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By Dr. Jim Dahle, WCI Founder
Real estate investing is almost synonymous with making mistakes. In few other fields of endeavor have so many learned the craft in the school of hard knocks. However, it's far better to learn from the real estate investing mistakes of others than to make them all yourself. Whether you are investing actively or passively, avoid making these mistakes.
#1 Paying Too Much
There are very few investments in the world that are a bad deal at any price. Most of the time, the difference between a good investment and a bad one is simply the price you pay. Just about every experienced real estate investor has overpaid for a property at least once and then was rewarded with poor returns, especially in the short run.
#2 Not Buying a Property as an Investment
Too many people mix business with pleasure, wanting to “invest” in a property that they plan to use themselves from time to time. The problem is that you purchase property differently when you plan to use it yourself. An investment is about the cold, hard numbers, but with a property you will use, you start caring about many different, more subjective factors. It is the same issue with turning your previous residence into a rental property. The only advantage of choosing that property as your investment property is that you can avoid some transaction costs and can possibly continue to use your lower-cost residential mortgage to finance it. If you wouldn't buy it today as an investment, you probably should sell it when you move out.
#3 Too Much Leverage
Real estate investors get in trouble all the time, and usually, the problem is too much leverage. It is possible to buy a property with as little as 0% down, but experienced, professional real estate investors are more likely to put down 25%-40%. Not only does a large down payment ensure cash flow positivity, but it provides enough equity to allow you to exit without bringing money to the table—even in a nasty real estate downturn.
#4 Financing a Long-Term Asset with Short-Term Debt
When you buy something that is likely to do well in the long term but has unknown short-term prospects, it is best to finance it in a long-term way. Using a balloon payment, financing with a rapidly adjusting ARM, or offering the lender or preferred equity provider the option to “call” their money is a great way to get into trouble.
#5 Thinking You Can Carry a Few Cash Flow Negative Properties for a While
Some investors buy a property knowing it will be cash flow negative for them. They think it will “turn the corner” in a year or two as they raise rents, and they figure their high income will allow them to “feed the beast” for a while. That's a huge gamble. If something happens to your income, your standard of living is going to drop and you're going to lose your nest egg, too.
#6 Focusing on the Deal Instead of the Operator
When investing passively, the most important thing is to invest with good people who know what they're doing. While you may be wowed by the great property, deal, or fund they're putting together, the most important aspect of any partnership is the partner. A good operator can make lemonade out of lemons. and there is no deal good enough that a lousy operator can't ruin it.
#7 Not Taking Operator Risk Seriously
When investing passively in syndications and private funds, you can get burned by a bad fund manager or operator. You can do all the due diligence in the world, but you may still end up with a scam artist or incompetent operator. Even good people with great track records make mistakes. Protect yourself from what you don't know and can't know by diversifying.
#8 Being an Out of State Landlord
It seems so easy. Just hire a local property manager. You'll be fine. But everything gets harder when your investment property is out of state. You can't drive by and check on it. Every little maintenance item has to be hired out. You're less likely to be aware of changing neighborhood characteristics or local laws. It's just a bad idea. When given the choice, active real estate investments are best when they are local to you.
#9 Allowing an Appraisal to Increase Your Price
Many purchase offers are contingent on financing, and many lenders won't loan on a property if you're paying more for it than for what it appraises. However, you should not make an offer where a higher appraisal than expected could result in you having to pay more for the property. Appraisers aren't perfect, and a surprising number may be willing to fudge things a little as a favor to the person selling you the property.
#10 Failing to Use a Specialized Realtor
You don't want a real estate agent whose business is mostly selling to people who will reside in the property; you want one who works mostly with investors. The Do It Yourself (DIY) route has many pitfalls and land mines, and it requires extreme caution and professional levels of knowledge. While realtor commissions are heavy, they are often well worth it, especially for the most knowledgeable realtor in the area and niche. You're not paying for their work so much as for their knowledge.
