If you’re just getting started in real estate investing, don’t expect to become an expert overnight. Yes, it’s true that you can make money buying and selling properties. However, it takes knowledge, determination, and skill. It also helps to know some of the classic mistakes that others make when they start investing in property to help you avoid making them too.
Here is a look at eight of these pitfalls of real estate investing that can come back to bite you if you’re not careful.
Failing to Make a Plan
The first thing to do is make a plan. Because the last thing you want to do is buy a house without knowing how it will generate income or gains. When there’s a hot real estate market, it can be hard to resist buying frenzy. But it’s important that you do take a step back and plan accordingly, including for what to do if the market sours or your assumptions were wrong.
Before getting a mortgage or plunking down cash, you need to decide on an investment strategy. What type of house are you looking for, for example—one-family or multi-family, vacation destination or not? Figure out your purchase plan, then look for properties that fit that plan.
Skimping on Research
Before buying a car or a television set, most people compare different models, ask a lot of questions, and try to determine whether the purchase they are considering is worth the money. The due diligence that goes into purchasing a house should be even more rigorous.
Not only does it make sense to ask a lot of questions about the property, but you should also inquire about the area (neighborhood) in which it is located. After all, what good is a nice home if just around the corner is a college frat house known for its all-night keg parties? Unless, of course, you’re targeting student renters.
The following is a list of questions that would-be investors should ask regarding properties they are considering:
Is the property near a commercial site, or will long-term construction be occurring in the near future?Is the property located in a flood zone or in a problematic area, such as ones known for radon or termite problems?Does the house have a foundation or permit “issues” that will need to be addressed?What is new in the house and what must be replaced?Why is the homeowner selling?How much did the previous owners pay for the home and when?If you are moving into a new town, are there any problem areas in town?
Doing Everything on Your Own
Many buyers think that they know it all, or that they can close a real estate transaction on their own. While you might have completed a number of deals in the past that went well, the process may not go as smoothly in a down market—and there is no one you can turn to if you want to fix an unfavorable real estate deal.
Real estate investors should tap every possible resource and befriend experts who can help them make the right purchase. A list of potential experts should, at a minimum, include a savvy real estate agent, a competent home inspector, a handyman, a good attorney, and an insurance representative.
Such experts should be able to alert the investor to any flaws in the home or neighborhood. Or, in the case of an attorney, they may be able to warn you of any defects in the title or easements that could come back to haunt you down the line.
Forgetting That All Real Estate Is Local
You need to learn about the local market in order to make purchase decisions that are likely to help you turn a profit. That means drilling down on land values, home values, levels of inventory, supply and demand issues, and more. Developing a feel for these parameters will help you decide whether or not to buy a particular property that comes up for sale.
Overlooking Tenants’ Needs
If you intend to purchase property that you’ll rent, you need to keep in mind who your renters are likely to be—for example, singles, young families, or college students. Families will want low crime rates and good schools, while singles may be looking for mass transit access and nearby nightlife. If your planned purchase will be a vacation rental, how near is it to the beach or other local attractions? Try to match your investment to the kinds of tenants most likely to rent in that area.
Getting Poor Financing
Although the real estate bubble in North America ostensibly popped in 2007, there are still a large number of exotic mortgage options. The purpose of these mortgages is to allow buyers to get into certain homes that they might not otherwise have been able to afford using a more conventional, 30-year mortgage agreement.
Unfortunately, many buyers who secure adjustable or variable loans or interest-only loans eventually pay the price when interest rates rise. Don’t let that be you. Make sure that you have the financial flexibility to make the payments (if rates go up) or a back-up plan to convert to a more conventional fixed-rate mortgage down the line.
Ideally, you’ll start out with a fixed-rate mortgage or pay cash for your investment house so that you can avoid these problems.
Mortgage lending discrimination is illegal. If you think you’ve been discriminated against based on race, religion, sex, marital status, use of public assistance, national origin, disability, or age, there are steps you can take. One such step is to file a report to the Consumer Financial Protection Bureau or with the U.S. Department of Housing and Urban Development (HUD).
This issue is somewhat tied to the point about doing research. Searching for the right house can be time-consuming and frustrating. When a prospective buyer finally finds a house that actually meets their needs and wants, they are naturally anxious to have the seller accept their bid.
The problem with being anxious is that anxious buyers tend to overbid on properties. Overbidding on a house can have a waterfall effect of problems. You may end up overextending yourself and taking on too much debt, creating higher payments than you can afford. As a result, it may take years to recoup your investment.
To find out whether your dream investment has a too-high price tag, start by searching what other similar homes in the area have sold for in recent months. A real estate broker should be able to provide this information with relative ease (particularly with their access to a multiple listing real estate agent database).
But as a fallback, simply look at the prices of comparable homes on real estate databases or even in the local newspaper. Logic dictates that unless the home has unique characteristics that are likely to enhance its value over time, you should try to keep your bids consistent with other home sales in the neighborhood.
There will always be other opportunities. Even if the negotiation process becomes bogged down or fails, the odds are in your favor that there’s another house out there that will meet your needs. It’s just a matter of being patient in the searching process.
Consider your return on investment in making improvements—it may be hard to recoup your money on a high-end bathroom renovation if the house still has a leaky roof.
Every homeowner can attest to the fact that there is way more to owning a house than just making the mortgage payment. It’s no different, of course, for real estate investors. There are costs associated with yard upkeep and ensuring that appliances (such as the oven, washer, dryer, refrigerator, and furnace) are in working order, not to mention the cost of installing a new roof or making structural changes to the house. You also have to take into account insurance and property taxes.
The best advice is to make a list of all of the monthly costs associated with running and maintaining a house (based upon estimates) before actually making a bid on one. If you plan to have tenants, once those numbers are added up and you add in the monthly rent, you can calculate an ROI that will give you a better idea of whether the income will cover your mortgage and maintenance costs. This will tell you whether you can really afford the property.
Determining expenses prior to purchasing a property is also critical for house flippers. That’s because their profits are directly tied to the amount of time it takes to purchase the home, improve it, and resell it.
In any case, investors should definitely form such a list. They should also pay particular attention to short-term financing costs, prepayment penalties, and any cancellation fees (for insurance or utilities) that might be borne when the home is flipped in short order.
What Are Some Common Mistakes People Make with Real Estate Contracts?
Buying a property involves a contract that transfers the deed from the previous owner to the new one. That means you should have a professional real estate attorney look over it before signing — a mistake that some people make in order to try to save on fees. Incorrect or ambiguous verbiage can translate into losses if not caught before closing. Additionally, the property should be surveyed to make sure that the lot size and borders are correctly specified in the contract to avoid future disputes with neighbors or tax authorities.
Is it Worth Making a Lowball Offer on a Property?
If you don’t need to buy a specific property right away and can risk losing out to other potential buyers, a lowball offer may not be a bad idea even if it is a longshot. However, it may annoy the seller who could then ignore future bids that you make that are higher. It could also harm the reputation of the realtor submitting the offer on your behalf, if you are using one.
Is an All-Cash Offer Better than Getting a Mortgage?
This all depends. If you have the cash on hand, it may be smart to avoid the closing costs and interest associated with a mortgage, but then it may reduce your liquidity picture and could also present opportunity costs whereby that money cannot be used for anything else. IFor these reasons, especially if interest rates are low, it could make more sense to take a mortgage, especially if it is covered by the rents earned on the property.
The Bottom Line
The reality is that if investing in real estate was easy, everybody would be doing it. Fortunately, many of the struggles investors endure can be avoided with due diligence and proper planning before a contract is signed.