Regardless of your level of experience along the real estate investor journey to wealth creation, making mistakes comes with the territory.
However, the more seasoned investors tend to make the least costly mistakes while the ones who really can’t as easily absorb mistakes, such as beginners, usually make mistakes that break the bank.
Whether your Airbnb real estate business is struggling right now in the midst of COVID and your looking for options, or you are just about to purchase your first property with your tax refund and stimmy check, the following list of pitfalls will equip you with a clearer path as you avoid common landmines hiding under the surface of real estate opportunity.
Pitfall #1: Buy Low
The biggest mistake real estate investors make is paying too much for a property. Many real estate investors forget that their profits are not made when they buy, but when they sell. Getting property at a good price is how to make money in real estate.
If you start at a high purchase point, your return on investment will suffer because the property will appreciate very little; you may even suffer a loss on the property.
If you don’t get a good deal on the front end, you also will have a difficult time getting a reasonable return after all the carrying costs real estate requires.
Owning real estate requires many ongoing costs (maintenance, property taxes, etc.) relative to other forms of investment (e.g., stocks); you must be especially sensitive to the purchase price, as even a significant appreciation from the purchase price to the sale price can lead to a subpar return.
Some real estate gurus recommend not paying a penny over 40% of the after-repair-value (ARV) on a property. This is actually crucial to your success on a property because you’ll have 30% of the ARV that can be used on repairs and still be all-in at 70% of the ARV. That leaves plenty of room for a 30% profit on a fix and flip deal!
Pitfall #2: Failing to do the Homework on a Deal
To arrive at an accurate ARV, one must start be doing thorough research on a deal under consideration.
Before most individuals buy a car or a television set they compare different models, ask a lot of questions and try to determine whether what they are about to purchase is indeed worth the money. The due diligence that goes into purchasing a home should be even more rigorous.
There are also research considerations for each type of real estate investor - whether a personal homeowner, a future landlord, a flipper or a land developer. (If you're flipping houses, check out Fix It And Flip It: The Value of Remodeling, Five Mistakes That Make House Flipping A Flop and Top 5 Must-Haves For Flipping Houses.)
Not only must the prospective buyer ask a lot of questions about the home, but he or she 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 attracting a student renter.)
The following is a list of questions that would-be investors should ask regarding the home in question:
- Is the property built in the vicinity of a commercial site, or will long-term construction be occurring in the near future?
- Does the property reside in a flood zone or in a problematic area, such as ones known for radon or termite problems?
- Does the house have 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?
- What did he or she pay for the home and when?
- If you are moving into a new town, are there any problem areas in town?
Pitfall #3: Lack of Preparation
Longtime real estate investor Andy Heller, an executive with an international transportation and logistics firm and co-author of “Buy Even Lower: The Regular People’s Guide to Real Estate Riches,” says the biggest mistake new investors make is not having a plan. They buy a house because they think they got a good deal and then try to figure out what to do with it. That’s working backward, Heller says.
“First, you find the plan,” he says. “Then, you find the house to fit the plan. Pick your investment model, and then go find property to match that. Don’t find the strategy after you find the home.”
The problem is that most people look at real estate as a transaction rather than an investment strategy, says Doug Crowe, a Chicago-based real estate investor, developer and speaker who took a hiatus from his local real estate endeavors to work on his “dream project,” a private-island resort in Belize.
“People fall in love with a property,” says Crowe, who also founded a real estate academy for investors. “I say, ‘Who cares about the property?’ I fall in love with a motivated seller.”
Pitfall #4: Not Understanding How Financing Works
Real estate investors typically use debt for two reasons:
To expand their buying power.
Rather than spending $100,000 of equity on a single property, financing can allow that same $100,000 to go further by spreading it out among several properties with a smaller down payment on each property.
To improve returns.
If an investor is able to obtain debt at a lower interest rate than the net yield of investment, the levered return of the investment is higher than if it was paid for with cash.
Both functions of leverage may be very attractive, but obtaining debt does not come without its risks, which is what novice investors should be wary of.
Less experienced investors may take on expensive debt that charges a higher interest rate than the investment yields. In that situation, you will experience negative cash flow, as the net income of the real estate investment is less than the monthly debt service. Now you’re forced to take money out of pocket to make up for this shortfall in order to keep the loan current and avoid defaulting.
The best way to avoid this scenario is to crunch the numbers of a deal and confidently know that the property will generate enough revenue to cover the loan amount.
Pitfall #5: Falling Hard for a House Instead of a Deal
Once you've got your feet wet and become a real estate investor, you'll wonder why you waited so long to begin. Now you'll face another problem - falling in love with your property. They've seen how well it is doing, cash flow has been going up each year, and they've fallen in love with their tenants (not literally).
Two big mistakes are made here. First, never fool yourself into thinking your property is doing well enough to sell or trade up because your cash flow is considerably higher than when you purchased the property.
The second part of mistake number 7 is getting so friendly with your tenants that you fail to maintain rental standards based on what the market will bear. This greatly hinders your growth potential.
Finally, allbusiness.com makes a great suggestion of mistakes to avoid in real estate investing – arguably, the single most important factor.
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