Why Are So Many Real Estate Investors Going Bankrupt?

They started investing in real estate 30 years ago... with so much hope for their future.

A rental house here, a duplex there... and soon they had a rental portfolio anyone would be proud of. They actively managed their properties and worked to make sure they were operating at peak efficiency.  Several years ago both the husband and wife retired from their day jobs and eased into retirement – funded by their rental income and social security.

This year they are filing bankruptcy and losing a majority of their properties to foreclosure.

This is not some made-up example... this is the story of one of my best friend's parents, and they are not alone.  In fact, 95% of the properties I've purchased have been foreclosures purchased from landlords who have failed and lost their properties in a foreclosure. Most of them, I would guess, will never again get into real estate investing.  They worked hard for years to build a financial future for themselves, only to see it come tragically crashing down around them – dashing any hopes for lasting wealth creation.

This begs the question: why? 

If real estate is as good of an investment as we all (on BiggerPockets) make it out to be... why do so many real estate investors fail?

Perhaps more importantly: how do I avoid this possibility in my own life?

This is the question that has been swimming around my mind for some time now. Each week on theBiggerPockets Podcast I ask our guest "what is it that sets apart successful investors from those who fail?"  I'm intrigued by this idea and scared that I may end up the same way. After all, as Mark Cuban famously said "everyone is a genius in a bull market."  Is that what real estate is? Do some people simply get lucky, and others not so? What are some of the trends that lead to this failure... and what are some trends that can minimize this risk?

I thought I'd take the opportunity to hammer out my thoughts here and get your feedback as well. Definitely jump into the comments below and let's talk.

Too Much Risk?
Let's talk about the elephant in the room first: risk.

Risk in inherent in every investment there is. After all, you know the phrase, "more risk, more reward."

However, there is obviously a tipping point where the risk becomes too great, as my friend's parents discovered. Perhaps it's over-leveraging properties by obtaining too many "low down" deals or maybe it's trying to buy too many, too fast. Maybe it's constantly refinancing the properties, pulling out all equity and investing it in more and more deals.  Whatever the reason for their bankruptcy, it's clear that the risk became too great and they lost.

As rock 'n roller Nick Cave sang, "if you're gonna dine with them cannibals; Sooner or later, darling, you're gonna get eaten . . ."

So how should someone prevent this?  Avoid risk altogether? Only invest in 100% safe deals?

Of course notRisk is required for entrepreneurs, but learning to navigate that risk will define your success. (Click Here to Tweet That Quote!)

Like a team of white-water rafters braving the wild waves, you can't always see what the future will hold, where the rocks hide just below the surface, or where the next waterfall will be.  However, by having the right people in the boat with you, keeping an eye out for potential dangers, working to avoid the problem areas, and wearing the proper life-saving jacket, you can avoid a premature death.

I would caution anyone reading this post, including myself, to think of risk as a dangerous, but powerful tool. Never forget that this tool cuts both ways.

Not Enough Education
Far too many people jump into buying real estate before understanding what they are doing. They simply decide that real estate is the right path, and they start buying properties. There is a big difference between being busy and being effective, and this is the case with a lot of real estate investors; they believe that because they are buying properties they are going to succeed. Never mind the fact that they bought the wrong property in the wrong area with the wrong financing.

The solution to this problem is proper education.

I'm not talking about the "Get Rich Quick" late-night TV kind of education. I'm talking about taking the time needed to build an educational foundation that can support your investing future.  At BiggerPockets, our mission is to help you build this foundation through a variety of methods, like theForums, the Podcast, the Blog, and more.

Furthermore, I encourage you to continue your education through books, meetups, and other low-cost sources. You don't need to spend tens of thousands of dollars to gain an education. Information has been democratized, so you simply need to reach out and grab it. No one can do it for you!

Not Enough Analysis?
When I first began investing in real estate I thought I knew what I was doing... but I made some big mistakes because I didn't do a careful enough analysis. Had I continued on that path, I would have been in the same boat my friend's parents are in.

You see, so many people buy properties without doing the right math. As I often say, "without the right math going into an investment, you'll never get the right profit coming out of it." (Click Here to Tweet That!)

The future is impossible to know, but with a solid analysis – it's much easier to predict. It's for this reason that I began to invest a lot of time and effort into building an in-depth spreadsheet that I could run all my potential deals through. Soon after, we took that spreadsheet, added a ton of new features, cleaned it up, and turned it into the BiggerPockets Property Analysis Calculators that hundreds of people are using every week to analyze their potential deals.  It's my hope that this tool will save tens of thousands of investors from making the same mistakes that millions of others have made.

No matter how you do your math, just make sure you are doing it – and doing it right.

Are You Working ON Your Business or IN Your Business?
Is real estate your investment or your hobby?

I believe one of the greatest reasons investors fail is because they don't treat their business like a business.

  • They never develop systems to help them as they grow.
  • They treat their tenants like friends.
  • They don't create clear policies for finding good tenants.

They simply approach their investing like a church picnic, and it shows.

If you want to avoid failing, treat your business the same way a CEO would look at a business, because that is what it is. Monitor your business' health, hire the right people to do the right jobs, and continually find ways to improve your bottom line and create a longer-lasting business.