#11 Trusting the Realtor Too Much
While having a good agent is important, you shouldn't trust them too much. At the end of the day, it's your money and it'll be your loss if they talk you into overpaying. Remember that their incentive is always to make a sale. It's a massive conflict of interest. In a way, they're compensated by the seller, and the more the property sells for, the more they will make.
#12 Buying Site Unseen
There is a lot of risk in buying a property without even laying eyes on it. Even in today's world of photos, videos, and drone footage, there is still a lot to learn about a property by walking it, talking to tenants, and driving the area around it. Just think about any flawed property you've ever owned. How hard would it be to take a seemingly “complete” series of photos without showing that flaw?
#13 Not Understanding Local Tenant Laws
Some localities are more favorable to tenants and others to landlords. Not understanding the laws that affect your investment is a major mistake. Many companies avoid entire states due to these issues. Learning the local landlord laws is certainly a key part of any due diligence process.
#14 Thinking Empty Land Is an Investment, Not a Speculative Instrument
Investments produce cash, whether in the form of dividends, interest, earnings, or rents. Speculative instruments rely on somebody else paying you more than you paid to produce a return. That can be risky. Empty land is far more similar to precious metal, cryptocurrency, and Beanie Babies than it is to a cash-flowing apartment complex whose value can be determined from the net operating income and other cash flow-based metrics.
#15 Not Being a Real Accredited Investor
Most private real estate partnerships, whether an individual syndication or a fund, require investors to be accredited. Most attending physicians qualify by virtue of having an income of $200,000+ for each of the last two years or by having an investable net worth of at least $1 million. However, REAL accredited investors can afford to lose the entire investment without serious effect on their financial lives AND can evaluate the investment without the assistance of an attorney, accountant, or financial advisor. I suggest you ensure you are both before investing in any investment with this requirement. That may mean an income of at least $400,000 AND an investable net worth of at least $2 million, given the high minimum investments for some real estate investments.
#16 Failing to Diversify
For some reason, many real estate investors don't understand the basic principles of portfolio construction, such as diversification. When you put all of your money into a single property—especially a property where you are not totally in control—you're asking for trouble. While experts can reasonably disagree on how much diversification is enough, more is generally better than less.
#17 Failing to Pay Attention to Fees
Along those same lines of investors not understanding the basics of investing, all else being equal, every extra dollar you pay to an advisor or manager will come out of your return. Real estate fees matter, and they add up over time, thanks to compounding. You need to understand how you're paying for services received and ensure you're not overpaying. Many passive real estate investments have fee structures similar to hedge funds: 2% a year plus 20% of profits. Paying 1% a year plus 20% of profits over a preferred return of 8% is a much lower fee, but it may still be too much depending on the deal.
#18 Impatience
Real estate is a long game. The good news is that time heals all wounds (OK, most wounds) in real estate. A decent property usually appreciates eventually, so even if you paid a little too much, it'll still work out OK in the long run. However, those who expect a get-rich-quick scheme out of real estate are likely to become impatient before they become wealthy, and they could do something dumb to mess it all up.
#19 Calling Publicly Traded Real Estate “Paper Assets”
Large, successful real estate companies often have an Initial Public Offering (IPO) and go public, often as Real Estate Investment Trusts (REITs). They are then traded on the stock market. This provides liquidity and transparency for investors, and it often lowers investor costs. The downside is that returns are then often more correlated with the market than they were before. However, just because there is increased correlation does not mean that these are not still large, successful real estate companies doing great things for their investors. Ignoring a real estate investment just because it is publicly traded is folly. In fact, a REIT index fund is the easiest way to add real estate to a portfolio, and it provides massive diversification and daily liquidity.
#20 Not Doing Cost Segregation Studies
Getting the tax break called depreciation is a big part of being a real estate investor. If there is anything better than depreciating a property, it is depreciating it faster, especially if you have passive income that it could offset. Even if you don't, depreciation can always be carried forward to be used later; you don't lose it. Cost segregation studies, especially when combined with bonus depreciation, can help you to get depreciation as fast as possible.
