654: 5 Common Mistakes Real Estate Investors Make

SHOW NOTES FOR EPISODE 654: 5 COMMON MISTAKES REAL ESTATE INVESTORS MAKE

Mistakes are a gift.  Without them, the learning process can take so much longer.  But it’s always better when others share the mistakes they’ve made and lessons learned – saving you the personal pain points!  In today’s podcast, Bill shares 5 common mistakes he and other real estate investors have made and how you can prevent the same from happening to you.

As you know if you have listened this show for any amount of time, I always ask my new guests what their biggest mistake was and what they learned from that mistake. One of the reasons I do that is because we can learn a lot from the mistakes of other real estate investors who are successful today.

My guests have shared many different mistakes, all of which have been very helpful to know for me personally and my listeners.

To be sure, there’s a lot that can go wrong when you invest in real estate. You can overpay for a property, buy in the wrong area, use the wrong lender or loan product, or overestimate the rent you’re likely to receive, just to name a few. The list of mistakes is far too long to discuss in this podcast. But here are four big mistakes first-time and experienced real estate investors should know about and take steps to avoid.

These are five potentially costly mistakes have been shared by guests and are mistakes that I have personally experienced.

#1 Plan for the Unexpected

If you buy a rental property that brings in $2,000 in monthly rent, and your monthly mortgage payment including taxes and insurance is $1,500, it may seem like the property should produce $500 in monthly cash flow. But that’s rarely the case.

One big mistake new real estate investors make is that they fail to budget for the unexpected — specifically vacancies and repairs.

At some point, your property will be unoccupied. It may only be for a few weeks between tenants, but it’s going to happen. This is why I encourage new investors to at least purchase a duplex as a first property, or, better yet, a fourplex.  That way, if you have a vacancy, it only impacts one half of your cash flow with a duplex, or one forth, if it’s a fourplex.

That’s why, as a rule of thumb, it’d a good idea to set aside 10% of the rent to cover vacancies so you don’t have to come out of pocket to pay the mortgage when your tenants move out.  When a tenant moves out, you have, what I call “turnover” or “turn around” expenses (painting/fixing things, replacing things like carpet or re-keying locks, etc.)

You’re also going to need to set money aside for maintenance and repairs over time.  That’s for fixing clogged sinks and toilets, repairing leaky roofs, replacing light bulbs, servicing air conditioners, heaters, changing filters, and repairing appliances, etc.  – not to mention replacing costly items like water heaters, HVAC, and appliances.  Plan to set aside another 10% to 15% of the rent you collect to cover maintenance and repairs.

When calculating your expected cash flow, don’t forget to consider these expenses, or your projections aren’t likely to be too realistic.

#2 Don’t Self-Manage Just to Save Money

When you buy your first investment property, you have to choose whether you want to hire a property manager or do it yourself. And if you’re not familiar, property managers typically take about 10% of collected rent on a long-term rental property.

To be sure, there are some good reasons to self-manage. For example, maybe you’re a retiree and have the time to deal with tenant issues. However, it’s important to realize that property managers can provide tremendous value for their 10% cut, and the decision to self-manage shouldn’t just be to save money.

A good property manager will market the property, screen tenants, handle complaints and tenant issues, schedule maintenance, pay utilities on your behalf, and more. And a property manager will likely know exactly how to price your rental property, which in many cases can be worth the 10% commission all by itself.

#3 Don’t Forget Administrative and Professional Fees

Your rental property – even if you only have one – is a business!  And you need to treat it as such.  Your accounting and bookkeeping are critical.  One of the biggest advantages of real estate investing are the great write-offs and tax advantages you have.  But you can’t enjoy that great benefit without keeping very good and detailed records.  Whether you get QuickBooks and try to do it yourself or employ bookkeepers and CPAs, there are real costs associated with that.

Not to mention attorney fees for the multiple legal documents associated with buying and selling properties, leases, evictions, setting up LLCs, and more.

And there are other costs like marketing a vacancy, paying lease-up and renewal fees, property management and others.

#4 Rental Properties Aren’t the Only Way to Go

It’s important to mention that (especially in today’s inflated real estate market) rental properties aren’t the only real estate investments available. In fact, in some markets, it’s very difficult to find a rental property that will produce positive cash flow, unless you’re willing to buy a property that’s in need of major repairs or upgrades.

You can invest in real estate through crowdfunding sites, syndications, buying deeds, trust and liens, as a hard money lender, wholesaler, flipper and more.

In fact, many investors are finding that real estate investment trusts, or REITs, are a great choice in the current environment. They have the same general concept (rent properties for income). Many REITs have long track records of growing profits and raising their dividends every year, so if you’re thinking of investing in real estate for the first time, maybe this option is worth considering.

#5 Avoid “Class C” Properties

One of my personal mistakes is that I purchased a bunch of “Class C” properties when I first started in real estate investing because they were cheap.

Class C properties are usually older buildings that are more than 30 years old with minimal amenities and outdated systems.  In fact, they may have most of their original appliances and systems.  Many of these investment properties show visible deterioration and often have deferred maintenance issues.  Due to their poor condition, they tend to have lower upfront costs compared to the other property classes.  However, they will often require more ongoing repairs and hands-on maintenance.  As a real estate investor, you must invest some money in repairing the structure and mechanical systems.  Some properties will require more than others and some will require significant renovation work before they can be expected to provide steady cash flows.

With all the negative characteristics of Class C properties, you may be wondering why an investor would want to invest in a Class C property.  One aspect that makes a Class C property a good real estate investment is the low acquisition cost.  They are cheaper than Class A and Class B properties and the rental rate is usually more than 1% of the acquisition cost.  Therefore, the return on investment when investing in these properties is higher in terms of cash flow and cap rates.  Out of all multifamily asset classes, these properties offer the highest potential for bigger cash flow.  Since areas with this type of rental property tend to have lower-wage tenants, home ownership is usually a big challenge.  Therefore, you will have a deep pool of renters if you decide to buy Class C properties for investment.  If your real estate investment strategy focuses on cash flow, then Class C properties may be a good investment. With the right strategy, it can still very lucrative.

In Conclusion

The bottom line!  Learn from other people’s mistakes.  I still believe real estate investing is still the best investment out there.  You just need to do your homework, understand the numbers, be a wise steward and sit back and reap the rewards!

Reference:

https://www.fool.com/investing/2022/08/25/real-estate-investing-3-mistakes-id-warn-every-new/

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