It can be difficult for the newcomer in the real estate business to figure out the most successful strategy of investing. Investing in real estate is not only buying houses and apartments, dealing with tenants and flipping the commercial properties. There are plenty of pitfalls that can make first-timers lose their money fast.
You can avoid some common mistakes if you would take into account some tips we will enumerate in this article. Some of the mistakes concern only investors, the other risks are applicable to the flippers. Let us review the eight main risks you can face if you are a real estate investor.
- Undervaluation Of Repairs
If you decided to buy a house for flipping, you need to calculate the repairs needed. Sometimes the repairs include minor cosmetic retouchings like painting or roofing. In other cases, the house needs a complete renovation. When you are going to purchase a rental property, one of the major issues to consider is the cost of renovation and repair.
In some cases, if your goal is house flipping and you underestimate the cost of renovation, the return can be lower than expected. So, the mistake in the calculation of the repair results in very little income.
Include in your contract a clause that allows you to reject the transaction in case of unforeseen circumstances with a full deposit refund. You may need it in case if the home inspection finds out some unknown issues with the house.
Then find the most reliable and picky inspector in your local area and then send him to check the rental property. Also, walk through a piece of a real estate with few contractors and listen to their opinions about needed changes.
Make the list of the issues that need to be checked: electricity, painting, plumbing, the roof. Consult your real estate agent, inspector, and contractors. Ask the seller about the age of the building and other necessary questions and then cross-reference his responses with the conclusions made by your team.
- Extra Payments To Contractors
Besides the mistake of undervaluation of repairs, there is often a risk to overpay for contractors’ work. It is often a challenge for real estate investors to find trustworthy, reliable and affordable contractors. Sometimes the situation gets more complicated when you are investing long-distance.
Some unreliable contractors find ways to put a high price for the renovation. Before you sign a contract with them, they offer you lower bids but once you commit them to the project, the contractors find ways to charge you more.
Build relationships with the contractors over time. Firstly, assign the contractors to the small jobs and then, if you see the good results of their work and they meet your requirements, you can task them with larger projects.
Discuss with the contractors all the potential risks or surprises of the real estate you are going to purchase. If they tell you about these risks, ask them about the additional amount of finance in the worst case.
Consult with the other contractors about repairs needed for your property and then compare their answers with the thoughts of the main contractor you assigned. Then apply all the necessary measures to minimize the potential risks and avoid extra expenses.
Negotiate with your realtor the contractor’s pricing and deadlines before signing the contract. After that find at least one real estate investor and ask him the opinion about the contractors.
When you sign a contract, keep in touch with the contractor. Regularly check the quality of work and talk about any concerns immediately.
Tips For Flippers
The tips we mentioned above are suitable for residential real estate investors but let us talk more precisely about the flippers.
- Overestimating After-Repair Value
The risk of overestimating ARV of after-repair value results in losing some significant amounts of costs. You should not overestimate the after-repair value in order to gain a good profit. The final price of your property may turn from a mathematical forecast to someone’s prediction.
If you purchase a property for $50,000, with the cost of repairs about $25,000, and you are going to sell it for $105,000 but you manage to earn only $80,000, then you may lose money.
You can look through the specialized websites and compare the property sales and estimate current values and the prices of the property after repair. To make the most accurate comparison, search for the property that is similar to yours according to some characteristics like the condition of the building or floor plan.
Take into consideration three major numbers:
- Minimum after-repair value
- Moderate ARV
- Approximate ARV
These numbers will serve you as the indicators that you are moving in the right direction, and will help you to stay in course.
- Unvervalying Soft Costs
In property flipping, soft costs are the expenses that include utilities, insurance, taxes, interest, lender fee, and other costs, except renovation, labor costs, and material.
You need to take into consideration that you need to pay soft costs every month. So, the longer you have a property in your possession, the larger the number of soft costs you need to pay in general. Thus, you will receive a smaller profit.
