How to Avoid the 3 Biggest Pitfalls in Real Estate

Unlike many so called “real estate experts,” I am more than a teacher… I’m truly an active investor. I started investing in real estate at age 18, when I bought and fixed up a rundown apartment building in my hometown. And in the past 20 years, I’ve made millions of dollars.

Right now, I’m working on more than 25 deals. This allows me to share winning strategies from the past as well as cutting-edge techniques that work in today’s down market.

Yes, investing in real estate has some risk associated with it. Some people lose tons of money in the real estate game. But for every tale of woe and failure, you can find a tale of victory. You see, real estate isn’t rocket science. And many of the problems that precede a failure can be prevented.

In my experience, there are three major pitfalls that new investors encounter:

  • Buying in the wrong location
  • Buying at the wrong time
  • Buying without examining the facts

Did you notice that none of those things are complex or technical? They all seem to be just “common sense.” Let’s look at each one and expose the iceberg under the surface.

Real Estate Pitfall #1: Buying in the Wrong Location

You’ve heard it many times… real estate is all about location, location, location. And while there’s no doubt that this is true, it’s a bit of an oversimplification.

Some of the ways location influences real estate investment values include:

  • Population demographics related to people moving in and out of the area
  • Quality of living factors (and these can change over time)
  • Over-exuberance on the part of buyers and builders because of the area’s past history
  • Major lifestyle trends that may not yet be apparent

These influences can apply to large areas of a state… or to local subdivisions or neighborhoods. The wise investor will focus on a local neighborhood he’s familiar with, but not to the exclusion of the entire city or county.

Location is more than just a pretty street with views. Here are some questions you should ask yourself before you invest in a property:

• Is there job growth, stagnation, or shrinkage here? (If an area has a sudden increase in jobs, more people will flood in, driving up real estate prices and apartment rentals. If an area suddenly loses jobs, more people will leave, depressing real estate prices and lowering rental demand. Both situations create different but profitable opportunities.)

• Are industry and commercial ventures moving in or out?

• Has there been a recent trend for government to dedicate large tracts of land for parks or green space? (This reduces land inventory for building, makes life more pleasant in the area, and is, thus, a predictor of more people wanting to live there.)

• Has the trend for more parks and green space driven builders to over-construct new homes… beyond the current demand for them?

• Are trends unrelated to the immediate area going to impact prices or the demand to live there? (For example, U.S. home prices fell 4.8 percent in the second quarter of 2008 compared with a year ago, a new record low. This could indicate that a home that was appraised for $200,000 a year ago and is on the market for $190,000 still may not be a good deal.)

• Are high gas prices going to cut into the demand for more rural living… or increase the demand for homes in urban areas?

The changes in demographics and/or trends that make a location more or less desirable happen gradually – and a careful investor makes every effort to uncover them.

Real Estate Pitfall #2: Buying at the Wrong Time

Look not only at what is happening in an area, but also how long it’s been happening. The announcement of major new land allocations to green space, for example, can be a good thing – but buying several years after the fact could be a purchase into a market about to change.

One of my students bought a nice three-bedroom brick home in a good rental area. Based on his research and knowledge of the area, he purchased the home with 100 percent financing and rented it for a $100 per month positive net cash flow (after paying mortgage, taxes, and insurance).

He bought this home because he could see that the path of commercial development was headed right through the area where it is located. And he plans on holding onto it until commercial development drives up the property’s value and he can apply for rezoning to office/commercial and either sell or lease it.

He knows that he will need to hold onto this property for four to five years to maximize his profits, but since he bought it with 100 percent financing and the place actually makes him money every month, he is in no rush.

Real Estate Pitfall #3: Buying Without Examining the Facts

Any successful investment starts with a good buy. Making a good buy in real estate requires a great deal of valuation analysis.

The following story about two of my friends illustrates the dangers of relying too heavily on your emotions and not enough on objective information that could be staring you in the face.

“John” and “Joan” fell in love with a beautiful Victorian home the moment they stepped inside. Although the house was in bad shape, it had leaded-glass windows, carved woodwork, built-in hutches, and hardwood floors. They bought it, cleaned it up, and made it sparkle.

“We loved the house even though it was in a questionable neighborhood. As a result, we violated the number one principle of real estate: Location, location, location. To make a long story short, the beautiful house we loved could be rented only to less than desirable tenants, because the type of tenants we’d hoped to attract didn’t want to live in that neighborhood.”

Although John and Joan eventually sold the house for a small profit, they would have been better off had they examined the facts and made a decision to buy a different home in a much better neighborhood.

Keep in mind that though real estate is local, major national and international events and trends can help the worst of markets… and damage the very best. So be sure to analyze a real estate investment’s national and local factors. Still, one very positive local factor can outweigh multiple national factors.

Start by researching location and market timing, then research them again. Get the picture for the area before you narrow your search to specific properties. Once you’ve decided that timing and location are right, then look at individual homes.

It is now number-crunching time. There simply is no substitute for a thorough property evaluation using all of the mathematical valuation tools available.

  • What is your gross potential income – the rents you can count on to be paid regularly and on time?
  • What is your breakeven ratio calculation (fixed costs/gross profits) for that magic turn to positive cash flow?
  • What are all your potential expenses and risks?
  • What is the property’s investment potential? (Use the cap rate calculator at www.deangraziosi.com for this.)

Your lender may keep you focused, because they will likely want to see numbers that assure them of a performing loan asset. But in the end, doing the math well is your responsibility… and to your benefit.

Sure, it takes work to find the right properties. But it’s not complicated. You don’t need any special education or skills. It’s all about gathering information and making decisions based on hard factual data, proven calculations, and a little bit of luck.

Hey, if a naive kid like me – who came from no money, had no mentors, and never went to college – can do it… you can too! By acquiring the right knowledge and taking the right actions, your first deal could be just weeks away.

[Ed Note: If anyone knows about the pitfalls of real estate, Dean Graziosi does. He’s a real estate expert, teacher, and author who’s been investing since age 18! His book Be a Real Estate Millionaire is a New York Times, Wall Street Journal, Amazon.com, and USA Today best-seller. For an ETR-reader-only special on this book, go here.]
  • Great list. I’m learning. My first rehab purchase hits all three on your list. Oh well. I’ll learn.