#21 Using an Opportunity Zone Fund When You Don't Have Capital Gains
Opportunity Zone (OZ) funds are a good way to minimize the tax hit from capital gains while investing in real estate. Many OZ fund managers feel like their investments would be great investments even if they weren't in an opportunity zone (i.e. an economically downtrodden area), but I would still consider it a mistake to invest in one of these funds if you don't need the special tax treatment it provides.
#22 Selling Property on Your Death Bed
When an investor dies, their assets receive a step up in basis and then the heirs can sell them immediately without paying any capital gains taxes. Imagine an investor who buys a property for $100,000 and then holds on to it for many decades while it appreciates to $1.1 million. There is now $1 million in unrealized capital gains. If the investor sells it the day before death, the IRS will get $238,000 in long-term capital gains taxes. If the heirs sell it the day after death, the IRS will get nothing. Don't sell highly appreciated homes, investment properties, stocks, or mutual funds if you're likely to die any time soon (like in the next 5-10 years) unless you have a very, very good reason to do so. Even then, you may be better off borrowing against it instead since the interest costs will likely be less than the tax costs.
#23 Putting Your Heir's Name on the Title
For the same reason, it is a bad idea to put your child's name on the title of a property you own. When you do so, it becomes their property at death, and it obviously makes estate planning and the transfer of ownership easier. But you lose that free step up in basis at death. The convenience is not worth the cost.
#24 Failing to Take Advantage of the 2 Years Out of 5 Rule
If you live in a property you own for at least two of the last five years, you qualify to get $250,000 ($500,000 married) in capital gains waived when you sell. If you rent out a former residence, it can make sense to sell it just less than three years after moving out. If you are considering selling a rental property, it can make sense to move into it for two years prior to selling.
#25 Bad Financing
Some loans are better than others. The best loans:
- Have a low interest rate
- Have a fixed interest rate
- Are not callable
- Are deductible
- Are long-term
- Are unsecured
Even a great property can be a bad deal if it is financed improperly. Don't be so desperate to own a property that you are willing to do anything to get it.
#26 Not Having an Underlying, Long-Term Plan
Too many investors become investment collectors rather than purchasing investments in accordance with their long-term investing plan. When drafting a long-term plan, you:
- Set your goals
- Decide which accounts you will invest in
- Choose an asset allocation
- Implement the asset allocation within the accounts by selecting investments
Too many investors, whether real estate or stock investors, try to jump straight to step 4. Don't do that.
#27 Over-Diversifying
Just like you can under-diversify, you can over-diversify as well. This can be a major hassle and expense with real estate investing. Every property, every syndication, and every fund will involve expenses and additional tax forms. You need enough diversification but not too much. If investing in private real estate funds, three different managers are a good idea. Fifteen are not. If purchasing individual syndications, 15 might be fine, but 150 is not. If buying individual properties, you might be better off with a half-dozen apartment complexes instead of 90 single-family homes. Consider diversifying geographically and between various real estate asset classes, but never forget you don't have to invest in everything to be successful.
#28 Overpaying at Auction
Sometimes you can score a great deal at an auction. But it is also an easy place to overpay for a terrible property. If you're going to buy at auction, make sure you know the property and know the price at which it is no longer a worthwhile deal for you. Then, stop bidding at that point.
#29 Underestimating Rehab Expenses
Accurately estimating repair and rehabilitation costs is an important skill for direct real estate investors, especially in the fix-and-flip space. If you underestimate those costs, you'll pay too much for a property and lower your returns or, even worse, find out you don't have the cash to even complete the deal and end up owning a money-sucking drain of a property.
#30 Overestimating Your Time (or Ability) to Do Repairs Yourself
A similar mistake occurs for those who plan to do the rehabilitation work themselves. Time is money.
