So, you’ve decided to invest in income-producing real estate for the first time. You have been burning the midnight oil and found a four-plex that has turned your head. You just know this is the right one. Boy, does it have chemistry: It’s in a great neighborhood and has recently been remodeled. You love the granite countertops, the quaker wood floors and vaulted ceilings. Oh, but it is a bit overpriced. Actually, a lot overpriced. Maybe you can get the seller to come down. If not, you will just have to raise the rents over time to achieve the cash-on-cash return you are looking for. You just have to own this property!
In writing my book on commercial real estate advice, I’ve identified the many mistakes that newbie real estate investors tend to make over and over. Here are the top six to beware of and avoid.
1. Falling In Love With A Property And Paying Too Much For It
The example at the beginning of this article illustrates the No. 1 mistake beginning investment property owners fall prey to: paying more than a property is worth because of its looks. Unless you are going to live in the property, which is unlikely, do you really want to give up your financial objectives and make an emotional decision? Isn’t this supposed to be an investment? Then start thinking of it as a new business that will need many right decisions to protect it.
There is no action you can take when purchasing investment real estate that is more important than buying it for the right price. Let’s go back to that four-plex example. You rationalize that the $950 per month average rents, although in line with market rents, can likely be raised by $100 over time to make up for overpaying by $50,000 for the property. It’s hard to believe, but it will take you over 10 years of those rent increases to make up for what you are overpaying.
2. Taking Shortcuts On Due Diligence
It’s easy to just take what’s in the marketing flyer as fact without verifying if some of it is fiction. It states that the property is being offered at a 6 cap, and that it is in great physical condition with outstanding tenants. But in reality, the financials show a 4.8 cap, which means it is overpriced. Furthermore, the property condition report indicates the roofs only have four years of useful life left, and after doing a rent collection report, you discover that some of the tenants are paying late or not at all. If you take the time to do all of your due diligence, you will catch things like these and will be armed with facts to negotiate a lower sales price prior to your due diligence period being up.
3. Not Buying In Your Own Backyard
This is a big one. When you are new to investing in real estate, it is especially critical that you have a hands-on approach to running the property — even if you have professional management. Do you really want to drive four hours or more — or worse, have to book a flight — to check on your investment? How will you know if the reason why units are not renting is that a tenant has unsightly junk stored on their patio, or the lawn is brown? Buying close to home also means you can use local professionals you know and trust to help you buy the property and oversee it.
4. Not Knowing Your Objectives Before You Go Shopping
You would be surprised how often first-time income property investors do not know at the beginning their objectives for the investment. Do you want to buy close to home, or out of state? What is the minimum return on your cash investment that is acceptable? How long do you plan on holding the property? How much can you afford to put into renovations? And can you add managing this property and overseeing it on top of everything else you have on your plate? Answer these questions at the start to get clear on your objectives.
5. Not Estimating The Cost Of Value-Adds Correctly
Say you’ve found an apartment building that has under-market rents because the interiors are dated. You get a ballpark quote of $5,500 per unit to replace the appliances, cabinets, fixtures and floor coverings, and your accepted offer is based on this. After closing, you can not find a contractor who can do it for less than $9,000 per unit. This reduces your cash-on-cash return from 8% to 5.5%, and now you are tearing your hair out for buying this property.
6. Not Applying For The Right Loan
Before getting involved in the loan preapproval process, be aware of what prequalification questions to ask the loan officer for the borrower and the property to make sure both qualify at the beginning. Your mission is to prevent something like this from happening: Just before your offer is accepted you find a great loan with a 30-year fixed rate of 4.5% and a 30-year amortization. You apply for this loan. Two weeks before the drop-dead date in your purchase contract, the loan is denied because your net worth does not meet the lender’s minimum requirement. Whoops! Why didn’t the bank check this out before they started the loan? Now the only loan you can qualify for that can close on time is private money at 8%.
When you find an investment property you like, take the time to look beyond its looks, investigate its credentials, make sure it’s not too far away from home to make surprise visits, know what your goals are for this investment, estimate the cost of renovations accurately and make sure out of the gate that you are going to qualify for the loan you apply for. Believe me, you will sleep better at night.