Real estate investing is a complex business with lot of variables. Many amateur investors end up making instinctive and illogical investing decisions. If you are new to the real estate business, learning from other people’s mistakes will hold you in good stead. In this blog post, we share 4 common mistakes that amateur real estate investors should absolutely avoid.
In order to be successful in any business, passion is important. Real estate investing is no different. Passion spurs you on to put your heart and soul into a business – and it keep you going in tough times. Passion also ensures that you do not slide into complacency once you taste success. Without passion it would be difficult to attend to a 3 am call from a tenant to fix a burst pipe. Don’t you agree?
However, as a real estate investor, it is important to balance your passion with logical reasoning. Simply relying on passion is a recipe for disaster. After all, you do not want to be the guy who ends up paying more than the ask price simply because your “gut told you to do so”. Such an emotionally driven approach can potentially lead to SERIOUS investing mistakes – the effects of which can take years and years to recover.
So, how do you know that you are making an emotionally driven investing decision? Asking these questions can help you –
If the answer to any of the above questions is a “Yes”, you better reconsider your decision.
Pro Tip – If you are unsure about the price that you are paying, we recommend keeping a tab on the property. If the property is overpriced, the seller is likely to reduce prices over a period of time. And you might be able to purchase your dream house without going over budget!
All successful real estate investors have one thing in common – they have their numbers on the tip of their fingers. Do you know your exact borrowing cost down to the last cent? What about your closing costs? Are you aware how much you can save via tax breaks? Ask any experienced real estate investor, and the answer is likely to be, “Why, of course”.
Follow these TIPS to get a sound grip on your numbers
Studying historical returns is a great way of setting your expectations straight. While past returns are not always an indication of future returns, this is a good starting point. For instance, McLean, VA is a much sought after area where average home prices are in excess of one million dollars. Due to poor affordability and over saturation, property prices have not appreciated by much in recent years. Folks are willing to put with the extra commute and stay in areas like Alexandria, VA. With some guidance, you can get easily get a great house in Alexandria, VA for $300,000 to $400,000. And not surprisingly, some zip codes in Alexandria, VA have witnessed double digit property appreciation in 2017.
In order to ensure that you do not end up overpaying for your investment property, we strongly recommend that you ask a trustworthy real estate agent to prepare a thorough Comparative Market Analysis (CMA). A CMA can vary from a concise 2 page report to an exhaustive 50 page one. Sold Listings have the greatest bearing on a comp report. Active Listings and Pending Listings can also help you understand your local real estate market. Studying Cancelled Listings and Expired Listings can also provide some great insights – these were the listings that were priced way too high.
Pro Tip – While running your numbers, understanding loan amortization will really help you calculate the exact equity in your home.
Mix Inexperience and overconfidence and you have a certain recipe for disaster. Rookie investors, lured by the potential of making MORE money, end up over leveraging or over borrowing. So, while you can potentially make more money, you also have to contend with more tenants, more maintenance and more mortgage payments. And this can have serious repercussion in a downturn.
In order to understand the repercussions of over leveraging, let us consider two scenarios –
Scenario #1 – No Leveraging
Let us presume that you put in $100,000 of your own money to buy a single property. This property nets you a gross rental yield of $1,000 per month. Now, let us presume that rental market goes kaput and you are unable to find a tenant for 3 months. What happens? You lose 3 months of income which is $3,000. But because you have not borrowed any money, you do not have to worry about anything else apart from maintaining your property.
Scenario #2 – Over Leveraging
So, in this scenario, let us assume that you decide to opt for leveraging. So, being the over optimistic and hopeful investor that you are, you decide to purchase multiple properties and retain only 20% equity in each property. You borrow the rest.
Adopting this strategy, you are able to purchase 5 properties priced at $100,000 each. You borrow $80,000 for each property – or a total of $400,000. Assuming a 30 year fixed traditional loan and a mortgage rate of 5%, your monthly mortgage payment comes to $2,690.
As long as you are enjoying 100% vacancy, you can sit pretty. You can collect $5,000 in rent per month. Deduct the monthly mortgage payments and expenses, and you can still take home a tidy amount every month. However, what happens if your occupancy level drops to 2? The rent that you take home drops to $2,000 per month. And you still need to make your mortgage payment and pay for expenses. If you have over stretched yourself, and not set aside an emergency fund, you shall be a fix.
This is another common mistake made by rookies who are high on confidence. Like most businesses, in order to get attractive returns, sometimes you need to take calculated risks. But this requires knowledge, skills and experience. So, this might mean buying a HUD home, flipping it over and selling it for a tidy profit. It is true that a poorly maintained property in a sought after neighborhood is apt for the “fixer upper” model. But inexperience and poor decision making can cause lot of things to go wrong. For instance, not opting for a thorough inspection can result in underestimating the cost of your repairs. This can leave you saddled with an overpriced property – and sometimes you can lose your shirt and everything else that goes with it. A trusted and capable real estate agent can put you in touch with inspectors and contractors who can carry out your home remodel within budget, and without compromising on quality.
Apart from HUD homes, an able and experienced real estate agent can also guide you on how to make money by buying a short sale, USDA housing (if you love the countryside) or a REO house. If you are a bigger investor, an agent can help you buy out all condo units in a building – by doing so, you can do away with association fees and hence, push down your ownership cost.
Apart from property scouting and fixing a property, an agent can help you negotiate better prices while buying and selling. Good negotiation skills are built up after years and years of practice. An agent who is aware of market practices knows precisely when to let go and when to push on. For instance, in a cold real estate market, you might be able to negotiate and have the seller bear the closing costs.
Real estate agents are experts at spotting invisible factors that can have a huge bearing on negotiations. Is the closet half empty – The seller might have gone through a divorce recently? Is the house devoid of personal belongings – Maybe the seller is planning to move to another state or country for work purposes? Is the house inhabited by elderly occupants – maybe, over the years their children moved out and they need to downsize? It takes a trained eye to spot and decipher such information.
“Foolish Men learn from their Experience. Wise Men learn from Other People’s Experience”.