10 biggest mistakes of novice investors

4 min read

Real estate has become the tech stock of the 2000s, the darling investment that everyone seems to think will be his ticket to easy wealth. And why shouldn’t investors be snapping up cute little cottages? After all, mortgage rates are low and the housing market is hot. How hard could it be? Slap on a new coat of paint, put some flowers in pots by the front door, put a “For Rent” sign in the yard, and start counting the cash.

It’s a popular notion. The National Association of Realtors reports that nearly a fourth of all the houses sold in 2004 went to investors; about 80 percent of investment properties are existing single family houses.

If they’re looking for rental income — and most investors are, according to the NAR — buying a single-family house may be the first mistake. All it takes is for a property to sit vacant for a couple of months — or a tenant to run out on the lease — to put a new real estate investor in a financial bind. Far better to buy multifamily units, such as duplexes.

That way, you can live on one side and have the rent from the other side pay your mortgage. Or, rent out both sides and give yourself some breathing room in case one tenant moves in the middle of the night without paying his rent.

“I’m not a proponent of single-family units,” says John Anthony, president of the Pennsylvania Association of Mortgage Brokers. “A first-time investor should look at (multifamily units of up to) four units to limit their risk.”

If you’re still convinced that investing in rental real estate is the road to riches, at least go into the proposition with your eyes, as well as your wallet, open. Here are 10 common mistakes made by new real estate investors:

1. Falling in love with the property.
Stop thinking like a homeowner and start thinking like a business owner, says Robert J. Hill, a Nashville-based investor and author of ” What No One Ever Tells You About Investing in Real Estate.” Get emotional about the deal, not the house.

2. Not performing your due diligence.
This is more than just an inspection of the property, although that’s essential. (Can you say, “deferred maintenance costs”?) It’s also a thorough investigation of your area’s current rental market, says Gerald Marsden, a New York-based CPA who specializes in investment real estate. What are the vacancy rates and average rents for comparable units? What’s the average age of the rental housing stock? How is the neighborhood zoned? What are the government regulations about rental properties? Has City Hall approved new rental complexes nearby?

3. Forgetting the rule of home improvements.
It will always take three times the money and twice as long as you estimate to get a unit ready to rent. Or is that twice the money and three times longer? Either way, you need to build that extra cost into your expenses, Anthony says.

— Updated: July 21, 2005

4. Thinking you’ll get those low mortgage rates you see on TV. Those are for owner-occupied homes, says Bob Walters, chief economist for Michigan-based Quicken Loans. Investment property is considered a riskier loan and you’ll pay more in points and interest rates. Expect about an extra 1.5 points or half a percent more in interest rate. The credit standards also will be higher. “You don’t need perfect credit,” he says, “but if your credit is in the dumps, you won’t get the loan.” And you won’t get many low-down or zero-down-payment offers, either.

5. Not prescreening tenants. New landlords can get very excited about prospective tenants who show up, take one look at the place, hand them a cash deposit, and want to move in that weekend. Don’t do it, Hill says. When selecting renters make them fill out an application, and check their credit, employment and rental history before you take a dime from them. It’s a much more expensive — and potentially nasty — headache to evict a bad tenant than to have a unit sit vacant for a couple of months.

6. Breaking your own rules. Landlords establish policies for good reasons. When they start ignoring those policies, they’re headed for trouble. No pets means no pets. Don’t ever let someone move in without a security deposit, and don’t ignore collecting late fees.

7. Investing long-distance. Unless your rental property is in a spot you love to visit regularly, such as a lake or the beach, keep your rentals very close to home, say New York-based real estate attorney Neil Garfinkel. Otherwise, you’ll eat up your profits by driving back and forth to manage the property or by paying someone to make repairs for you.

8. Paying too much for the property. If you’re embarrassed to make a low-ball offer to a seller, don’t invest in real estate, Hill says. Rental property owners generally work off a multiple of 100. That means that if you pay $100,000 for a unit, you need to collect $1,000 a month in rent to pay all the bills and have a decent profit margin. If you’ve done your homework, you’ll know what your rental market will bear.

9. Not studying the competition. Why does the guy across the street fill his units the same day someone moves out and yours sits vacant for months? He might not be very picky about whom he rents to, but he also might have lower prices, have washers and dryers in his units, pay for lawn maintenance and trash pick-up, or have his building on a wireless network.

10. Being underinsured. Insurance on rental property goes beyond insuring the building against fire or a hurricane. You need to look at your own coverage for liability, Garfinkel says. If there’s a loose railing and a tenant’s child falls off a balcony or there is a burglary and a tenant says it’s because you wouldn’t install security alarms, you’re likely to get sued.

— Updated: July 21, 2005