5 Investing Pitfalls

5 Investing Pitfalls

Investing in real estate can be a lucrative and rewarding opportunity, but it also carries risks and pitfalls that can lead to costly mistakes. In this article, we will discuss some of the common mistakes that property investors make and how to avoid them.

Not Doing Enough Research:

One of the biggest mistakes that property investors make is not doing enough research before buying a property. It is important to research the market, the neighborhood, and the property itself thoroughly to make sure that it is a good investment. Harvard Professor Arthur Segel suggests that proper real estate analysis means that the product, the people, the capital markets, and the external environments need to be thoroughly examined.

In this case, the product is the property that is for sale (whether commercial or residential). The product has many factors that are critical to profitability such as location, infrastructure, condition, and how well it matches the market demand. To become profitable, the property needs to match the investor’s expectations physically, geographically, and financially.

In a real estate deal, almost every interaction with consultants, sellers, and officials becomes a price negotiation. Having a good existing relationship, professional negotiating skills, and conversational prowess will pay off (literally!) when your connections result in exclusive deals and discounts. If you aren’t good at interacting with a variety of people, the real estate investment market might not be a great fit for you.

When analyzing the external environment, consider factors that are beyond your control and can greatly affect the property. Is there a single local business or attraction that brings in residents or vacationers? What would happen to your rental if that business shut down and the local demographic shifted dramatically? Is the location of the rental susceptible to natural disturbances like flooding, tornados, or fire? When you are investing money into a property, try to reduce the number of external factors that negatively impact the property and reduce income or resale potential.

Capital market agreements are unique for each property buyer, but primarily the options are either to take on debt (mortgage) or to pay upfront (equity). Depending on the amount of money set aside to purchase the property, the amount of money needed upfront, the extent of repairs or updates required, and the expected rate of return it might make more sense to take on debt than to exhaust cash flow. In other cases, it would be wise to avoid debt and use existing resources to purchase a property.

Overpaying for a Property:

Another common mistake that investors make is overpaying for a property. This can happen when investors get caught up in a bidding war and act on emotion instead of using sound reasoning. When submitting an offer, be prepared to analyze a counteroffer and set a solid figure that you refuse to go beyond (at risk of reducing the return on your investment). If you are unsure of your ability to negotiate with a level head, utilize the professional consultants at your disposal. Contact a property attorney, real estate agent, or even a business partner who will navigate the negotiation without the emotional investment.

Ignoring the Condition of the Property:

It is important to carefully inspect the property before buying it to make sure that there are no major issues that will be costly to repair. Some investors make the mistake of buying a property without fully inspecting it or underestimating the cost of repairs. A current trend in the housing market is to rush through the process of making an offer by cutting corners and waiving inspections with the hope of snagging a property before a competitor does, but this method can be detrimental in the long-term. If there are any unforeseen problems with the property the investor might need to perform various costly improvements and the property will sit vacant until those improvements are completed! Anyone who has done construction recently knows that projects can drag on for any number of reasons including the high demand for contractors, backlog of building supplies, and low employment levels among inspectors and government permitting offices. We don’t suggest ever purchasing a property while waiving the right to a formal inspection by a licensed inspector (not your handyman!).

Not Considering the Potential for Rental Income:

Another mistake that investors make is not considering the potential for rental income when selecting a property. It is important to look at comparable properties and rental rates in the area to make sure that the property will generate enough rental income to cover expenses and make a profit. Bigger Pockets reminds us that a seller’s job is to represent “pro-forma facts” to any potential buyer. The seller will create an appealing picture of what the rental income could presumably be, whether or not this is truly a market reality! It is the buyer’s job to analyze the true state of the rental market, compare local properties, and examine the cost vs. income to see what kind of profit they would truly be making from the investment. If you want a guide to analyzing a deal, consider reading “Real Estate by the Numbers: A Complete Reference Guide to Deal Analysis” by J. Scott and Dave Meyer. This book will walk you through the various metrics needed to analyze your finances and evaluate any potential investment property.

Not Having a Clear Investment Strategy:

It is important to have a clear investment strategy before buying a property. This includes setting goals, determining your budget, and deciding on the type of property you want to invest in. Without a clear investment strategy, it can be easy to get sidetracked and make costly mistakes. Market trends can be captivating and can seemingly promise heaping financial rewards, but they tend to carry increased risk. By creating a plan that mitigates risk and promises steady financial gain, an investor can predict income over time and avoid the pitfalls that come from making quick decisions based on trends and groupthink. If you struggle to create a clear investment strategy and stick to it, consider using “Buy, Rehab, Rent, Refinance, Repeat: The BRRRR Rental Property Investment Strategy Made Simple” by David Green as a guide!