For inexperienced investors, it can seem like buying real estate is a sure-fire way to make money. If house prices have risen for years, all you need to do is dump money into a property and wait for the profits to roll in. Right?
Well, no. It's true that, other than a few burps along the way, the long-term trend for property prices is always up. But don't kid yourself. There are legitimate costs and risks associated with real estate investing. Some of these are less than obvious to a new investor and can trip you up.
Our first advice is to review these videos on real estate investing. Next, browse through a selection of books for real estate beginners for a quick primer on the perils. Here are the five most dangerous.
Not Investing in the Right Tools
One myth related to real estate investing is that you don't need special tools or skills to get started. This comes from familiarity. Most of us live in an apartment or a house and think we know how to spot a good one. And we “naturally” understand what a great area for investment looks like.
In reality, real estate is as complex as any other marketplace. Property investors don't need the same powerful prediction software that stockbrokers prefer. Still, a suite of lower-priced predictive tools isn't a bad idea.
A minimum toolkit includes a listing service subscription, accountant software, and a secure communication channel to keep the mischief-makers out.
Not Running the Numbers
Some investors fail to assess whether buying a particular property makes financial sense. This is an easy mistake to make. There are a variety of costs associated with property ownership. For the best chances of profitability, you must consider them all.
First calculate the mortgage, interest, taxes, insurance, repairs, ongoing maintenance, and other expenses. Compare this total to the estimated monthly rent you expect to receive. The goal is to have the latter exceed the former.
What you find might surprise you. Even in a strong market area, some properties simply don’t make financial sense. At any price.
Though a property may look like a great deal upfront, but don't stop there. Run the numbers as if you plan to hold the investment for at least five years. This might not be your plan, but market fluctuations often have different ideas. You need look no further than the present for an example. Analysts predict that, although home values went up 4.1% year-over-year in July 2020, they will fall -1.5% by July 2021.
Not Screening Tenants
A third common mistake made by newbie investors comes with evaluating prospective tenants. Without the financial stability and good character to meet monthly rent obligations, not much else matters. Problems in this area are often created by a poor understanding of how assets work. New investors tend to think that it is easy to evict non-paying tenants, but that isn't always true. State laws vary a great deal. Some, like California, make the process difficult and time-consuming. This can have a negative effect on a property’s long-term value.
The reality is that evicting a tenant can be hard. Even one causing permanent property damage must receive due process of law. If your property gains a reputation as a haven for undesirable tenants, word will get around. Trust us. Word always gets around. Expect that you’ll find it more difficult to secure tenants in the future.
The bottom line is this. It’s crucial to screen tenants efficiently. The perfect tenant is reliable, conscientious, and interested in occupying your property for a long time. Spend a few weeks researching potential tenants. This due diligence could save you thousands of dollars.
Not Keeping Cash Reserves
Unless you're Elon Musk or Jeff Bezos, you have a finite amount of money to spend on your first property. The tendency is to use it all. New investors want to buy the property that takes everything they have in the bank for max returns. The problem is there is nothing left to cover unexpected expenses.
Here's a tip. There will be unexpected expenses. There are ALWAYS unexpected expenses. If you can't pay for them, you're left with a property that you can't sell or rent. Its value will decline over time. This is the opposite of smart investing.
If you’re investing in distressed real estate, the need for cash reserves is obvious. But you should hold significant levels of cash reserves even if you want to buy new property. If you have to replace a roof or repair a foundation, that check ain't gonna be a small one.
For most investors, $20,000 in cash reserves is enough. This allows for necessary repairs but leaves an acceptable amount of breathing space. You don't want to take on more credit unless you have to.
Not Asking for Help
If you've read this far, you might not make this mistake. For some strange reason, new real estate investors sometimes resist investment advice.
Or at least fail to take it from the right sources. In today's hyperconnected world, it's hard to avoid opinions on the best way to invest in real estate. Everyone and their dog has a “surefire” plan to make a killing in real estate. You can’t fail to make money.
Here's the uncomfortable truth. You certainly can fail to make money, and it's not fun. At the risk of sounding trite, if a deal sounds too good to be true, there's a good chance it is.
It's not an unforgivable sin to take advice from professionals who stand to gain from helping you. That's the way the world works. Remember that not all who charge a fee are worth it. But it’s also okay to reach out to a trusted friend with your plans. It's at least another opinion. Or look for a mentor who has already been through the process you are embarking on.
The Bottom Line
New real estate investors should recognize that the market they want to enter is complex. It’s easy to make mistakes. Sift through all the advice you can get. Keep what makes sense. Discard the rest. Check out our beginner’s guide to buying investment property Real estate mistakes tend to be costly. Let's avoid that.