#31 Being House Poor
This one applies more to your residence than an investment property, but it can apply there as well. If you purchase a home that is so expensive that it dominates your financial life, it will keep you from building wealth properly or, worse, cause you to lose money or even go bankrupt. Just because property generally appreciates over time does not mean that buying a more expensive property will always make you richer. The home you live in is at least as much a consumption item as it is an investment.
#32 Buying a Home Just Because the Mortgage Is Less Than Rent
A common justification for buying instead of renting is because a mortgage payment would be lower than a rent payment. This is ignorant. Of course, the mortgage payment is less than the rent payment. On average, 45% of rent paid to a landlord goes to non-mortgage expenses. The other 55% of that rent payment must cover the mortgage and provide any profit. How would a landlord make any money if the rent payment were less than the mortgage? There certainly would not be any cash flow, at least positive cash flow. Buy a home because the overall cost of ownership is less than the overall cost of renting over the time period of ownership. The only other justifications are that you cannot rent what you actually need or want and that you can afford the purchase as a consumption item.
#33 Not Lining Up Financing in Advance
You should know how you are going to pay for a property before making an offer on it. It is best if you are both pre-approved and pre-qualified. Even better is already having the cash in hand (even if you borrowed it), allowing you to make an attractive “all-cash” offer without any sort of financing contingency.
#34 Choosing Bad Contractors
It will not surprise any experienced real estate investor or homeowner to learn that there are many terrible contractors out there. Whether siding, masonry, carpentry, plumbing, paint, landscaping, roofing, tile, carpet, or drywall, perhaps even the majority of contractors should never be given any work. The threshold to be good in this field is so low that it basically consists of just saying what you are going to do and then doing it. Selecting one or more of these bad contractors is an unfortunately common mistake among real estate investors and homeowners.
#35 Skimping on Research
One of the downsides of real estate investing is that you have to do more work than you do with mutual fund, especially index mutual fund, investing. I selected the index mutual funds I invest in almost 20 years ago, and I am still investing in the same ones. If you want to invest in real estate, you're going to have to put a lot more work into selecting investments. Failing to do adequate research is a great way to buy a terrible investment. Nobody wants to put in more work than they have to, but consider that professional real estate investors might evaluate 20, 50, or 100 properties for every one that they buy. If you're only looking at one or two, what are the odds that you're doing it as well as them?
#36 Skipping Due Diligence
Even if you hire a professional to do this for you, make sure you do proper due diligence on them. While diversification can protect you from what you don't know or can't know, you still lose something from bad decisions, even if you're diversified. This calls for a belt and suspenders approach: diversify and do due diligence.
#37 Not Learning the Jargon
Real estate, like medicine and finance in general, has its own jargon. “Unique” and “cozy” are not positive terms in a property description. Don't read ads like a layman does; read them like a real estate professional does.
#38 Not Doing the Second Job
In some ways, real estate investing is like having a second job. Sure, it's a combination of a job and an investment. The mistake is when you don't put in the work to actually do that second job. If you're a landlord and don't actually get out there and get tenants into your building, it's not going to end well. Same thing if you don't collect the rent and fix the things that break.
#39 Choosing a Bad Location
The three most important things in real estate investing are location, location, and location. No amount of work can save an investment in a terrible location.
#40 Not Building a Team
The likelihood that you personally possess all of the skills necessary to be successful in real estate investing, particularly direct real estate investing, is very low. Even if you have the skills, you probably don't have the time to do everything. At a minimum, even passive investors are likely to need a good accountant to deal with all of their K-1s. On the direct real estate side, it is not unusual to need at least one accountant, attorney, realtor, property manager, housekeeper, handyperson, and contractor in each of the trades (plumbing, HVAC, paint, and electrical).
#41 Not Understanding the Market
You need to know where you are at in the market cycle and you need to understand the vagaries of your local market. While timing the market is difficult even in real estate investing, maximizing your leverage right at a market peak is a classic rookie mistake.
