When my students ask me a question about how to start investing in real estate, I tend to respond with a question of my own:
“How much savings does your personal budget generate each month?”
Yes, I know. It’s so annoying to answer a question with a question.
This particular question usually leads to a double dose of annoyance from my students.
My students are first annoyed that I ignored their question about real estate. They didn’t come to me to talk about something boring, like budgeting. They want to know about the exciting stuff, like becoming a real estate investor.
What I’ve noticed is that after this initial annoyance fades away, another form of annoyance sets in. My students get annoyed because they can’t actually answer the question.
They realize they have no idea how much money they’re saving each month because they don’t have a personal budget.
That’s a problem.
Not having a personal budget is a problem for anyone who wants to be a successful real estate investor.
Investing in real estate means running a business. Money comes in and money goes out. To be successful, you have to make sure that more money comes in than goes out.
This is obvious stuff, right?
The same logic applies to your personal budget: if you want to get ahead in life, more money needs to come in than goes out.
The problem is most people have a hard enough time managing their personal finances. How are they going to handle managing business finances?
That’s why I ask my students, “If you haven’t mastered this idea with your personal budget, are you sure you want to take on the stress and risk of an investment property?”
It would be much easier to simply invest in an index fund, like VTSAX. At least in that case, you don’t have to manage a business budget. You just have to do your best to constantly add money to your investment account.
It’s usually around this point when my students start nodding in understanding.
Before investing in real estate, make sure your personal finances are in order.
My goal here is not to dissuade you from investing in real estate. I am a big proponent of rental property investing.
I’ve said it before: I think every professional or lawyer can benefit from owning rental properties.
My only goal is to help you avoid the mistakes that crush so many beginner real estate investors. One of the biggest mistakes I see is people taking on a major financial commitment (and time commitment) without starting from a strong foundation.
If you’ve been following along on the blog, you likely noticed the progression in topics we’ve covered.
You’ll see links to each one of these topics featured on the top of the Think and Talk Money homepage:
We initially covered each of those topics in order from top to bottom. First, we talked extensively about the mental side of money. Without having your money mindset in the right place, nothing else matters.
We then spent a lot of time talking about personal finance fundamentals, like budgeting, saving, and handling credit and debt responsibly.
Only after having our personal finance foundation in place did we talk about more fun concepts like investing and real estate.
There’s a reason we’ve covered these topics in this order.
If your money mindset is not in the right place, you won’t be able to stay on budget.
If you can’t stay on budget, you’ll likely fall into debt.
When you’re falling deeper and deeper into debt, it doesn’t make a lot of sense to prioritize investing.
Why bother with real estate if any profits are just going to disappear?
Let’s focus on that last point for a minute.
What sense does it make to invest if you’ve never proven to yourself that you can use those investment gains responsibly?
I never want to see people take on the challenge of investing in real estate just to have any profits disappear because they don’t have a strong personal finance foundation in place.
Imagine someone does the work to find and sustain a good rental property that generates $1,000 per month in cash flow.
It’s not easy to earn that much. It takes time and effort, not to mention the risk involved.
If that same person blows the $1,000 he earned on things he doesn’t care about, what was the point?
Why take on the risk and do the work if the money will all be gone by the end of the month?
Unfortunately, this is how many people go through life. They work hard, make good money, and then have nothing to show for it.
I don’t want that to be your fate. I want you to have a plan for your money before you earn it.
That means sticking to a budget that consistently moves you closer to living freely on your terms.
Most of us don’t know where our next dollar is going.
The reason most people never get ahead with their finances is because they don’t have a plan for where their next dollar is going.
Their income hits their checking account, they spend it on this or that, and pretty soon that money has disappeared. They haven’t used the money to advance any of their priorities. It’s just gone.
To me, this is one of the most important money mistakes that we need to fix right away. We definitely need to fix it before we take a chance on investing in real estate.
If not, you’ll just be making the same mistakes, just with more money to lose.
Having a plan for our money, before we earn it, is essential if we want to reach our goals. With a plan, we can eliminate the disappearing dollars with confidence that our money is being used to serve our purposes.
How do you create a plan for your money before you earn it?
You need to have a budget.
If you don’t currently have a budget that results in excess money at the end of each month, I encourage you to start there before thinking bout real estate.
How to create a Budget After Thinking.
The key to budgeting is to eliminate disappearing dollars by creating a plan for Now Money, Life Money, and Later Money.
Your Later Money is what you’ll eventually use to accelerate your journey to financial freedom by investing in stocks or buying real estate.
1. Now Money
Now Money is what you need to pay for basic life expenses.
These expenses include housing, transportation, groceries, utilities (like internet and electricity), household goods (like toilet paper), and insurance.
These are expenses that you can’t avoid and should be relatively fixed each month.
2. Life Money
Life Money is what you are going to spend every month on things and experiences in life that you love.
This bucket includes dining out, concerts, vacations, subscriptions, gifts, and anything else that brings you joy.
We can’t be afraid to spend this money. This bucket is usually what makes life fun and exciting. The key is to think and talk so you are spending this money consistently on things that matter to you.
3. Later Money
Later Money is what you are saving, investing, or using to pay off debt.
This bucket includes long term goals, such as retirement plan contributions (like a 401k or Roth IRA), college savings for your kids (like a 529 plan), emergency savings and paying off student loan or credit card debt.
This bucket also includes any shorter term goals, like saving for a wedding or a downpayment for a house.
Most fun of all, this bucket includes any investments you make to more quickly grow your wealth, like investing in real estate or the stock market.
Later Money is the key category that fuels your ultimate life goals, like financial independence. The more you fuel this category, the faster you can reach your goals.
When you have strong fundamentals in place, money becomes fun.
Being good with money doesn’t have to be stressful. Once you have the fundamentals in place, you’ll start to see how each dollar you earn gets you one step closer to financial freedom.
Before you think about investing in real estate, make sure that your personal finances are in order.
Owning rental properties means running a business. When the money comes in, you want to make sure it doesn’t go right out.
Otherwise, the effort, stress, and risk of owning real estate is not worth it. Any dollar you earn is likely to disappear as quickly as it comes in.
To prevent that from happening, establish good money habits before you buy real estate.
In the end, you’ll be so happy that you did.
For any real estate investors out there, did you jump in before establishing strong personal money habits first?
What advice would you have for beginners thinking about investing in real estate?
Let us know in the comments below.
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