12 FATAL SINS REAL ESTATE INVESTORS MAKE
By Fred Reilly, American Attorney and English Solicitor
Experience is essential to making a sound real estate investment. Investors can dramatically improve their investment decisions by avoiding the twelve fatal sins outlined below. Knowledge of these sins is especially important to foreign investors who must also content with the unfamiliarity of another country.
- Paying too much. Ensure your profit margin when you acquire an investment property by purchasing at a rational price. Do not count on the market to bail you out at a later date. Many people who bought investment properties at the height of the market in 2005 are now learning the hard way that they overpaid – in some cases by tens of thousands of dollars. Seasoned investors target properties that are discounted or undervalued by ten to thirty percent. It is not impossible to identify these properties in any market, but it does take hard work, persistence and a willingness to seek the best information available.
- Failure to practice strategic fundamentals. Investors frequently fail to formulate an investment strategy for purchasing a property. Will you be buying the property with no money down, a ten percent mortgage or should you ask the owner to hold paper? Is your intention to flip the property within a one-year period, upgrade the property to command a better tenant or change the zoning to a higher, more valuable classification? Buying an investment property because someone has touted it as “a good investment” is not a sound business strategy.
- Falling in love with a property. I think it’s very healthy from an investment standpoint to have an attraction to a particular property for rational reasons. I am very concerned when an investor falls in love with a property because emotional involvement tends to cloud a person’s business judgment.
- False assumptions. By doing your homework, you can substantially eliminate the tendency of inexperienced investors to rely on false assumptions. Identify the factors that make the property attractive from an investment point of view, then confirm the existence and accuracy of each factor. You’ll be surprised by the number of times that your assumptions were less than perfect.
- Failure to conduct appropriate Due Diligence. This sin is unforgivable. When negotiating the contract to purchase an investment property, include a specific time period (i.e., 30 to 90 days) to conduct due diligence. During this period, your deposit should be refundable for any reason. The purpose of the due diligence period is to confirm the status of the real property and address all issues that will impact your intended use of the property. For example, an investor with a pending contract on an apartment building should investigate zoning, construction code, density, hazardous waste, utilities, impact fees, health and safety regulations, structural integrity and related issues. In addition, the investor should review and confirm records that relate to occupancy rate, cash flow, status of current lease agreements, tenant deposits held, service contracts, status of scheduled maintenance and repairs, status of actual or threatened lawsuits and the costs of possible improvements to upgrade the property.
- Misjudging market dynamics. The real estate market is in a constant state of flux. The economy, interest rates, supply and demand of properties, threats of terrorism, natural disasters, laws, taxes, government policies and politics are just a few of the factors affecting the availability of attractive investment properties in any given market. It’s relatively easy to place emphasis on the wrong factors and ignore the relevant factors when analyzing the investment potential of a prospective purchase. I highly recommend that you spend sufficient time researching a specific sector of investment properties (such as Central Florida condominiums or Los Angeles office buildings under 10,000 square feet) before you take the plunge. The better your understanding of market dynamics, the more likely your focus will be on the factors that really count in a specific market.
- Misjudging appreciation. Some investors purchase real property under the misguided expectation that it can only increase in value. These investors learn the hard way that property can and does decrease in value. Optimism is an admirable quality, but it should be tempered by reality. If you analyze the sales history of properties in a specific market, you can spot the pricing trends and make good faith projections about the anticipated appreciation. I highly recommend that you compare apples to apples (like kind properties) and use a price per square foot analysis in these comparisons.
- Misjudging cash flow. There are very few real estate investments that “pay for themselves.” A negative cash flow means that you’ll be subsidizing your investment every month. After you’ve determined that a prospective property has some investment appeal, run the cash flow numbers. Consider all potential expenditures including but not limited to mortgage payments, homeowner’s association fees, real estate taxes, insurance, utilities, waste disposal, maintenance and repair reserves, property management fees and landscaping fees.
- Failure to assemble a team. It is highly advisable to assemble a team of professionals before you ever pursue real estate investment opportunities. Your team should include a real estate agent, attorney, lender, appraiser and property inspector. These professionals will help reduce your risk and increase the likelihood that your investment strategy will be successful. At the least, have consultation sessions with each of these professionals to explain your basic strategy and pick their brains. Seasoned professionals will have counseled countless investors before you and will be in a position to explain the most common landmines that they’ve encountered. The money that you spend on these consultations usually result in an outstanding return on investment.
- Failure to control expenses. Runaway expenses can sour any real estate investment. Renovation work is a great example. Contractors are often over-budget and long overdue when it comes to the estimating the actual time to complete a project. If the renovation work is delayed, there’s no rent, diminished opportunities for appreciation and a high likelihood of losing money month after month.
- No Exit Strategy. Do you intend to hold a modestly appreciating property for a long term? Or are you purchasing a speculative property in a high-growth market where you can get in, make a quick profit and get out in one year. Prior to purchasing an investment property, formulate an Exit Strategy so you have a clear-cut plan for the future. Once you’ve formulated an Exit Strategy, don’t make the mistake of being trapped by it. As circumstances change, you should revisit your Exit Strategy and determine whether new conditions justify a different approach.
- “Get Rich Quick” schemes. Real estate investment is hard work and requires persistence. Most people who fall prey to “Get Rich Quick” schemes are unwilling to pay their dues in a field that demands it. If it sounds too good to be true, there’s ample reason to be suspicious. If you can’t resist the temptation to pursue potential “Get Rich Quick” schemes, investigate thoroughly and do everything within your power to reduce your risks.
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© Copyright 2007 by Fred Reilly. All rights reserved.