One of the richest people of all time, Andrew Carnegie, once said “90% of all millionaires become so through real estate investing.” Real estate has proven to be a successful method of building wealth for centuries, but that doesn’t mean you can just buy a property and expect to be a millionaire the next day. There is a right way and a wrong way to purchase real estate, and if you’re not careful, you could find yourself falling into a very large pit.
Here are eight popular pitfalls that investors often face when investing in real estate:
Pitfall #1: Chasing the Highest Yield
Some investors focus too heavily on one number – yield and the highest they can get. There is nothing wrong with investing in high-yield properties, but focusing solely on the yields can cause you to overlook important factors that affect profit.
As with investing in any asset class, there is always a balance between risk-and-reward. And those properties with the highest yields often come with the highest risks. This typically comes from higher tenant turnover, vacancies, and costly renovations. “Investors need to realize that higher-yielding properties are great for real estate experts that have the time to manage their own assets and understand local laws,” says Steve Hovland, Director of Research at HomeUnion. “The goal for our investors is to help them make successful choices when it comes to their real estate investing, so they can achieve positive results, not just high yields.”
How to Avoid: If you are going to chase the highest-yielding properties then you need to be prepared. This means allocating large chunks of your budget to renovations and preparing ahead for months of no cash flow due to unpredicted vacancies. An alternate solution would be to invest in properties in good neighborhoods that have stable returns, albeit with a slightly lower yield.
Pitfall #2: Waiting for an Unrealistic Opportunity
Real estate investors have been capitalizing on strong markets around the country, many of which are seeing new highs. On the other side of the equation are investors who are standing by, waiting for the perfect investment property to appear.
This “perfect opportunity” stems from a very specific picture of how an income property will look and feel, and even where it will be located. Investors often picture a turnkey property with very high yields, a great school district, and stable tenants. This perfect investment property is extremely rare in this tight housing market, and if you wait, all you will be doing is letting your money sit idly, while others prosper in real estate investing.
How to Avoid: Instead of waiting for the perfect investment property to fall into your lap, focus on finding the right investment property for you. Finding the right property means looking at a neighborhood that presents the right risk-versus-reward for your goals. This means coming in with realistic expectations for yields based on what you are trying to achieve; for instance, someone closer to retirement, should be looking to maximize their income today in a low-risk neighborhood. In comparison, someone with a 20+ year retirement horizon can look for properties with more of a balance of risk-and-reward.
Pitfall #3: Thinking You’ll get Rich Quick
Another popular pitfall that many new investors find themselves falling into is looking at real estate investing as a way to get rich quick. While you can certainly successfully invest in income properties with a solid ROI, expecting real estate to lead to riches overnight will leave you thoroughly disappointed.
An exception to this pitfall is fix and flip, since it has a much quicker timeline to generate income, if performed successfully. That being said, a majority of fix and flips are fix and fails that require a ton of work from the investor. This work includes hiring contractors, managing the rehab, designing the renovations, and more. In this current market of low homeownership rates and increasing rents, buy-and-hold strategy is definitely the better way to go.
How to Avoid: In order to maximize your gains from real estate, it should be viewed as a long-term investment, or buy-and-hold strategy. Monthly cash flow can be generated through rents, but profits can also be found on the property through appreciation.
For example, here is what it looks like to invest in 9 rental properties with a 15-year fixed loan.
As you can see in the graph above, your initial investment of $371K has grown to be over $1.4 million in just fifteen years. Real estate is an asset class where time works in your favor. A longer timeline gives you the ability to find profits through appreciation and build equity by using leverage. While this means you won’t achieve massive profits overnight, you’ll have a stable and tangible asset that increases in value for generations to come.
Pitfall #4: Not Accounting for Enough of the Costs
Part of the research that comes with finding and purchasing a quality investment property is evaluating all the costs. While it is easiest to only look at the large yield percentage and not factor a realistic scenario of the overall investment, your ROI is very important.
