Many people have learned that Investing in real estate is not as easy as it seems. At least that is true for investors trying to get a fair deal. For those of us who have been investing for years, and learned many hard and expensive lessons, here are issues you should think through, understand, and consider before jumping into the real estate investing arena. These are in no particular order, since an individual would be smart to read and think through each and every “lesson learned” in the list.
1. Not penciling out your real estate deal
This describes about 80 percent or more of real estate investors.
They don’t take the time to put pencil to paper and make sure that the rental revenue from the property will be more than all the property expenses – and leave some monies left over to return to one’s bank account.
A negative cash flow property will virtually guarantee a measly – at best – investment return on your money.
2. Not penciling out your deal with conservative numbers
For those few fortunate ones who do know how to pencil out a deal, many use unrealistic numbers. They overestimate rental income, underestimate the vacancy, then underestimate the expenses associated with operating a property. That turns into low or negative investment returns for the property owner.
3. Getting renovation costs wrong
Most buyers have little idea how much it costs to renovate a property. They listen to the home inspector, their real estate agent, and just throw out a number like $25,000 for everything. Then they start getting bids for the work and quickly see it will actually cost $80,000 for everything. Word to the wise: Always do a lot of homework and be very conservative in your renovation budget estimates.
4. Underestimating renovation time
Additionally, inexperienced investors believe a good renovation can be done in 30 days, or 60 days. Many times it takes much longer to finish these projects than originally estimated. As a real estate buyer, you should talk to others who are experienced to get a realistic expectation of the time involved in a property rehabilitation.
5. Thinking something can only cost ‘that much’
It never does, it always costs more; many times much much more. So whatever the expense, renovation, service, contract, capital item, etc; chances are it will cost more than you think.
Looking to diversify your investments and take advantage of the current dip in real estate prices? While by no means a passive investment, if you’re up to the challenge, residential rental property ownership can provide not just additional short- and long-term income, but tax benefits as well.
But the trick’s in the buying. An error at this critical stage is one you’ll pay for again and again over the life of the property, so it’s important to be a well-informed and cautious buyer, taking the time to do the necessary research.
My own experience with six rental properties has taught me a few things worth sharing.
1. Buy at the right price
A bargain now will help you to better withstand fluctuations in property value over time so you can profit if and when you eventually sell. Whether working with a realtor or solo, you need to develop a deep understanding of what constitutes a “value” price in the neighborhood(s) you’re looking at. As an investor, you can keep making low-ball offers and wait for the deal you want, but great bargains generally get snapped up, so you need to be able to act quickly once your target’s in sight.
You also need to benchmark rental prices for comparable units in the area, getting a feel for demand. The local classifieds are a great starting point for this, and a few hours of research should give you a good basis for determining what you can charge. Just make sure to factor in for utilities (electric, gas, oil, water, sewer, cable, etc.) if they’re included.
Depending on your personal goals, there may not be enough of a spread between what you will pay out monthly in mortgage, taxes, and utilities and what you can charge. Figure out what your spread needs to be, and analyze every house you consider against this amount. My rule of thumb, since I’m looking to make a yearly profit without much additional out-of-pocket investment beyond the down payment, is that there needs to be at least a $500 difference per month between income and costs.
Of course, a bigger spread is preferable, as it means more profit. If you’ve got a few good options to consider, the spread can aid in your decision-making.
2. Find the right neighborhood
Rental properties don’t always make good neighbors, but there are a few tricks to making it work. Overall, it’s important to find a community where your rental property will have a good chance of being accepted, and the ritziest corner of town may not be it. On the other hand, it’s hard to find and keep good tenants in bad areas, where crime rates may be higher.
I’ve had the best luck with solid working-class neighborhoods, generally middle to lower income areas where tradesmen and even some businesses might reside, intermingled with the houses. One can often tell these neighborhoods by the work vans and trucks parked in the driveways. Not only do the residents understand the value of hard work, they appreciate the effort I invest in rehabilitating and improving my properties. Your presence in the neighborhood should help to make it a better place.
Regardless of what neighborhood you choose, you never want your property to be the worst-looking one on the street, or complaints and possibly citations may follow. If you choose a property which visibly needs maintenance, you should budget to correct these issues within the first year, and ideally prior to renting it at all. This helps to show the township or city officials that you’re one of the good landlords, committed to keeping your property up, and can make a huge difference in your experiences over the life of the property.
Each property you own serves as a reference to your work, abilities, and commitment.
3. Be aware of local rental regulations
In many locales, rental properties are treated more like businesses than residences, and while 8×10 might constitute a proper bedroom in your personal home, it likely won’t be considered such for a rental property. In one local township where we presently own three properties, there are minimum ceiling heights (7′) and square footage (100 sq. ft.) for bedrooms, substantially different from what is required for residential homes. Occupancy is calculated by the township based on the square footage of the unit, so what the local realtor touts as a four bedroom home may only legitimately be a two bedroom home if rented.
Township-enforced renovations can be a massive expense; in fact, I personally know someone who paid nearly $50,000 to get two basement bedrooms and a bathroom upgraded to meet this code. He’d bought the house with a “finished basement” which the previous owners had completed without a permit. Because rental properties are treated as businesses, he was not allowed to do the work himself but had to hire an architect to draw and seal the plans, then licensed plumbers, electricians, and building contractors to do the work.
It is a safe assumption that you’ll need to bring your property into accordance with local rental regulations prior to your earning any income from the property. Knowing the issues, you can budget accordingly.
4. Ensure proper parking is available
In one local township, parking requirements for rental and residential real estate differ substantially. While almost anything goes for residential homes, for rentals, one paved off-street parking space is required for all tenants old enough to hold a driver’s license, whether or not they actually have a license or own a car. A house rented to a family of two fiftysomething adults, an 18 year old son and 20 year old daughter would require 4 parking spaces.
Other jurisdictions may institute a flat, per-property parking space requirement or even a sliding scale based on square footage. More and more municipalities are passing such regulations, which are often conditions for licensure. Landlords are being forced to either retrofit their properties to meet the new requirements or throw in the towel and sell, as some lots lack the space to provide sufficient paved parking.
Besides meeting existing regulations, off-street parking is desirable for landlords seeking quality tenants in areas where cars are de rigeur. People who care about their cars don’t like to park them on the street, so offering a protected parking spot can help you to attract better tenants.