If you’re just getting started in real estate investing, don’t expect to become an expert overnight. You can indeed make money buying and selling properties, but it takes knowledge, determination, and skill. It also helps to know some of the classic mistakes that others make when they start investing in property, to help you avoid making them as well.
- People who are new to real estate investing tend to make several classic mistakes.
- It’s important to start with a buying strategy so that you can align your purchases with your long-term goals.
- Be sure to do your due diligence on the neighborhood and on the specific property that you intend to buy.
- Assemble a team of professionals, such as a real estate agent, an attorney, and a handyman, to help you succeed.
- Do a careful estimation of the costs, such as mortgage payments, insurance, renovation, and upkeep, to make sure you don’t overbid and can afford the property you bid on.
1. Failing to Make a Plan
The first thing to do is make a plan. The last thing you want to do is buy a house without knowing how it will generate income or gains. When there’s a hot real estate market, it can be hard to resist the buying frenzy. But you must take a step back and plan accordingly, including what to do if the market sours or your assumptions were wrong.
Before getting a mortgage or plunking down cash, you need to decide on an investment strategy. What type of house are you looking for? For example, are you looking for a single-family or multifamily property? Vacation rentals? Mixed-use, commercial, or office buildings? Figure out your purchase plan, then look for properties that fit that plan.
2. Skimping on Research
Before buying a car or a television set, most people compare different models, ask a lot of questions, and try to determine whether the purchase they are considering is worth the money. The due diligence that goes into purchasing a house should be even more rigorous.
There are also research considerations for each type of real estate investor—whether a personal homeowner, a future landlord, a flipper, or a land developer.
You should ask a lot of questions about not only the property but also the area (neighborhood) in which it is located. After all, what good is a nice home if just around the corner is a college frat house known for its all-night keg parties? Unless, of course, you’re targeting student renters.
The following is a list of questions that would-be investors should ask regarding properties they are considering:
- Is the property near a commercial site, or will major construction occur soon?
- What are the city’s plans for the area and neighboring ones?
- Has the area changed, or is it expected to see major changes in terms of demographics or household types?
- Is the property located in a flood zone or a problematic area, such as ones known for radon or termite problems?
- Does the house have foundation or permit issues that will need to be addressed?
- What major things in the house will need to be replaced (e.g., appliances)?
- What is the key reason why the house is being sold?
- How much did the previous owners pay for the home, and when?
- If you are moving into a new town, are there any problem areas in town?
- What is the proximity to key necessities, such as grocery stores, hospitals, and major employers?
3. Doing Everything on Your Own
Many buyers think that they either know it all or can close a real estate transaction on their own. While you might have completed several deals in the past that went well, the process may not go as smoothly in a down market—and there is no one you can turn to if you want to fix an unfavorable real estate deal.
Real estate investors should tap every possible resource and befriend experts who can help them make the right purchase. At a minimum, a list of potential experts should include a savvy real estate agent, a competent home inspector, a handyman, a good attorney, and an insurance representative.
Such experts should be able to alert the investor to any flaws in the home or neighborhood. Or, in the case of an attorney, they may be able to warn you of any defects in the title or easements that could come back to haunt you down the line.
4. Forgetting Real Estate Is Local
You need to learn about the local market to make purchase decisions that are likely to help you turn a profit. That means drilling down on land values, home values, levels of inventory, supply and demand issues, and more. Developing a feel for these parameters will help you decide whether or not to buy a particular property.
5. Overlooking Tenants’ Needs
If you intend to purchase property that you’ll rent, keep in mind who your renters are likely to be—for example, singles, young families, or college students. Families will want low crime rates and good schools, while singles may be looking for mass transit access and nearby nightlife. If your planned purchase will be a vacation rental, how near is it to the beach or other local attractions? Try to match your investment to the kinds of tenants most likely to rent in that area.
6. Getting Poor Financing
There are still a large number of exotic mortgage options, where the purpose of these mortgages is to allow buyers to get into certain homes that they might not otherwise have been able to afford using a more conventional, 30-year mortgage agreement.
