Failing to Make a Plan
The first thing to do is make a plan. Because 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 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 multi-family property? Vacation rentals? Mixed-use, commercial, or office buildings? Figure out your purchase plan, then look for properties that fit that plan.
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.
Not only does it make sense to ask a lot of questions about the property, but you should also inquire about 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 be occurring 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 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?
Doing Everything on Your Own
Many buyers think that they know it all, or that they 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. A list of potential experts should, at a minimum, 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.
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 that comes up for sale.
Overlooking Tenants’ Needs
If you intend to purchase property that you’ll rent, you need to 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.
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 (ARM) 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.
Overpaying
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 a too-high 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 becomes bogged down or fails, the odds are in your favor that there’s another house out there that will meet your needs. It’s just a matter of being patient in the searching process.
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 add in 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 the home, improve it, and resell it.
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.