How to Avoid: While each property is unique, you have to account for many of the costs that all rental properties will face. This includes costs like vacancies between tenants, maintenance, and repairs. Additionally, there are other fees such as HOA, taxes, leasing fees, property management, and insurance, which can all affect your bottom-line. Calculating these costs in advance can help you plan accordingly and know what kind of realistic profits to expect.
Pitfall #5: Focusing too Heavily on the Appearance of the Investment Property
The old saying goes that we can’t “judge a book by its cover” and that is a pitfall that many investors find themselves being stuck in when it comes to residential real estate. Just because a property might have been the victim of bad lighting or pictures taken from an amateur, it shouldn’t be the overall deciding factor, if it is a good investment or not.
See the example above that shows how photos can sometimes be deceiving when it comes to real estate. Based off the before photos, an investor may have overlooked this investment property, which would have been a big mistake. After the renovation, as you can see in the After photos, this property tenanted quickly and received the full monthly rent projection of $980.
How to Avoid: Look past the outside appearance of a property, as this can help you see a property’s true potential. A little rehab can go a long way and help you maximize your profits by attracting the right tenants. Often times, a simple rehab of minor changes to flooring, paint, or even small repairs can lead to a significant difference in rent potential. Also, remember you are not living in the home; it’s purely an investment opportunity. With the right attitude, you can combat this pitfall.
Pitfall #6: Buying Just Because a Tenant is in Place
Investing in a property with a tenant already in place can be a serious motivator for investors. Although this means that cash flow is likely coming-in on day one, managing these types of properties might not always be as clear cut as it looks. Often times these properties come with tenants that are more than you bargained for, such as delinquent on the rent, not making enough income to pay, or they come with a poor rent payment history that could led to possible eviction later on. And the worst part? The seller probably failed to mention any of these issues with the tenant.
How to Avoid: As an investment firm that helps investors find, acquire, and manage residential real estate, we’ve had a very personal experience with Pitfall #6. In clear transparency, when we first started providing properties with tenants in place for our investors, we noticed a serious problem. 23% of these tenanted properties came with 60 to 90-days delinquent tenants. The previous third-party owner did not mention this upfront. This led us to create and implement a thorough screening process for tenants already living in the home before we made any recommendations to our investors. Make sure you do your homework on the tenant before purchasing rental properties with a tenant already in place, or buy an untenanted property and put in a reliable tenant from the get-go by using our proven screening methods.
Pitfall #7: Limiting Yourself to Your Own Backyard
When looking for locations to invest in residential real estate, many investors simply look to their own backyard. While there might be some good investments nearby, you could be missing out on better investment opportunities across the country, especially if home prices in your neighborhood are high.
How to Avoid: Remote investing allows you to purchase residential real estate in markets throughout the U.S., therefore making it easier to find properties that fit your investment goals, initial investment amount, and more. By working with a partner who will help you find these markets as well as manage the properties, you’ll reap the benefits. This means investing in markets that are poised for growth, have higher cap rates, and/or have a solid cash-on-cash return.
Pitfall #8: Doing it by Yourself
Some investors choose to take on the entire investment process on their own, but this is a huge hazard. While it is certainly possible to find, acquire, and manage your rental properties by yourself, there are benefits to working with real estate investing experts. Additionally, there are many roles that play a part in the investment process including real estate agents, lenders, contractors, property managers, and other highly specialized roles.
How to Avoid: Just like you would research different properties, the same principle applies to the groups you work with. Working with the right parties can help you achieve your investing goals, and provide expertise on the real estate investing process.
Also, working with the right management company can make sure that you don’t have to oversee all the daily details with your tenants. A good property management company will help you find tenants, collect rents, and take care of any repairs.
The Best Way to Avoid Pitfalls, and Leap to Success
Carnegie and many others have used real estate to help them grow their capital, and you can too. Although many investors fall into the pitfalls above, you won’t, since you’ve learned what you need to avoid, and how working with an expert partner can help ensure your success.