I’ve been a real estate investor my entire adult life. I love it. I’ve made lots of money investing in real estate using every strategy you can think of. Did every deal work out? No, and some didn’t do well at all. Sometimes you can’t do anything about it, and it’s not something you did wrong. Sometimes it’s not anything you missed in your research.
What goes wrong that’s not your fault in a real estate investment?
- Economic surprise: You’re almost finished with a fix & flip with a rental investor ready to buy. A major employer announces they’re leaving and about to lay off hundreds of employees. Rents tumble, people move, and your buyer backs out.
- Major hidden structural problem: In the vast majority of cases, a good inspection will help you to avoid major condition problems. However, sometimes things turn up in a fix & flip that simply weren’t visible until they were uncovered. Bad mold can at times be an issue. Or, sometimes it’s a foundation problem uncovered when floors are pulled up for replacement.
- Financing falls out: This doesn’t happen often, but at times when working with independent individuals who are providing funding for a project, they may pull their funding during the deal.
However, the vast majority of deals that don’t work as planned are the result of mistakes on the part of the investor. Let’s look at what I’ve seen as consistent mistakes made usually by new investors, but not always.
Mistake # 5: Putting too much trust in new contractor relationships.
Once you’ve completed several projects with a general contractor or a group of sub-contractors, you can begin to build a trust level and not expend as much effort in monitoring their activities, financial condition, and work quality. Unfortunately, no matter how well you research their references, you can’t just start out with that trust in a new contractor relationship.
This mistake is more common with new investors, and it can be devastating, putting some out of business on their very first deal. It doesn’t just apply to fix & flip either. You could be buying a rental property and doing your own rehab.
What can go wrong with a rehab contractor?
- Financial problems keep them from completing contracted work.
- Poor quality work that must be re-done or reduces the property’s value.
- Failure to properly supervise subs on the part of a general contractor.
- Different interpretations of job specifications between the investor and the contractor.
- Contractor doesn’t show up or spends time on other jobs that impacts the project.
Develop good contracts, be clear in specifications and scope of work, don’t pay until work is delivered, and get lien releases.
Mistake # 4: Taking a short-term view of a long-term investment.
There are a number of successful real estate investment strategies that are short term in nature, from wholesaling to fix & flip. But, rental property buy and hold is definitely the opposite; long term. Some investors do everything right, but they still end up in trouble with a rental property simply by not taking a long term planning view.
What do they do right in their rental investment?
- Study their market and understand home prices.
- A good handle on rents, rental demand and competition.
- Smart purchase negotiating and buying right.
- Good cost analysis and reasonable monthly positive cash flow.
When they get all of this right, how can they get burned? Usually they won’t. But, there are some long-term considerations that can eat up gains over time.
What do they get wrong in their rental investment?
- Good cost analysis in buying, but poor understanding of ultimate sales and closing costs.
- Overestimating expected annual appreciation rate.
- Related to that one, underestimating holding time to recoup investment and make a profit at sale.
Buying right, at a discount to current value, is a good start. But, if you don’t have a pretty good plan for when you will sell the property and what it will cost to sell, you could end up losing a chunk of the cash flow you enjoyed in a sale that loses money.
Mistake # 3: Working only with real estate agents for rental homes.
This isn’t about bashing real estate agents, as they have a job to do and commissions pay for it. It also isn’t about foreclosures, as you often will work with agents hired to market them for the lenders and asset managers. The fact is that most foreclosures these days need from a little to a whole lot of rehab to be livable. Here, we’re talking about rental home investors who want to buy a home ready for a tenant.
What I’m talking about here is always working with real estate agents to buy a home as a rental investment. You can do some negotiating with sellers, but the commissions are in the deal and generally you’re buying at or close to the retail market value. The best rental property deals are purchased at a discount to current value, locking in some profit from the first day of ownership.
Other Ways to Find Rental Homes for Investment
- Real estate investor wholesalers who offer ready properties at a discount.
- Do your own marketing for distressed sellers.
- Work Craigslist for sellers, especially landlords who want to get out of the game.