That is why it is essential for contractors to complete their job on time.
Divide the soft costs into three main categories:
- One-time purchase expenses
- Expenses per month
- One-time selling expenses
One-time purchase expenses usually include home inspection, property insurance, lender fees, and appraisal. Get the evaluation from your lender and then add some extra costs to the list in order to ensure safety.
Monthly expenses consist of property taxes, utilities and loan payments. The biggest expenditure is the realtor’s commission and additional fees.
The flipper’s income usually depends on two options: expenses and after-repair value. If you manage to calculate these numbers properly, you will earn a good return. If you have some concerns, add some additional money for expenses and take into account minimal ARV.
Tips For Long-Term Investors
Long-term and buy-and-hold investors face their own unique risks that we will discuss below.
5. Overvaluing Rents
Comparing to the flippers who may face the risk of overestimating after-repair value, long-term investors can overvalue the rent price. You need to estimate the cash flow from rents in a proper way.
Firstly, check the local rental listings, review the newspapers and research the rental marketing prices in your neighborhood.
Secondly, imagine yourself as a renter and explore some houses and properties for rent. You need to have a good understanding of the prices in the local market.
6. Undervaluing Rental Costs
The most common mistake among landlords is underestimating rental expenses. This leads to the loss of potential profit.
As an owner of the rental property, you need to take into consideration the following expenses:
- property management;
- vacancy rate;
- administrative, travel and other costs.
You can follow the “50% Rule” which implies that about half of the rent will be spent on non-mortgage expenses. The 50% Rule is the most useful formula applied by the most skillful investors to determine cash flow from the property. This method is applicable to any type of real estate, including townhouses, single-family houses, and large apartment buildings. If you buy a piece of real estate that does not generate cash flow according to the 50% Rule, you may experience a great financial risk. That is why it is important to search for those properties that correspond to this rule and gain a positive monthly income.
Calculate the approximate amount of costs for each item from the above-mentioned list. Talk to property managers and landlords from your area about vacancy rates.
Keep in mind that the older property needs more costs on repair, thus preventive measures are more advantageous than the costs for repair after a long amount of time.
7. Unpaid Rents
Sometimes renting out a property is a risk because you may encounter dishonest tenants. In fact, you are entrusting your asset at a cost of millions of dollars, to complete strangers. In addition, you can not fully count on courts, because most part of landlord-tenant laws usually protects tenants more than landlords, especially in large cities.
A good way to avoid dishonest tenants is tenant screening. Tenants screening reports usually contain one or more items:
- consumer credit report;
- rental references;
- eviction records search;
- criminal records search;
- employment verifications etc.
You need to put a lot of effort into finding good tenants. Examine every tenant application attentively, check their credit and criminal reports thoroughly. Talk to the previous landlords and employers.
8. Damage Caused By Tenants
As in the previous case, you can encounter horrible tenants who may cause damage to your rental property. For example, tenants can throw a party without your knowledge or forget to unplug the iron.
The tenant screening method also is quite useful here. You may ask previous landlords about the tenants, especially about their cleanliness and how well they treated the property. In addition to that, you may also visit the current property where your tenants live and pay attention to the surroundings.
One more way to prevent your property from damage caused by the tenants is regular inspections. You need to include these semi-annual inspections to your contract.
This approach is useful due to the following reasons:
- It warns your tenants that if they will not treat the property in an appropriate way, they will receive the notice from you to correct the situation.
- It is a clear message that you hold your property in perfect condition and expect the same approach from them.
We described some useful tips for real estate investors and flippers. These methods are very simple, though you need to put some work into it. If you follow these tips, we guarantee that you will avoid the risks that include losing the part of the profit, fixing the damage caused by horrible tenants or selling the property at a low price.
All these methods require some amount of time and a little effort, though they made bring significant results in the future. One of the essential factors of success in the real estate business is a reliable team of professionals. So, gather the team of a real estate agent, property manager, and contractors, and that is half of the battle.