7 Strategies Professionals Use to Avoid the Pitfalls of Real Estate Investing
The current housing market has made Real Estate Investing very attractive to a much wider audience recently. Whether you are a seasoned Real Estate Investor, or are new to real estate, the same rules of thumb still apply. It is not a simple strategy, and many out there would water down the process in the hope that they can convince a would be investor that their’s is a no-lose proposition and gloss over many of the details. While there are an overwhelming majority of professionals out there who have built their business on giving sound advice when it comes to any kind of investment it only takes a run-in with a less virtuous coach to scar you for life. If you are new to Real Estate it is not always obvious whose advice you should be taking, but a good rule of thumb is usually the cost of the advice – this being – if it costs money, then it is not advice.
Making the Real Estate investment decision even more difficult is the fact that some of the best performing markets are not local. Real Estate by nature is a hyper-local industry, and without actually being there the opportunity for someone to take advantage of market ignorance increases exponentially with every mile, making the job of due diligence that much harder. There are great markets out there for investment, but you have to do your research to take advantage of them. Without it you are truly throwing darts at a dartboard while blindfolded and in a different time zone-not a winning proposition, even if you are good at darts.
As real property has become more affordable a much wider range of investors are emerging, and those that do their homework stand to do very well over time. This article will cover some of the most important topics that should be on every investors mind when weighing investment options in Real Estate.
Come up with a plan and then find the property that fits it
There are as many investment strategies in real estate as there are investors. A good portion of that is because there is no strategy to begin with and the plan evolves after the need for a plan is realized. Any opportunity can be a good or bad investment, but without a clear and calculated plan you can’t really know ahead of time which it is. That is why one of the most important things you can do before making an investment is identify what your goals are and develop a road map on how you are going to achieve them. Are you interested in a fix and flip model, or would you prefer a more hands off approach such as a buy to let or buy and hold strategy? Are you an investor that would prefer to be hands on, or would you want your homes be managed for you?
Many new investors will see a transaction perceived as a good deal and then decide what they will do with it after it is purchased, which exactly the opposite of how this should be approached. Because of the fast paced nature of the industry, many decisions have to be made quickly in order to realize the returns. This compounds the problem, and the solution is to do your homework first, then find the asset that matches your plan. That way your homework is done ahead of time, and if you are forced to make a quick decision, it is not based on limited information on the market. Resist the urge to think of this as a purchase, rather, view it as an overall investment strategy of which the purchase is just a small part.
Identify the Risks
Risk management is critical in any type of investing. While there are many aspects of investing in Real Estate that differ from other types of investments, the principles remain the same. When you decide that investing in real property is something you would like to pursue, part of the planning must be understanding your own tolerance for risk. As with any other investment, returns will go down with the risk, and the converse is also true, as the risk increases so does the potential for higher returns. You must not forget, however, that as the potential for returns goes up, so does the potential for loss. When identifying an opportunity you must also keep in mind that there are ‘deals’ out there with extremely high risk that have virtually no possibility for any return at all. Identifying these types of transactions and avoiding them at all costs is paramount to your success. There are some very clear warning signs many of these lose-lose propositions have in common which we will discuss in detail in another article, but follow the simple mantra ‘buyer beware’ and always keep a healthy skepticism in every transaction and you will be able to identify ,and avoid, many of these pitfalls. Crucial to this is something we have already talked about, and that is having a plan and tailoring your investments to match the plan. Keep a watchful eye on the roadmap and don’t veer off of it. Contrary to what you may have heard, all roads don’t lead to Rome, so stick to the plan, recognize that a focused approach over time will serve you much better in the long run and remember that a savvy salesman can sway even the most conservative investor from straying from the path if they step off of it even momentarily.
Focus on the Financials
More than any other investment, Real Estate presents a multitude of opportunities for savvy salesmen to misrepresent your returns. Headlines like 28% ROI, turnkey! are everywhere. Give it the smell test, and if it sounds too good to be true it probably is. You have to take the time to dig in to the numbers and identify for yourself where the costs are. Some of the most commonly overlooked costs in real estate are maintenance expenses, vacancy expenses, management expenses, taxes, transaction fees, closing fees, HOA fees, and the list goes on and on. To do a true cost analysis of any opportunity these expenses must be accounted for in great detail. Your rate of return cannot be calculated by taking your monthly rental income and subtracting taxes and insurance, there are just too many other variables that must be considered. If you are unsure of how to calculate this take a tip from the IRS and calculate it just as you would your income on any other performing asset.