Unfortunately, many buyers who secure adjustable-rate mortgages (ARMs) or interest-only loans eventually pay the price when interest rates rise. Don’t let that be you. Make sure that you have the financial flexibility to make the payments (if rates go up) or a backup plan to convert to a more conventional fixed-rate mortgage down the line.
Ideally, you’ll start out with a fixed-rate mortgage or pay cash for your investment house so that you can avoid these problems.
Mortgage lending discrimination is illegal. If you think that you’ve been discriminated against based on race, color, religion, sex, marital status, use of public assistance, national origin, disability, or age, there are steps that you can take. One such step is to file a report with the Consumer Financial Protection Bureau (CFPB) or the U.S. Department of Housing and Urban Development (HUD).
This issue is somewhat tied to the point about doing research. Searching for the right house can be time-consuming and frustrating. When potential buyers find properties that meet their needs and wants, they are naturally anxious to have the seller accept their bid.
The problem with being anxious is that anxious buyers tend to overbid on properties. Overbidding on a house can have a waterfall effect of problems. You may end up overextending yourself and taking on too much debt, creating higher payments than you can afford. As a result, it may take years to recoup your investment.
To find out whether your dream investment has too high of a price tag, start by searching what other similar homes in the area have sold for in recent months. A real estate broker should be able to provide this information with relative ease (particularly with their access to a multiple listing real estate agent database).
But as a fallback, simply look at the prices of comparable homes on real estate databases or even in the local newspaper. Logic dictates that unless the home has unique characteristics that are likely to enhance its value over time, you should try to keep your bids consistent with other home sales in the neighborhood.
There will always be other opportunities. Even if the negotiation process bogs down or fails, the odds are in your favor that another house out there will meet your needs. Just be patient in the search process.
Consider your return on investment (ROI) in making improvements—it may be hard to recoup your money on a high-end bathroom renovation if the house still has a leaky roof.
8. Underestimating Expenses
Every homeowner can attest to the fact that there is way more to owning a house than just making the mortgage payment. It’s no different, of course, for real estate investors. There are costs associated with yard upkeep and ensuring that appliances (such as the oven, washer, dryer, refrigerator, and furnace) are in working order, not to mention the cost of installing a new roof or making structural changes to the house. You also have to take into account insurance and property taxes.
The best advice is to make a list of all of the monthly costs associated with running and maintaining a house (based upon estimates) before actually making a bid on one. If you plan to have tenants, once those numbers are added up and you include the monthly rent, you can calculate a return on investment (ROI) for the rental that will give you a better idea of whether the income will cover your mortgage and maintenance costs. This will tell you whether you can afford the property.
Determining expenses before purchasing a property is also critical for house flippers. That’s because their profits are directly tied to the amount of time it takes to purchase, improve, and resell the home.
In any case, investors should form such a list. They should also pay particular attention to short-term financing costs, prepayment penalties, and any cancellation fees (for insurance or utilities) that might be borne when the home is flipped in short order.
What are some common mistakes that people make with real estate contracts?
Buying a property involves a contract that transfers the deed from the previous owner to the new one. This means that you should have a professional real estate attorney look over it before signing—not doing so is a mistake that some people make to try to save on fees. Incorrect or ambiguous verbiage can translate into losses if not caught before closing. Additionally, the property should be surveyed to make sure that the lot size and borders are correctly specified in the contract to avoid future disputes with neighbors or tax authorities.
Is it worth making a lowball offer on a property?
If you don’t need to buy a specific property right away and can risk losing out to other potential buyers, a lowball offer may not be a bad idea even if it is a long shot. However, it may annoy the seller, who could then ignore future bids you make that are higher. It could also harm the reputation of the real estate agent (if you are using one) who submits the offer on your behalf.
Is an all-cash offer better than getting a mortgage?
That depends. If you have the cash on hand, it may be smart to avoid the closing costs and interest associated with a mortgage, but then it could not only reduce your liquidity picture but also present opportunity costs whereby that money cannot be used for anything else. For these reasons, especially if interest rates are low, it could make more sense to take a mortgage, especially if it is covered by the rent earned on the property.
The Bottom Line
The reality is that if investing in real estate was easy, everybody would do it. Fortunately, many of the struggles endured by investors can be avoided with due diligence and proper planning before a contract is signed.