#42 Putting Up with Problem Tenants
Most tenants pay their rent and don't trash your property. There's no reason you need to put up with those who don't. If you don't have people fighting to get into your property and taking great care of it, you probably just need to lower rent slightly and you'll have a line out the door.
#43 Not Starting the Eviction or Foreclosure Process Promptly
Leopards don't change their spots. Have a clear eviction policy and follow it to a T. A good landlord has reasonable rules that are clearly explained and strictly enforced. The same applies when investing on the debt side. If a tenant doesn't pay rent or a borrower isn't making payments, that probably isn't going to change going forward. It's going to take months to evict or foreclose on them, so you might as well get started. Reasonable compassion is OK (you can always stop the eviction process), but you should get it started just as outlined in the contract.
#44 Ignoring Tenant Desires
Since most tenants are reasonable, you had best pay attention to what they want. If they're complaining about rats, replacing the tenant isn't going to solve the problem. If your ideal tenant at your price point and community wants two-bedroom apartments, don't build a complex with one-bedroom apartments. Pools are a necessity in Phoenix but not so much in Minneapolis where the tenant will likely care a lot more about snow removal.
#45 Skipping Inspections
While an offer without an inspection contingency is more attractive to a seller, major problems that can be missed without an adequate inspection can eat up your return and even your principal. Remember you can always get a STAT inspection before making an offer. With time, you may even become qualified to do a mini-inspection yourself.
#46 Not Looking at Comparables
The main way to determine the value of a property is to look at comparable properties that have recently sold. You don't want to pay dramatically more than somebody else just paid for a similar property. But you need to make sure the properties are actually similar. Many inexperienced or busy realtors will use comparables that aren't really comparable. It is best if you compare properties yourself in exactly the same way your prospective tenants will. A two-bedroom apartment managed by a jerk in a complex built in 1990 without a pool is not the same thing as a three-bedroom apartment managed by a saint built in 2010 with a pool.
#47 Not Providing Easy Access for Showings
Sometimes a tenant is interested in your property but is pressed for time. They have a regular job and busy family responsibilities. Plus, they're under time pressure from another landlord to put down a deposit or lose their spot in another property. If they can't see your property quickly at their convenience, you don't even have a chance to compete for their business.
#48 Overpaying for Real Estate Courses and Coaching
Education is important and many people learn best from online courses or even from a paid coach or mentor. However, there are plenty of extremely expensive real estate courses and coaches out there. Some people have even paid hundreds of thousands of dollars for those services. If you can get the same information and motivation from a cheaper course (or even without a course), you're just paying for hype and marketing. Read the reviews, try to find both satisfied and dissatisfied customers, and learn to recognize value. Good advice at a fair price should be your motto.
#49 Failing to Educate Yourself
Perhaps even worse than overpaying for education is not becoming educated in the first place. Real estate is a business, and if you don't know how it works, you'll make all the mistakes yourself.
#50 Failing to Research the Neighborhood
Due diligence and location analysis include understanding the surrounding area. That includes the state, the city, and even the neighborhood itself. Even within a neighborhood, things change from one block to another.
#51 Failing to Market Adequately
You might think you overpriced the property when, in reality, you just didn't get the word out there adequately. Think like a tenant. Where will they go when they need to find a place to live? Advertise there. Ask tenants where they heard about you so you know which of your marketing efforts are working and which are not.
#52 Pricing Too High
Sometimes the problem is the price, whether you're looking for a tenant or a buyer of your property. Some tenants might be willing to pay your price, but if you can't get enough of them to mostly fill your building, your rent is still too high.
#53 Waiting Until Spring to Sell an Investment Property
While spring is the most common time to sell a residence, real estate investors are always looking for their next investment. There is no reason to wait months just to “list it in the spring.”
#54 Not Seeing the End from the Beginning
You need to understand the exit strategy for an investment before you make it. Changing exit strategies midstream can be very expensive.