Do your research
Avoid the tendency to look at each investment as a transaction. You must follow the mindset that the transaction is just a small part of the overall investment strategy. Many opportunities will come with financial data prepared by the seller, and it can be a very useful starting point for sizing up any opportunity, but it should never take the place of your own due diligence. Keep in mind that it is their job to sell, and if you have taken the time to listen to what they have to say they have already met some of your initial requirements for purchasing. Assume that they are good at what they do, and you must be equally good at what you do, if not better, to get the information you need to make a sound decision. Take the time to independently verify all the information presented. Did they tell you that a property was in a certain school district? Call the districts head office and verify it. Are the taxes estimated or actual? Check it with the assessor. Did they mention the cost of a management fee? Call the management company and verify it. Double check any number that is presented to you and recalculate your returns independently every time. One of the main benefits you will get from doing this is that over time you will be able to size up an opportunity much more quickly, and secondly the people you are talking to will recognize that you are not going to just take their word for it and will only bring you the best deals because they know it would be a waste of their time to present you with anything less.
Build a team of professionals around you
This is especially important if you are not local to the market where you have decided to invest. Your team should at minimum include a home inspector, real estate agent, property manager, real estate attorney or title agency, local contractor, and an insurance agent. It will take a good amount of time on the phone to find the people you are comfortable working with, and ultimately may mean a trip to the market or markets that you have targeted as the best suited to your style of investing. You can cut out a lot of legwork on the phone by asking each one of these professionals for recommendations, especially if you find someone you really connect with and trust. The bulk of this will be relationship building and can be quite educational and enjoyable, but you can’t skip over this. For example, if you decide you are going to buy a property at 123 Main St any agent you call will write you an offer on it when you call them, but if you already have a relationship with a professional in the local area you can ask them their opinion and may find out some very interesting and useful information you were not aware of. The same is true of any professional in the list. Develop the relationship first and then you will get valuable input from them when you need it, otherwise you are just buying off the shelf.
Base your relationships on performance
There are some great people out in the real estate world full of charm and charisma that don’t know the first thing about investing. When you enter into this world you will find many people that could become life-long friends, but you cannot base your professional relationships solely on the personal relationships you develop with your team. Your property manager may be the greatest guy in the world, and you may really enjoy the time you spend together working, but if they are not finding high quality tenants for rental units in a reasonable amount of time you can’t afford to continue employing their services. In fact many professionals will fall back to the personal relationship when professionally they are not performing up to par. Learn to recognize this and act on it accordingly. This applies to anyone on your team. The reason the relationship was developed in the first place was as a means to an end, more specifically, earning returns on your hard earned investment dollar. Always keep this as the focus of your conversations with anyone on the team and you will find that you will attract a higher caliber professional to you while the others, who are not focused on your success, will drift away. Success draws its own to itself, remember this and it will be easy to recognize the performers from the rest. A quality professional will always recognize that their success in the business is tied to the success of their clients. Don’t shy away from the tough questions and always be on the lookout for complacency in your team and address it immediately. If the expectations are kept high and the goals are always the main topic of conversation you will find that their level of performance and commitment to your needs as a client will always be first on their list.
This is probably the single most important part of any transaction. Your returns will not be more affected by any other single variable. Nearly every opportunity can be a winning proposition at the right price, and you have to be a champion at identifying what that price is. Keep in mind that the price is very seldom the sales price, there are always other costs involved. Become a student of what those costs are and you will be able to calculate your returns more accurately. Many times you will be presented with options that are back-loaded with unidentified costs and you must be astute at being able to identify these. If it is going to cost you money it is an expense whether it comes before or after an acquisition. Is the roof 15 years old? Identify it and account for it in your offer. Are the vacancy rates extremely high in an area you are interested in? Identify it and account for it when calculating returns. What is the cost of securing a new tenant, and what is the tenant turnover rate? Identify and account. Take the time to double check pricing with comparable sales. No single factor will have as much impact on your returns, or losses, as this one, so make this a focus when evaluating any investment.
There is a lot to learn when entering into the world of real estate investing, and so much of it must be by self education. It may seem overwhelming at first, but as you become familiar with the markets much of what you will learn will carry over to other aspects of the business. Keep these things in mind when you are developing your investment model and you can increase the return on your investment dollar. Never stop learning and surround yourself with quality professionals and likeminded investors. Avoid letting your emotions get involved in any transaction, and stick to your plan. Use the resources available to you to learn from others mistakes and always keep your goals in mind.
Residential Real Estate Investment Advisor