- Get referrals from real estate agents of sellers they can’t help, as maybe you can, possibly with a short sale.
- Aggressively keep up with FSBO, For Sale By Owner, homes advertised in print and online.
Don’t NOT work with real estate agents, but do open up other avenues to buy at below retail pricing.
Mistake # 2: Getting the Numbers Wrong
No, it’s not as complicated as the image makes it look, but it is the most critical part of the real estate investment process. It doesn’t matter what strategy either; wholesaling, fix & flip, or rental property investment.
The many numbers involved in real estate investment:
These aren’t all of them, and they’re not in any particular order, but you must do your research and due diligence to identify your costs and risk versus reward. Some apply to all strategies and some only to rental property investment.
- Current market value of the property to be sold or purchased.
- ARV, After Repair Value, if rehab work is to be done or purchased.
- Costs for rehab, including contractors, materials and cost of money.
- Extra marketing costs if doing fix & flip for the retail consumer buyer.
- Current market rents for similar properties.
- Competition in the market, both for properties and for buyers and tenants.
- Your buyer list requirements for profits and what they are willing to pay for properties.
- For buy-and-hold rental property investing:
- Initial cost with closing costs.
- Property taxes.
- Debt service; the mortgage payment.
- Management costs.
- Marketing costs to get and keep tenants.
- Legal costs, including eviction.
- Repair and maintenance costs.
- Vacancy costs and estimated vacancy time between tenants.
- Move-out rehab for new tenant move-in.
- Estimated non-payment of rent losses.
- Costs involved in the ultimate sale.
- Estimated appreciation in value over time.
- Estimated hold time until sale.
That’s not everything, but you’re getting the idea. There is a whole list of valuation and profit calculations involved in real estate investing, and you need to determine which are appropriate for your investing, learn them and use them properly.
- Gross Rent Multiplier, GRM
- Gross Scheduled Income, GSI
- Vacancy and Credit Loss
- Gross Operating Income, GOI
- Net Operating Income, NOI
- Capitalization Rate, or Cap Rate
- Net Income Multiplier
- Income Before Taxes
- Income After Taxes
- Cash Flow
That’s the short list, and you won’t need them all in every case, but you need to know what they are and why they are important.
Mistake # 1: Not Doing It!
This is the top mistake simply because I know that many more people make this mistake than most of the others put together. They wave the white flag of surrender before they even get started. In fact, someone reading this article is about to do just that. They look at the mistakes and think that they’re almost certainly going to make one or more of them or even find a new one to make all theirs!
I don’t have enough money to invest in real estate.
Yes, you do. I say this without offering up some get rich quick or “no money down” strategies that can be scams to rope you into spending money to learn failure tactics.
There are real estate investment strategies and techniques that can be profitable and successful with little or none of your own cash invested. Will they fall into your lap? NO. But they are easily learned.
Time is an interesting fear, as many people really don’t realize what they do and don’t have available. They respond to “urgency,” but that’s not always important. The other thing about real estate investment is that you are the boss, the only employee, and you control when and how you want to work. You do have the time, but you may have to change a few things in your life to free it up.
Knowledge is really one of the easiest fears to get rid of. On the Internet alone, there are tens of thousands of articles about real estate investing. Not all are good or even trustworthy, but they’re free and you can read as much as you need to begin to understand how it works and whose information to trust. Any education level is OK, it’s not about diplomas or degrees.
As far as worrying about the economy and losing what you’ve gained, real estate is far less risky than many other investments. There will never be any more land created on this planet, and people will always need a place to live. Learn the ropes, understand the numbers, and you’ll do fine over time. It’s one of the top wealth-building tools in existence.
Naysayer: one who denies, refuses, opposes, or is skeptical or cynical about something.
It can surprise you how many naysayers you’ll find in your life if you announce you’re about to become a real estate investor. Family and friends, some well-meaning and concerned about your welfare, will come up with all kinds of doubts and concerns.
IGNORE THEM. You can do this. Avoid the mistakes I’ve shared here, learn how to do it, and your naysayers will come to you in the future asking if they can get involved.
For more information on Dean Graziosi and his real estate investing strategies, click here.