We are certainly in an interesting time as real estate investors. Is it a good time for real estate investors or is it a bad time? Yes!
Huh? Why would I say that? Well, when there are significant changes in the real estate investing landscape, there are always opportunities for those that are prepared.
Unfortunately, there are also real estate investors that can make missteps and wind up having to deal with the unpleasant outcomes. Real estate investing like any other investing always carries risks. These risks can be reduced and or mitigated, but never eliminated. One of the best ways to reduce risks is to avoid making mistakes where ever possible.
As a real estate investor for over thirty years, I have seen many mistakes, and in these interesting times, I felt that it was worth sharing the 10 biggest mistakes that real estate investors should avoid.
1) Overpaying for Properties
Overpaying for properties can eat into profits and make it difficult to generate a return on investment. So many of real estate investors get caught up in the frenzy of FOMO, which generally results in higher competition and bidding wars. This phenomenon usually occurs later in the buying cycle in a particular market. Understanding the real values of property both currently and potentially in the short- and long-term future will be paramount in your real estate investing decision making. Is the intended fishing hole overcrowded?
One caveat is that overpaying for a property based upon its current value may not be a mistake especially if you have some verifiable information that could significantly and positively alter the values of the properties, i.e. New LRT Line stations announced within 1 KM of the intended property.
2) Failing to Conduct Due Diligence
Conducting thorough due diligence is essential to understanding the potential risks and rewards of a property investment. It is critical for real estate investors to spend the necessary time to conduct this due diligence. It not only includes due diligence on the property, income and expense projections but you need to understand the conditions of your specific target marketplace at the local, provincial and national level.
Investors that ignore this step or don’t take it seriously enough can easily find their investment value upside down, which can have an adverse effect and can affect the entire real estate portfolio.
3) Ignoring Market Trends
The notion about “location, location, location” used in many real estate investment circles and agents, and even though it is arguably important, there is an even more important factor which I wrote about in my real estate investing book “Look Before You Leap, But Leap!” It is “Timing, timing, timing”, which refers to market trends within the real estate cycle. In my opinion it is even more than location because if you are investing in the market at the wrong point on the real estate cycle then it really doesn’t matter what the location is. The trend can be your friend or not. Failing to keep up with market trends and changes can lead to missed opportunities and poor investment decisions.
4) Underestimating Expenses
Underestimating expenses, such as property maintenance and repairs, can quickly eat into profits, making it difficult to generate a positive return. I can’t tell you the number of times I have reviewed investors’ proformas and found underestimated expenses.
Property taxes, insurance, repairs and maintenance, and now the “Biggy”… mortgage payments, especially if the investor has been using variable rate mortgage financing. With the significant increases in the prime mortgage rate, many investors are finding that the net rent is not even covering the monthly mortgage payments.
Now if the investor has several properties this can be a very concerning situation. To avoid this pitfall, expense estimates should build in a margin of growth and need to be done regularly to keep up with inflation and changing costs.
Getting back to the idea of underestimating the expense excluding mortgage what I have found is either the actual amounts are too low because they were based upon previous conditions that are no longer reflective of today, or even worse they do not account for the future increases in expenses in these inflationary times. I have always been an investor that generally over estimates the expenses so that if I am wrong then it is a good surprise.
This is another real estate investment portfolio killer. Over-leverage is that “Jenga” block that can topple the entire structure.
Taking on too much debt or leveraging properties to the max can lead to financial instability and put investors at risk of default. It was so tempting to take on lots of debt building a portfolio with cheap “borrowed” money using none of your own cash. So many did exactly that and have accumulated up huge HELOC balances because their home values significantly increased, and the banks were happy to lend them the funds based upon the higher values.
It’s my experience that nothing goes up or goes down forever and one needs to plan for that eventuality. There is a cyclical nature to everything.
Unfortunately, this over-leveraged situation in a rising interest rate environment is not over, and there will be real financial fallout for those investors that are not financially well backstopped. If the overleveraged investor can hold on to the properties through this tumultuous time, then they may be okay once things settle down, but planning and budgeting around what is happening and stress testing the investment real estate portfolio is a critical step. Contact an investment mortgage broker if you need to but don’t wait till it’s too late!
