners decide they want out of a property early. Again, a quality investment system compels the investor to take these steps. No flying by the seat of their pants. It also acknowledges that skipping steps is the same as willfully adding risk. I always have checklists and stick closely to proven systems for all aspects of the business. Follow my example and your brain is free to be ultra-creative in structuring deals that build your portfolio. Checklists don't box you in. They are catalysts for creativity.
Short-term concern over a vacant rental suite does not lead a sophisticated investor to deviate from a diligent selection process. Tenants can be thoroughly vetted. Leases can spell out exactly when and how rent is to be delivered and what happens if it is late. The specific terms of move-in and move-out inspections can be laid out in advance. The eviction process, which protects your investment, should be planned in advance. If the details of how to put any of these points into action elude you, make it your business to replace your ignorance with information. (The Authentic Canadian Real Estate System, as detailed in my book Real Estate Investing in Canada 2.0: Creating Wealth with the ACRE System is a good place to start. REIN's home study course, Landlording Secrets: The Definitive Tenant and Property Management System, is another. The latter spells out your due diligence with templates like the Renovation “Rent Ready” Checklist, Instant Rental Approval Form, Landlord's Hospitality Checklist for New Tenants, Basic Residential Lease Agreement and much more!)
Remember: the investor mentality views tenants as our customers. This changes the dynamic between you and the tenant and you find ways to make the relationship work over the long term.
Beware the Powerful, Unfounded Motivators
New investors sometimes confuse my enthusiasm for their early successes with my position that investors must take emotion out of their decision-making process. So let me be clear: real estate investors should celebrate their acquisitions and their sales. This is a long-term journey to success, so don't wait until the end to celebrate your achievements. Give yourself and your team that proverbial pat on the back for accomplishments along the way. Following a system isn't designed to take the glory out of life. It is meant to add freedom, so the journey is more enjoyable and ultimately more successful financially.
Fear and greed are the emotions the system is designed to mitigate. Fear stems from ignorance and it can lead investors to buy the wrong property (What if one gets away?), accept the wrong tenants (What if that property sits vacant?) or change an exit strategy because they fear losing a co-venturer or because they can't sleep at night because they're haunted by naysayers who are convinced the real estate sky is about to fall on their heads.
Sophisticated real estate investors understand that fear is a powerful motivator. It is also easy to recognize, because the action it dictates cannot be traced back to one's investment system.
Greed is more complicated—and just as dangerous. Fear encourages us to doubt our investment system and take risky actions, even though all of the checklists and analyses say we should not do what fear encourages. Instead of analyzing the facts dispassionately, we act as if the facts don't matter.
Here, the facts don't matter because there is no way to measure what the investor knows to be true. At the height of the real estate boom in 2006 and 2007, I heard Canadian investors make statements such as the following:
- “Sure it has negative cash flow, but I'll make money when I sell.”
- “Buy high, sell higher. This market can't go down.”
- “Cheap is good. I don't need classy tenants.”
- “I can always find a buyer for my properties.”
These are not the statements of sophisticated investors with a healthy and wise investor mentality. They are the statements of speculators. Speculators make money, but at what cost of added risk? They also lose money when they hit an economic bump on the road (and there will always be bumps!).
The Importance of Following Through
The investor mentality helps investors understand that problems need solutions. Real estate investors take responsibility for finding the solutions that work for their portfolio, rather than complaining about their situation. Guided by the data gleaned from the due diligence outlined in their investment system, they effectively train themselves to make success a habit—and that's what following through is all about. Will you make mistakes? For sure (and I certainly did). But if you understand why you're investing in real estate you will also stay the course, learn from your mistakes and profit over the long run.
In sum real estate investment is a thinking person's business and it demands action. But this is not rocket science and you do not need to qualify for Mensa or have a university degree to do incredibly well. As investors acquire experience and expertise, they will: