In the late 1980s, my wife, Kim, and I began investing in small, single-family homes. When it was time to move on to bigger properties, we purchased a six-unit apartment building in downtown Portland, Ore.
We paid only $105,000 for the building, and the owner allowed us to put very little down and carried the note. It was in a rough area of Portland, which is why the price was so good, but Kim and I were convinced that the area would clean itself up as Portland grew.
Today, almost 20 years later, the building is still in a bad area. In our panic to get people into the apartment building, we didn't screen potential tenants very well. We didn't run a credit check nor did we require a criminal background check. After the building was filled, our real problems began.
The Friday Night Fights
One night, as Kim and I were finishing dinner, a police officer called and asked one of us to come to the apartments. When I arrived at the building on a warm summer night, I found the tenant from unit No. 4 hanging over the balcony yelling at the tenant who lived below him in unit No. 1.
I approached the officer who had phoned and asked him what the problem was. Chuckling, the young policeman said, "The guy who lives upstairs is a transvestite."
"Oh." That was all I could think to say.
"And the woman who lives below him is a hooker."
The officer continued: "...and the argument is about who is better looking."
Chuckling out loud, I asked, "And who's winning the argument?"
"I can't really tell," said the officer. "The guy upstairs is older, so he's pointing to a picture of himself in full drag when he was younger. And the hooker is strutting her stuff right here on the street, claiming to be younger and hotter. I might have to arrest her for indecent exposure if she takes any more off."
A crowd was gathering, with people looking out their windows or standing in the street watching. Apparently, it was much more entertaining than anything on TV.
Eventually the argument stopped, and a few months later the prostitute moved on.
Things Heat Up
Shortly thereafter, a young single mom who wanted to move into the building gave me a sob story about how she was down on her luck and couldn't come up with the security deposit.
Feeling sorry for her and her two kids, I bent my own rules and rented her the apartment that had just been vacated by the prostitute.
Three weeks later, the fire department called to say that there was a fire in one of my units. Arriving on the scene, I was informed that the young mother had built a fire on the floor of the apartment to keep warm.
That fire nearly ended my career as a real estate investor. I was so fed up with real estate, tenants, and property management, I almost considered investing in mutual funds.
The Rich Get Lawyers
Many novice real estate investors soon quit the profession and invest in a well-diversified portfolio of bonds. That's because, when you invest in real estate, you often see a side of humanity that stocks, bonds, mutual funds, and saving money shelter you from.
I'm not talking about only the poor tenants, either. Some of the worst tenants I've encountered have been affluent, well-educated people. In fact, in my experience they're often the worst.
Many times, instead of simply picking up their phones and calling the onsite building manager to handle a problem, these folks call their attorney (who's invariably on speed-dial) and threaten a lawsuit first.
Instead of quitting real estate with this building -- which we considered -- Kim and I sought out advice from professional real estate investors. We're glad we did: Some of the lessons we learned from the fiasco at the six-unit apartment house have made us very rich.
Three Simple Rules
As I've said many times, mistakes are designed to make you rich. Three of the priceless lessons Kim and I learned from this experience are:
1. Decide if you're going to be a slumlord or landlord.
One way some investors make a lot of money is by collecting the rent but not fixing or maintaining the building. Over a number of years the property deteriorates, as do the tenants. The owner then puts the property up for sale at a distressed price, hoping a true landlord will come along and rehabilitate the project.
Today, one of the ways Kim and I increase our wealth is by looking for properties run by slumlords. We purchase them for a good price, rehabilitate them, get rid of bad tenants, bring in good ones, increase the rents (which increases the appraised value of the property), and borrow out the increased equity tax-free. Then we move on to look for more badly managed properties.
2. Decide if you're going to be a small-time manager or a big-time investor.
Another lesson we learned from professional managers is that it's not economically feasible to hire higher-paid, college-educated property managers if the building has fewer than 100 units. Put another way, we learned that if a building had fewer than 100 units, Kim and I were the de facto managers.
This inspired us to write a long-range plan that outlined how we would gradually buy bigger and bigger buildings until one day, we could afford to buy great buildings in great neighborhoods with 100 or more units.
It was a 10-year process. Today, we own over 1,000 apartment units and have well-educated professional management overseeing the properties. Managing your own property can be a full-time job. That's why we would rather pay people to manage our properties, which allows us to be investors.
3. Mistakes are good.
It's human nature to blame someone else for your shortcomings or upsets. I've met many people who have only horrible things to say about real estate and property management. I'm sure most stories are based, in some part, on fact. But mistakes are a part of life, and we learn by making them rather than avoiding them.
For example, a friend of mine recently purchased a 120-unit apartment house as his first real estate investment. He never asked Kim and me for any advice -- even after he found out we'd passed on purchasing that same complex.
His first real estate investment is now eating him alive, and as a result he says all real estate is a bad investment. He blames everyone for his mistakes. But as I'm fond of saying, "The word blame stands for ‘be lame.'"
Today, his 120-unit slum continues to deteriorate as it sits on the market. As a result, it looks like a better investment for Kim and me every day.