6) Failing to Plan for Contingencies
Unexpected events can impact property investments, so it’s important to plan for contingencies. The simple idea of creating a contingency fund for those inevitable cost overruns for maintenance, repairs, and renovations seems to get lost with some investors. It is another major error that happens often and it can wreak havoc on a proforma.
For example, in my experience I have never seen a renovation that has happened on budget and on time, both of which are integral to your investment profit whether to renovate to sell or rent.
All investments carry potential risk with the potential reward. As an investor it is imperative to address the potential downside risk which I refer to as those landmines you don’t see or want to see but are there all the same.
Building contingencies into your plan will only create a stronger portfolio. No winning leader goes into battle without a plan and contingencies for the unexpected.
7) Not Having an Exit Strategy
Having a clear exit strategy is essential to knowing when to sell a property and maximize returns. In an ideal world that can and does happen and I have made very good returns doing so.
Call me cautious, but I believe that it is better to have more than one exit strategy. It is not always about selling the property because life doesn’t always cooperate with our plans even if we have done all our research. There are things such as black swan events that occur which can decisively alter the norms. Do you remember the 2008 financial crisis which affected real estate not only the US where it started, but also globally including Canada? So many homeowner and investors were blindsided by this event, just like they are now with the rapidly increasing interest rates that weren’t supposed to happen for a while.
So, if the timing is not right to sell, what are some alternatives? Can you do a joint venture? Was there a plan to leave the properties for the family and s there something that could be done there? Is the property right for doing a rent to own? Can you afford to wait to sell it? These are just a few different exit strategies that an investor can plan for when buying the property so that if there is a surprise the investor can minimize the impact.
8) Being Too Emotional
Making investment decisions based on emotions rather than facts and data can lead to poor investments.
Investing in real estate is a business and needs to be treated as such. The facts and data need to drive the decision making for performance and a profitable outcome.
9) Ignoring the Importance of Location
As I alluded to in mistake #3 above, location is very important. In fact, the location of a property is a key factor in its potential value and return on investment. It can mean the difference of making a profit when selling, and earning a good return when renting. It can even make a difference in the quality of tenants you attract and how your property is looked after.
Knowing what is happening or planned by the city for the neighbourhood in which your property is located is incredibly important. When you ignore that type of readily available information can lead to disastrous results. It comes back to doing your due diligence before purchase and staying up to date with current and future plans for the area is paramount to any real estate investor’s success
10) Failing to Diversify
There are two schools of thought around real estate investing: one is concentrate all your focus on only one area and become that expert investor in that area; and the other is to diversify. Both have their pros and cons.
Putting all your financial eggs in one basket by investing in only one type of property or location can increase reward when all is great, but it can certainly increase your risk and limit potential returns when the market is not trending as you may have projected. When this error is made in conjunction with any one of the previous errors, it too can have cascading negative results.
When diversifying for the purpose of reducing potential risk, as an investor, you can wind up foregoing stronger potential returns if you have not done your due diligence with regards to understand that secondary market or property type.
Generally your financial resources to invest in real estate are limited, so being strategic with your real estate investing does take research and because all the data is not definitive, at times it takes courage and calculated risks to determine when and if to diversify or not.
In my experience, I believe that you can do both, but it must be a sequential thing unless you have a team of market experts in several locations and the markets in which you are focused are all “popping” at the same time. That rarely happens!
As an investor and a licensed real estate investment agent in BC and AB, I have seen the good bad and ugly when it comes to these mistakes. I will share some case studies of these mistakes in future blogs so that it may help you to avoid them. The bottom line is with proper planning, budgeting, having a trustworthy team of experienced, qualified experts you can avoid these BIG mistakes, can reduce your risks, make smarter investment decisions, and achieve greater success in the long run. If you are finding yourself in any of these situations don’t wait but get on it and contact me so that I can assist you.