#55 Visiting a Property Only Once
Just like in radiology where “one view is no view,” seeing a property more than once can be very useful. Going by after dark can provide a very different experience than what you see at 10am. You are also likely to focus on different aspects on a second visit. The first time we toured our current residence, we were so smitten by the view that we couldn't even remember whether we liked the layout afterward. We had to go back and look at it again.
#56 Failing to Plan for the Unexpected
Bad things happen in real estate investing. A little extra cash and lots of flexibility go a long way in overcoming the obstacles that will be thrown your way. Stress test that pro-forma. How reliant is projected performance on each assumption, especially those assumptions with the least amount of data to support them?
#57 Not Expecting Taxes to Go Up
Taxes go up over time, but they particularly jump right after a property is purchased. Your estimates need to count on a significant tax increase.
#58 Not Managing Your Manager Adequately
Property managers, like bosses, need to be managed, too. Not only does a squeaky wheel get the grease, but a bad manager can cost you more money than you might think as they lose good tenants and pander to bad ones.
#59 Making Lowball Offers Instead of Fair Offers
Inexperienced real estate investors make lowball offers hoping for the best. You will be much better off figuring out what a property is actually worth and paying that. When asked why your offer is so low, you'll have a ready answer and a good argument for why they should sell it to you at your price. They will also discover that nobody else is willing to pay them any more than you are. Make your first offer a fair offer and stick with it rather than playing negotiating games like lowballing and then trying to split the difference.
#60 Not Taking Advantage of Cash
Cash is king in real estate. When you have it, you can get special deals not available to those who have to borrow money. Take advantage of that fact and make sure you're actually getting the special deals.
#61 Failing to Read Your Contracts or Mortgage Paperwork
I went to refinance once and discovered the lender had slipped in a prepayment penalty despite knowing that I was planning to move in just two more years. When called out on it, they crossed it out and we proceeded with the deal. If you don't have time to read the contracts, you need to find a different way to invest.
#62 Making the Same Mistake Twice
You're going to make mistakes as a real estate investor. Try not to make the same one twice.
If you are interested in private real estate investing opportunities, start your due diligence with those who support The White Coat Investor site:
Featured Real Estate Partners
DLP Capital
Type of Offering:
Fund
Primary Focus:
Multi-Family
Minimum Investment:
$100,000
Year Founded:
2008
Origin Investments
Type of Offering:
Fund
Primary Focus:
Multi-Family
Minimum Investment:
$50,000
Year Founded:
2007
37th Parallel
Type of Offering:
Fund / Syndication
Primary Focus:
Multi-Family
Minimum Investment:
$100,000
Year Founded:
2008
Southern Impression Homes
Type of Offering:
Turnkey
Primary Focus:
Single Family
Minimum Investment:
$60,000
Year Founded:
2017
Wellings Capital
Type of Offering:
Fund
Primary Focus:
Self-Storage / Mobile Homes
Minimum Investment:
$50,000
Year Founded:
2014
MLG Capital
Type of Offering:
Fund
Primary Focus:
Multi-Family
Minimum Investment:
$50,000
Year Founded:
1987
Mortar Group
Type of Offering:
Syndication
Primary Focus:
Multi-Family
Minimum Investment:
$50,000
Year Founded:
2001
AcreTrader
Type of Offering:
Platform
Primary Focus:
Farmland
Minimum Investment:
$15,000
Year Founded:
2017
* Please consider this an introduction to these companies and not a recommendation. You should do your own due diligence on any investment before investing. Most of these opportunities require accredited investor status.
What do you think? What mistakes have you made? What should we add to this list? Comment below!
The post The 60+ Worst Mistakes You Can Make in Real Estate Investing appeared first on The White Coat Investor - Investing & Personal Finance for Doctors.
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By: The White Coat Investor
Title: The 60+ Worst Mistakes You Can Make in Real Estate Investing
Sourced From: www.whitecoatinvestor.com/biggest-mistakes-in-real-estate-investing/
Published Date: Tue, 23 Apr 2024 06:30:34 +0000
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