You may be one of the many people who are interested in investing in residential real estate. Real estate as an investment has broad appeal and stories abound about people who claim to be “killing it” in real estate. On the other hand, how often do you hear about the people who are “getting killed” in real estate.
The reality is that not everyone who tries their hand at real estate investing does well with it. Some certainly do. Others just don’t. Minimizing mistakes is a key element in determining how well anyone in the real estate investing game will do. Just like managing people, not everyone who tries it is successful. Why? Because they’re either not cut out for it or they make too many mistakes.
It’s important to understand that successfully investing in real estate involves good timing, some brain power, having a personality/demeanor that lends itself to taking appropriate risks, access to money, access to good real estate deals (viable investment properties) and a little luck. Beyond these things, what are some specific things that can trip an investor up?
The list below doesn’t include everything you might encounter, but it’s what many consider to be a top ten “watch-outs” list of things you should at least be aware of as you think about building a real estate portfolio.
- Emotional buys. One of the hardest things to get newbies in the real estate game to understand is to not fall in love with sticks and bricks. Emotional buys in real estate can kill returns and place bad properties into a portfolio unnecessarily. Keeping emotion out of the process of finding and securing deals is critical. Emotional buying in real estate isn’t really much different than buying a car, for example. How many people fall in love with a vehicle and pay full list price for it without negotiating? It happens frequently with cars and with real estate. Just remember that the “buy” is critical in real estate investing because it factors into your returns in a big way.
- Failure to devote enough time to researching and vetting properties. Too many real estate investments are made with limited knowledge of the properties in question. It’s true that sometimes you have to act quickly to snag a hot property which means your time to evaluate it is limited. But there are certain steps you just can’t skip. It shouldn’t come as a big surprise that some investors cut corners in evaluating properties. Then when issues arise with the property, they become frustrated or suddenly realize that their returns are going to suffer.
- Willingness to accept low returns and/or little promise of acceptable appreciation. Sometimes when a property meets all of your criteria except potential return over the hold period (period of time you will own the property) it can be tempting to accept returns that aren’t worth the risk associated with owning the property. When an investor accepts a return profile that is materially lower than their threshold or what they can earn with their money elsewhere, they may be compromising overall returns and possibly hindering wealth building. Assuming you are trying to accumulate wealth with your various investments including real estate investments, being a little patient and careful about which properties you buy can make a sizable difference in how quickly you build the wealth you desire.
- Not understanding or not having return criteria. Suffice it to say that you should have return goals or guidelines at a minimum and one could argue hard and fast thresholds that you won’t deviate from at the other end of the spectrum. Without this sort of guidance, it’s easy to stray into subpar returns territory on too many properties.
- Underestimating capital requirements. So, you’ve seen ads and social media claims that tell you that no money is needed to invest in real estate. While it’s not necessarily impossible to buy properties with no cash down, the likelihood of making it happen is small. The reality is that many successful real estate investors start small with some cash they’ve saved or borrowed from family members or others. They understand that they will have to parlay the first successful acquisition into a second and the second into a third and so on. But, unless you’re flush with cash, this takes some time since you need to establish a track record of success in order to get your bank to continue to lend money on additional properties. Typically, leveraging properties through debt makes sense because it can increase cash-on-cash returns. But, banks are just a little funny about wanting to get repaid and they want to know that there is sufficient equity and/or you have enough non-rental income and reserves to be able to make loan and other payments related to the property (e.g., property taxes, HOA fees, insurance). In fact, there are certain down payment requirements on real estate investment properties that your bank will make you aware of.
- Underestimating costs associated with prospective properties. While related to point 5, this one is specific to a critical part of analyzing property viability. Most of the data/information on potential ongoing costs associated with a property are often readily available, however it’s not uncommon for inexperienced real estate investors to miss or underestimate certain expenses associated with owning and maintaining a property. Suffice it to say that more than one investor in real estate has missed the mark on projected ongoing costs only to be surprised later on by lower returns than expected.
- Overestimating total returns over the hold period. As mentioned, estimating ongoing direct property costs is relatively straightforward. But when you’re comparing different properties, there can be a somewhat wide disparity in how they will actually “behave” over the hold period (the length of time you own the property). Repairs and maintenance, for example, are part of this disparity since one property may need more of both given its current condition or quality of construction and installed equipment such as furnaces, air conditioning units, etc. while another may require far less since the property is newer, better maintained, had recent renovations, etc. Another key factor is appreciation potential. Some properties present better appreciation potential due to various factors including location, layout/configuration, condition, etc. So, for example, if you underestimate repair and maintenance expense and overestimate your projected annual appreciation rate as part of calculating a total return number over the hold period (number of years owned), you’ll potentially buy some properties that underperform relative to alternative properties.
- Failure to properly screen prospective tenants. In their haste to get a property rented, investors sometimes rush into a decision about to whom they rent. It’s important to understand that there are people you simply don’t want as tenants. Those people who may be very nice and warm may also have poor credit history or some other negative in their background that makes them a risky tenant. Tenant quality matters a lot in terms of overall returns.
- Not understanding liquidity risk. Liquidity simply refers to how quickly you can get your hands on your cash. If your financial situation is such that you’ll need access to cash quickly and the majority of that cash is tied up in one or more properties, you may not have access to enough cash in a timely manner. Certainly, you can try to sell your properties, but getting a property sold and closed can take time. Since life happens as they say, there may be times when you find yourself short of cash. So, the issue here lies in projecting what your cash reserves or ready cash needs are and ensuring that you don’t tie up too much cash in assets that aren’t readily liquid. Stocks, for example, require cash, but they can be sold within a day or two and the cash becomes available relatively quickly. Real estate is generally a much different story.
- Generally, not paying attention to details. Like any business venture, details are important. When buying and renting properties, attention to detail is important at every step. Too many landlords/property owners fail to dot i’s and cross t’s on various aspects of their venture into real estate investing. Keeping good records on every property is a great start. Include your purchase documents, rental and property management agreements, repair and maintenance invoices/records, HOA communication if applicable, etc. Details also relates to the property itself. Clean, well maintained properties often rent faster and at higher rates than those that are not. Clear communication with tenants, bankers, property managers, attorneys, and anyone else involved in your real estate investments is another critical detail you can’t overlook. Excellent follow up with tenants when there is an issue is another detail you can’t overlook. The point here is that details matter a lot and your degree of success may be significantly determined by how well you attend to them.
This quick hit list of potential mistakes made in real estate investing shouldn’t be ignored or minimized. Your success in real estate investing is dependent on a number of factors and you always want to put yourself in the best possible position to be successful. Being careless in real estate investing has taken down more than one newbie real estate investor and more than one seasoned investor. Don’t be that guy!