Understanding these pitfalls will be most useful for beginning investors but even experienced investors benefit from an occasional reminder.
Pitfall #1: Thinking You’ll Get Rich Quick. Andrew Carnegie (among the richest people of all time), once said “90 percent of all millionaires become so through real estate investing.” You too can be one of those millionaires. But don’t start out thinking you can buy a property tomorrow and be set for life. Jumping in without knowing what you are doing is the wrong way and you will lose your shirt.
How to Avoid: Spend at least a weekend or a week of your life studying different ways to invest in real estate. Everything you need to get started is free on the internet. Start by googling, “how to invest in real estate”. You’ll find thousands of sources of information. To begin, look for lists giving a short explanation of several investment methods. Don’t fall for the first one that says you can double your investment in 30 days – you won’t. Start learning investing terminology like passive income, active income, and return on investment. Pick three or four investment strategies that interest you. Deeply research those specific strategies. You may eventually want to buy an inexpensive book that organizes the information for you. But it’s all available for free if you’re willing to spend the time. Do a little networking with investing professionals at local investing clubs or send questions to blogs on the internet. One thing you want to learn quickly is if the current real estate market works well with the strategy you are considering.
Pitfall #2. Not Sticking to Your Criteria. This can be a two edged sword. Some people are overly reluctant about committing to a deal. They do all of their homework but even when they have a deal meeting their criteria, fear prevents them from pulling the trigger. The other edge of the sword is when an investor has money to invest but the right property isn’t currently on the radar. In the excitement of the moment, they consider lowering their criteria to buy what is immediately available rather holding off for the right deal.
How to Avoid: You need to have criteria that defines when a deal is acceptable and when it is not. The criteria will be different for different strategies. And the criteria may vary depending on market conditions. Still, there needs to be minimum criteria regardless of market conditions. Using check sheets to compare multiple properties side by side is an effective technique. This enables investors to select the best deal when two or more properties meet the minimum criteria. Be sure to pull the trigger when the criteria are met. Not finding the right balance between doing and not doing deals causes lost money, lost time, and frustration.
Pitfall #3. Trust, But Verify. It’s human nature for a seller to put their property in the best light possible. This should be your staring point but not your conclusion. Numbers like ROI and cash flow will not be the same for the seller as they are for the investor. Loans against the property and upgrades are only a couple of the variables that will make your numbers different from the seller’s.
How to Avoid: There are several ways to verify the property will perform as you anticipate. Having licensed professionals such as inspectors and appraisers review the property conditions is a good beginning. It is also a good idea to look up permits for any significant upgrades that have been made. As for the income potential, asking to review the seller’s income tax returns is useful. Also have an accountant review the seller’s numbers and create a pro forma financial statement based on your specific numbers and circumstances.
Pitfall #4. You’re Making an Investment – Not Buying Your Home. There are two mistakes you make if you become emotionally attached to a property. This is a slippery slope that can cause you to over pay or lower your decision criteria. And after you own it, it can lead you to investing too much in improvements to make it the property that you want to live in. You’re buying a return on investment. Not your own home.
How to Avoid: Don’t put in granite kitchen counters if your return on investment won’t match your investment criteria. The norm for the neighborhood determines your ROI. Having features that you personally want in your home is not part of your criteria.
Pitfall #5: Understand Both the Risk and Reward. Don’t only focus on obtaining the highest yield from an investment. This goes hand in hand with the other potential pitfalls. There is nothing wrong with investing in high yield properties but higher potential reward always comes with higher potential risk. Again, make sure the property meets your investing criteria and that you don’t overlook or overestimate important factors.
How to Avoid: To better understand the risk, don’t look at only the upside. Your calculations should include the worst-case scenario and if this still meets your criteria. If you’re considering investing in upscale properties requiring extensive renovations, be sure to consider how long the property will be a money pit without generating income. Also anticipate that once the property is market-ready that it takes longer to find high-end buyers or renters.
Pitfall #6. The Right Location. As soon as you have two or more investment properties the distance between them becomes a factor. It might not be a big deal having two properties on opposite sides of the same city that you need to manage but when they are in two counties your ability to check on them regularly becomes compromised. When your inventory of investment properties reaches 10 or more units distance can become unmanageable. When properties are in multiple states you have to deal with different regulations, LLC registrations, state tax filings, and other time consuming issues.
How to Avoid: Start investing in local communities that you know well and can access easily. Before stepping up to owning distant properties, understand the additional costs in time and money. You’re going to need to work with professional property managers, accountants, and occasionally lawyers. This needs to be part of your revised investing criteria. At least staying within one or two states is more manageable than investing from coast to coast.
What is your investing pitfall advice? Please leave a comment. If you have a question that might interest other readers or a suggestion for a future article please submit ideas to [email protected].
Author bio: Brian Kline has been investing in real estate for more than 35 years and writing about real estate investing for 10 years. He also draws upon 30 plus years of business experience including 12 years as a manager at Boeing Aircraft Company. Brian currently lives at Lake Cushman, Washington. A vacation destination, a few short miles from a national forest. With the Pacific Ocean a couple of miles in the opposite direction.