The 5 Most Common Mistakes By Real Estate Investment Beginners
Nowadays, everybody wants to get into real estate investing, but it’s not as easy as we’re shown on TV and elsewhere. Whatever your goal is in real estate, you are going to face many challenges and making mistakes is inevitable.
Here is a fantastic snippet of an article by Holly Johnson over at The Simple Dollar discussing the most common mistakes new investors make in the real estate world:
#1: Forgetting the Home Inspection
Jensen says some buyers might be willing to forgo a professional home inspection to get a deal to go through. This is always a mistake, she says, since a home inspection can reveal all the repairs you’ll need to make and plan for. How can real estate investors properly run the numbers if they aren’t sure how much they’ll need to spend on repairs? The answer: They can’t.
Not only that, but it’s possible you could get the seller to cover some of the repair costs during the negotiation process. However, this is only possible if you know what’s wrong to begin with.
Jensen suggests walking through the home with the inspector to ask questions as they move from room to room. “Continue asking until you’re satisfied that you understand what they’re saying,” she said. While a home inspector won’t be able to give you estimates for repairs, they can often let you know approximately how much you’ll pay.
You can use this information to determine whether a property is worth investing in, or whether you should cut your losses and run.
#2: Not Running the Numbers
This leads us to another common mistake rookie real estate investors make. Sometimes would-be investors get so excited about buying a property they forget to formally vet the deal.
Not every property will make a good investment, says Jensen, and some properties don’t make sense at any price. For that reason, you have to sit down and run all the numbers to decide if a property is worth investing in.
At the bare minimum, you have to estimate mortgage payments, taxes, insurance, upfront repair costs, ongoing maintenance costs, and other expenses and compare them to the estimated market rent or sale price you’ll receive for the property.
And don’t forget to tally up and consider every expense you’re likely to encounter. “Not accounting for all expenses is the most frequent problem,” said Jensen. “Excluding vacancies and capital expenditures are the worst offenders.”
You will have a vacancy at some point, and not accounting for a month of lost rent every year (or every few years) can blow your entire profit. The same is true for big expenditures like a new roof, a new HVAC system, or a water heater.
#3: Failing to Properly Screen Tenants
If you’re investing in real estate to become a landlord, you’ll want to have a plan in place to vet and screen tenants who apply for your rental. Jensen says it can be difficult to spot potential problem tenants since bad renters won’t tell you their shortcomings upfront.
“No one is going to approach you as a tenant and say, ‘I’m not going to pay rent after the first month, and I’ll throw diapers in the toilet and punch holes in the walls,’ yet this happens far more often than you’d think when you don’t screen your tenants.”
Jensen says you should run credit checks as well as criminal background checks on prospective tenants. In addition, you should watch out for “red flags” that could signal you may have a problem. Some things to watch out for include:
- Tenants who want to move in right away: “While not always a bad thing, it can mean someone is getting evicted,” said Jensen. “It’s also a sign of very poor planning on their part, and people who plan poorly for large things like a move will also tend to plan poorly for smaller things like paying rent on time.”
- Wanting to pay upfront for a year: Jensen says this is a huge red flag for a few reasons. First, it may mean they want to do nefarious things in your property and don’t want you around. Second, it means they could be bad with money and may want to pay you ahead of time while they have some, possibly from an inheritance or some other type of windfall.
While vetting tenants is a crucial component of any landlord business, real estate investor Shawn Breyer of Sell My House Fast Atlanta says it’s also important you don’t unknowingly discriminate against tenants.
“To avoid lawsuits from the Federal Housing Administration (FHA), you will need to tread carefully when managing a rental property so that you don’t unknowingly discriminate against tenants,” he said. “There are the obvious protected classes; race, color, religion, sex, and national origin. The two that new landlords accidentally discriminate against are age, family, and disabilities.”
If you have questions about when you can deny an application from a potential renter, Breyer says to seek out an attorney in your state.
#4: Not Having Enough Cash Reserves
We mentioned how you should always run the numbers when you invest in real estate, but it’s also important to make sure you have cash on hand to pay for big expenses you anticipate (e.g., a new roof or HVAC system) — and the surprise expenses you couldn’t predict if you tried (e.g., renters destroying your property).
According to Breyer, even if you recently renovated the property and you haven’t had any issues in a year, you should still be setting money aside. He also says this is one lesson he learned the hard way. He and his wife purchased a duplex as their first rental property and renovated it from top to bottom. Since everything was new, they thought they could relax and avoid pricey repairs for a few years. Boy, were they wrong.
“A year into the ownership, we were notified that the city was coming out to do a routine inspection to check out the property condition,” he says. “After the inspection, they sent us a three-page list of items that needed to be addressed, ranging from rewiring and replacing the roof down to replacing outlets and fixtures.”
In one month, they had to replace half of the roof, replace a furnace, install a new water heater, install a sump pump, and rewire the whole garage. The grand total turned out to be $13,357.
The important lesson here is that you should always set aside money for vacancies, repairs, upgrades, and surprise expenses. While there isn’t a hard and fast rule that dictates how much you should save, some landlords say setting aside 10% of the annual rent could be sufficient. Obviously, you may need to save more if you have larger expenses and component replacements coming up in the near future.
#5: Getting Advice from All the Wrong Places
When you first start out in real estate investing, it can seem like everyone has an opinion. Cornelius Charles of Dream Home Property Solutions in Ventura County, Calif., says one of the biggest rookie real estate mistakes you can make is taking these random opinions to heart.
“As we all know, people are more than willing to give their advice, no matter how good or bad it might be,” he says. “The last thing you want to do is to buy a rental property because your real estate agent says it will make the perfect rental without running the numbers and doing your own due diligence.”
When it comes to taking advice from people who have never invested in real estate before, take any “words of wisdom” with a grain of salt. The same is true when you’re getting advice from someone who might benefit from the sale of the property you want to buy, like your real estate agent.
Always do your own research and reach out to experienced real estate investors if there are concepts you need help understanding. You can also check out online platforms for real estate investors if you need to ask questions and get advice from people who have been through it all. The real estate investing forum at Bigger Pockets is an excellent resource when you’re first getting started.