Whether you buy and flip houses, own a lot of rental property or just dabble in real estate, investing in real property is appealing when the housing market is strong. Like anything, though, there’s a right way and a wrong way to go about it.
Bankrate spoke with established, full-time real estate investors and professionals to identify the common traps into which real estate investors fall. Here’s what we found:
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1. Planning as you go
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.”
Determine what you’re willing to pay. The number is the number, and you don’t go above that, Crowe advises. It’s best to have lots of activity and make offers on multiple properties. Then you don’t care which one you get, as long as the numbers work out in your favor.
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2. Thinking you’ll get rich quick
Eric Tyson, co-author of “Real Estate Investing for Dummies” and a former personal financial adviser, blames “self-appointed gurus who have infomercials and make it sound so easy to get rich in real estate” for leading people to think investing in real property is an easy, fast way to make tons of money.
It’s a good long-term investment, but so is putting your money in a mutual fund, which is a lot easier. “These gurus don’t talk about all that hard work. You have to be smart, you have to be willing to work, and you have to understand your risk tolerance,” cautions Tyson.
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3. Not having the right people around you
A key to success is building the right team of professionals. Good relationships with at least one real estate agent, an appraiser, a home inspector, a closing attorney and a lender are key, both for your own deals and to assist with financing for prospective buyers.
In the remodeling and maintenance segment of the business, the team includes a plumber, an electrician, a roofer, a painter, a heating and air-conditioning contractor, a flooring installer, a lawn maintenance service, a cleaning service and an all-around handyman. You can’t build a business as an investor if you’re spending all your time fixing leaky faucets and putting up ceiling fans.
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4. Paying too much
Heller says the biggest reason investors don’t make money is simple: They pay too much for the properties. “The profit is locked in immediately once the investor buys the property,” he says. “Due to mistakes in the analysis, the investor pays too much and then is surprised later when he doesn’t make any money.
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5. Not doing your homework
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You wouldn’t be qualified to perform heart surgery without years of education and training. Yet, many wannabe real estate investors don’t think twice about diving into the business without even cracking a book. Educate yourself before you put your financial security on the line. Read as much as you can and look for a local chapter of the National Real Estate Investors Association, which has speakers that cover a multitude of topics, such as buying foreclosures and screening tenants.
If you can’t find a local chapter, find out who owns a lot of rental properties in your area, call that person and offer to pay for an hour or two of his or her time to find out whether this is a good career for you.
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6. Ducking due diligence
Investors often have to move very quickly on their deals. This is where a lot of newbies trip up, says Houston-based real estate adviser and government relations consultant Laolu Davies-Yemitan. They don’t do their due diligence about the deal, the costs or the market conditions, the current mortgage rates, and they wind up draining their personal savings because the house needs extensive repairs or they can’t sell it.
“Sometimes, new investors are buying property just based on the idea that the property is going to appreciate,” he says. “Usually, they don’t have any information to substantiate that.”
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7. Misjudging cash flow
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If your strategy is to buy, hold and rent out properties, you need sufficient cash flow to cover maintenance. “People think they can get a property manager,” Tyson says. But many have never interviewed a property manager and have little idea about how one works.
Most managers, for example, are reluctant to take on one single-family home or a duplex, he says, preferring larger complexes, and fees of 8 percent to 12 percent of the monthly rent are common. “It’s a huge expense,” Tyson says. “I can put my money in a mutual fund and it costs a half-percent a year.”
Davies-Yemitan agrees. It’s not uncommon for a property to sit on the Houston market for several months before it’s leased, he says. Meanwhile, the owner has to pay the mortgage, the taxes, the insurance, the cost of advertising and homeowner or condo association dues, he says. If the owner hasn’t budgeted for that, an asset can quickly become a liability.
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8. Lowering the volume
If you’re working on one deal at a time, Crowe says, you’re doing transactions, not running a business. You need a steady pipeline of prospective deals; sufficient volume will weed out the marginal deals and let the good ones rise to the top.
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9. Not having backup plans
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Many people buy a property and get stuck with it because they have only one exit strategy. They’re going to sell it or they’re going to rent it out. What if it doesn’t sell? What if the rental market stalls? Always have two ways, if not three, to get out of any deal.
For example, if plan A is to rehab the house, put it on the market and resell it, then plan B could be to offer a lease-purchase to a buyer. Plan C might be to hold the house and rent it out. And as a plan D, there is the wholesale option, which would involve selling to another investor at a below-market price. Hopefully, you’ll still make a profit, but at the very least, you’ll cut the losses you’re taking every month in carrying costs.
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10. Miscalculating estimates
Crowe tells his new rehabbers that after they’ve done their homework, they should double the amount of time and money they think it will take. If they can still make money, it’s a good deal.