Let's Sum Up
There are a variety of reasons that a real estate investor may fail. However, in my limited time on this planet, I've seen the above four mistakes played out time and time again in the lives of those who have failed in their investments. It breaks my heart to see someone so excited for what real estate could do – only to lose it all in a foreclosure or bankruptcy.

Don't be that person.

If you want to avoid losing all the hard work you are putting in (or the hard work you are about to,) pay attention to the four points in this article:

  • Understand that risk is a powerful but dangerous tool, so tread cautiously.
  • Build a solid educational foundation for yourself before getting in too deep.
  • Don't skimp on the math. Always understand the numbers for any property you buy.
  • Work ON your business, not in it. Treat your investments like the business that it is.

Questions? Comments? I hope you can add more to this discussion by sharing your thoughts below!

This article Why Are So Many Real Estate Investors Going Bankrupt? originally appeared on The Bigger Pockets and is Copyright 2014 BiggerPockets,

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Read/Post Comments (9) | Recommend This Article (19)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On August 17, 2014, at 8:44 PM, Investa wrote:

    All the properties we purchased over 30+ years ago are paid off. But between the taxes, water sewer, garbage and insurance that we pay there is really not much profit when you look at the vacancy rate today and the rents received. Of course this is in NJ where taxes and other town/ county charges are really incredibly high.

  • Report this Comment On August 17, 2014, at 11:29 PM, volcan357 wrote:

    Buying a property for rental purposes is complicated and a lot depends on location. However the obvious reason you might lose a property to foreclosure is too much debt. If you are just starting out it helps to be handy with plumbing, electrical, and construction in general.

  • Report this Comment On August 18, 2014, at 12:38 AM, fredjohnson55343 wrote:

    Several years ago I came to a crossroad. Invest in the stock market or start buying rental properties. I had a full time job so no time to do both. I picked the stock market. Studied relentlessly about it, investing, stocks, bonds, you name it. I'm so happy I went that route, especially after homes in my area lost 40% of market value and still haven't recovered to this day. My stocks however are up 150% from the lows and I put more dollars in when DOW was at 8000. My stocks are worth $4.5 million now. My own residence I bought in 2002 isn't even worth what I paid for it 12 years ago. Stocks forever for me.

  • Report this Comment On August 18, 2014, at 4:45 AM, plange01 wrote:

    until a failing america replaces the disgrace obama with a PRESIDENT the dying country's economy will continue to move toward a major collapse...

  • Report this Comment On August 18, 2014, at 11:06 AM, TexasAccountant wrote:

    Real Estate is like any other investment. My wife and I have been successful because we buy in a down market and make sure that the net rent provides a rate of return greater than 9%. Leverage can boost your return, but we are risk averse. We have 7 rentals (and recently sold 2 properties) but only one mortgage. Do the smart investors use more debt? Absolutely! However, the dumb investors do too. We have a system in which property managers look after our properties and I have usually never met my tenants. Our current net cash flow enables us to retire at any time. No investment is easy or a good fit for everyone.

  • Report this Comment On August 18, 2014, at 11:48 AM, SirDuude wrote:

    Too many people believed that you can't go wrong with real estate, and if you can't go wrong its best to leverage up as much as possible to create the largest portfolio you can. The problem with that leverage is it left no room for error. With the hyper-rise of 2005-2007 many got in too deep and lost it all due to their own greed.

  • Report this Comment On August 18, 2014, at 12:23 PM, barbershores wrote:

    From the article: "The solution to this problem is proper education."

    --------------------

    Real estate is a cyclical industry. There are times that investing in it offers great returns, other times/phases of the cycle, you are better off staying out. When one takes on a huge mortgage, that cash is at risk. So, rule number one, is to not take on that risk during a poor phase of the real estate market, LIKE THE ONE WE ARE IN NOW.

    So, I agree. Proper education is very important.

    Most of the people I know that were devastated in the real estate market recently, lost it all because their timing of the cycle was horrible. They bought and held as the market ran up when all the trashy mortgages formed a bubble. When it popped, they were stuck with big loans on properties that were now underwater. Then, the rates jacked up on their variable rates, and they could no longer make payments. Some held on with negative cash flows for quite some time until they finally threw in the towel and defaulted.

    Now is "not" the time to get into real estate. That is the best "proper education" you are going to get in real estate today.

    Just my opinion.

    Best of luck,

    Barbershores

  • Report this Comment On August 18, 2014, at 3:52 PM, Beney wrote:

    I have to agree to disagree with BarberShores.

    This is very much a great time to get into real estate; however, education will be key no matter when you decide to invest.

    One of my mentors makes this comparison: would let someone perform surgery on you after a 3-day surgery bootcamp? Would you raise money for medical school by performing surgery?

    Without education, any investor is at a supreme disadvantage.

    Experienced investors, especially, argue that since they've been doing it for decades they should be teaching classes instead of taking them. These are the same people this article is written about. They may know what they know quite well. The danger to them is what they don't know, or never "tripped" over and so never had to learn from those hard-knocks.

    There ARE alternatives to the real estate investment education "gurus" and their sell-a-thons... er, I mean "bootcamps". The Fool's Posting Guidelines prohibit me from mentioning them, unfortunately.

    Seek those alternatives - they ARE out there!

  • Report this Comment On August 18, 2014, at 4:10 PM, dragonmonkey wrote:

    Did I just read an advertisement for another web site disguised as an article? Feels like it...

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