Top 3 Real Estate Investment Mistakes To Avoid
Investing in real estate can be a lucrative way to build up your portfolio and create a passive income for your future — but first-time real estate investors can face an uphill battle if they jump into it without an effective plan. When it comes to buying and renting properties, it's essential to avoid some classic mistakes.
In this guide, we're touching upon some of the most detrimental mistakes inexperienced investors make — and how you can avoid falling into the same trap.
Not Shopping Around for Financing
Financing investment property is different to financing your personal residence, and you should expect to pay a higher interest rate. Inexperienced investors often go wrong by opting for an adjustable-rate loan, or an interest-only loan. This isn't a bad option if you can afford a rise in the interest rate, but you may find yourself in hot water if you can't.
Seeking the advice of a mortgage advisor can help you to weigh up the pros and cons of each loan product that's available, enabling you to make an informed decision.
Forgetting Their Due-Diligence
When you purchase an investment property, it is crucial that you research not only the property in depth but also the neighborhood. This is especially important if you plan to rent out your property, as the type of home and neighborhood will dictate your potential renter. For example, four-bedroom single-family home is likely to attract families with children; therefore, the school zone becomes an important aspect.
Other things you should consider include; is the property located in a flood zone or an area of high crime that would increase your insurance premiums? Does the home have local amenities nearby that will attract renters, such as entertainment and dining options? It's also a good idea to try and find out if there are any plans for new commercial developments around your chosen neighborhood, which could potentially increase (or decrease!) the property's value in the future.
Paying Too Much
This is arguably the most important thing to consider when purchasing an investment property. Paying more than a house is worth, or can taking on more debt than you can recoup in rent, can cause a multitude of problems for investors. If you've found an investment property that ticks all of your boxes, be sure to compare how much similar homes in the area have sold for in recent months. It is crucial to keep your offer consistent with comparable sales in the neighborhood — If you aren't sure how much to offer, reach out to a local real estate agent or a company that specializes in investment properties.
Calculating the "capitalization rate" (colloquially known as the cap rate) is one way to assess the profitability and return potential of a property. You can calculate the cap rate by the following:
Capitalization Rate = Net Operating Income (NOI) / Current Market Value
The NOI is the expected annual income (e.g. from rent) and is calculated by deducting all management expenses, such as maintenance and property expenses. The current market value is the value of the property at this moment, according to the open market.
For example, if you purchase a home for $200,000 and believe the NOI will be $16,000 annually, the cap rate would be 8%. This is greater than the 5%-6% return of long-term government bonds.
Although you may be tempted to try and save money by handling everything on your own, consulting a real estate investment professional can save you (and make you!) thousands of dollars in the long run. A knowledgeable professional can advise you on potential neighborhoods, locate investment properties, and help you avoid the stresses and uncertainty of navigating the real estate investment process alone.
If you have any questions regarding purchasing a single-family rental home, we would be happy to assist you! You can reach us here, and also check out our podcast for general financial advice and useful tidbits.
All information and materials in this article are for educational purposes only. Opinions expressed in this article are based on information considered reliable, but The Daily Money Show cannot guarantee the accuracy of the information, nor should it be relied upon. The information discussed in this article should not be used as a recommendation to buy or sell securities, nor should it be taken as investment advice. The Daily Money Show is not a Registered Investment Advisor or Broker Dealer. The Daily Money Show is not an accounting firm and does not give tax advice regarding any security or real estate transaction. You may want to consult with an accountant, attorney, real estate agent, or financial advisor before proceeding with any transaction regarding securities or real estate.