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SHOW NOTES FOR EPISODE 386: 7 TIPS TO AVOID MAKING A BAD REAL ESTATE INVESTMENT
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7 Tips to Avoid Making a Bad Real Estate Investment
Bad deals in real estate are everywhere. Unfortunately, quite a few novice investors fall into their trap. Whether it’s a lack of due diligence or overinflated numbers from the seller, things can often go wrong. But thankfully, there are just as many good real estate deals out there waiting for investors. In today’s podcast, Bill shares seven valuable tips on how to avoid bad real estate deals.
1. Find the Right Neighborhood
Buying an investment property in a bad neighborhood is one of the worst things a real estate investor can do. As the old adage goes, real estate is all about location, location, location.
The worst neighborhoods will typically offer subpar occupancy rates, poor rent growth, and low appreciation. This all compounds to create an unfortunate situation for investors: you may struggle to find tenants, charge reasonable rental rates, or even resell the rental property for a profit. So don’t let low price tags fool you into thinking you’re automatically getting a good real estate deal!
Every real estate investor needs to study up on the neighborhood they plan to invest in. Because if you buy a rental property in a bad neighborhood, there’s not much that can salvage your investment.
Investment properties don’t exist in a vacuum, and the real estate market trends within a neighborhood have a huge impact on the success of your investment. Performing your due diligence by studying the neighborhood is a great way to avoid bad real estate deals.
2. Check Your Cash Flow
One thing that catches a lot of real estate investors by surprise is cash flow issues. If you end up with a bad rental property, your income might struggle to catch up with your expenses.
To avoid a bad real estate deal, make sure to study up on your cash flow before purchase. You’ll need to take an exhaustive look at every cent that has to be spent on the rental property to avoid any surprises. Thereafter, work on maximizing the avenues wherein the same property can generate income. If you can guarantee positive cash flow, you’re on the tail of a good real estate investment.
By using a real estate investment calculator, you can simplify this process quite a bit. Compile all of your expenses, such as mortgage interest, maintenance costs, upgrade costs, and others. If the calculator provides you with negative cash flow based on the rental income estimates, that are one of the most blatant signs of a bad real estate deal. And the best real estate deals will provide investors with very high cash flow — and therefore a very high income.
3. Have Ample Reserves
Every rental property comes with its surprises and challenges. You can have years of great, consistent cash flow without an issue and then – Bam! Something happens that can wipe out a year’s worth of cash flow over night. It’s happened to me! Even with a single family home, things like extended vacancies, broken water heaters, A/C condensers, weather damage, replace plumbing, pay for extensive tenant damage, black mold remediation, property tax or insurance increases… and the list goes on and one. A smart landlord should always have an untouched cash reserve equal to at least 6 month’s worth of regular expenses (that includes mortgage, property taxes, insurance, utilities, lawn care, repair/maintenance, etc.).
4. Perform a Real Estate Return on Investment Analysis
A lot of beginner investors get into bad real estate deals because of one simple reason: not running the right numbers. When it comes to making an investment, properties for sale need to be evaluated very thoroughly. The worst investment property is one that provides a low return on investment.
Thankfully, there’s a handful of free powerful tools that can use to help. By performing an investment property analysis, you can mitigate a lot of this risk. BiggerPockets offers online calculators and estimators that crunch all of the numbers you need to make a successful property investment. It compounds the asking price with the amount of income it can generate to give you a holistic view of the return on investment you could be making. These tools makes research so easy, so you could easily compare dozens of rental properties for sale to find one with a high return on investment (granted there is a limit for free use but Pro or Premium members can get unlimited reports). This is a fantastic way to avoid a bad real estate deal and guarantee that you’ll be making a good sum of money from the investment. The worst real estate deal is one that provides no or negative ROI.
5. Know the Market Value
As a beginner real estate investor, there’s a good chance you fall into this trap: overpaying. There can often be quite a large rift between the listing price and market value, as a property seller may overestimate the value.
One of the best things you can do in this regard is to study your real estate comps. Comps are properties of similar specifications, and within a comparable region that have sold in recent months. This data can go a long way to informing whether your selected property is overpriced. To avoid real estate deals gone bad, a real estate agent can be very helpful in these cases.
This information can also be pulled from Realtor.com, Zillow or Trulia or through the MLS (if you have access) or a Realtor. If it’s a commercial property, you can work with a commercial broker.
6. Conduct a Home Inspection
Hands down, the best way to avoid a bad real estate deal is to perform a thorough home inspection BEFORE you buy. Without a proper inspection, there’s a real risk you may end up with a lemon of an investment property.
Inspections come in different forms and can vary in quality, quite significantly depending on the provider and the selected services. In a majority of cases, home inspections will cover your “mechanicals” electrical wiring, plumbing, insulation, foundation and a small handful of other features. This is already a great step towards avoiding a bad real estate deal. You may, however, want to go for a more holistic service. Basic inspections don’t typically cover things like asbestos, sprinkler systems, and additional facilities. You may, therefore, want to consider taking on additional inspections to guarantee that you don’t fall into a bad real estate deal and avoid losing money in real estate.
Also, don’t forget to check if your property is in a flood zone. This information is available at no cost online.
7. Contingencies to Make Sure You Have an Out
If you’ve gotten yourself in a bad real estate deal: fear not. Here’s how to get out of it.
Contingencies in real estate are clauses that you can agree upon with a property seller at the time of purchase, which can prohibit such things as the transfer of liens or getting stuck with deferred capital expenditures. If one or more of these contingencies is violated, you have the right to back out of the deal at any time.
In a majority of cases, you’ll be able to exit a bad real estate deal if the property does not pass a home inspection. Therefore, it is crucial that you start this process as soon as possible.
Finally, before negotiations wrap up, consider hiring a home appraiser. A real estate appraisal can be a great negotiating tool during pending sales that would allow you to reduce the price, or otherwise break off the deal entirely. Many real estate deals gone bad could have been saved with a proper appraisal.
In Conclusion
Real estate investing gone bad can be a huge detriment to any investor’s career. But by following these key tips, you’ll know how to avoid a lemon. Finding good real estate deals depends pretty heavily on conducting the proper due diligence, using the right tools, and making sure you have an easy exit if things should go south.
Well, that’s it for Today!
DISCLAIMER: Many of the above strategies take knowledge and have a higher degree of risk. You need to do your research and/or work with someone who is experienced to reduce your risk.
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