To demonstrate how these 10 Big Mistakes can affect your investment real estate, here are some real life examples. Many of these BIG mistakes are interconnected because one decision may affect another.
1) Overpaying for Properties
This mistake happens because of Mistake #8 where an investor gets emotionally fixated on a property and logic takes the back seat, so stick to the financial data it reveals the real value. Don’t fall in love with the property but focus on the deal profitability. There are always other deals!
Also, another real life example of overpaying is the presale market, where the developer is throwing all sorts of “goodies” (buyer incentives) in with the deal, such as condo fees, property taxes, management fees, and rent guarantees for a set period of time.
Developers are not philanthropic and needs to get enough sales for construction financing. Also, all of those “goodies” will be built into the price. You are actually paying for them in advance, which many investors mistakenly overlook.
How to avoid this mistake and improve the clarity of the deal is to ask for the price net of these incentives.
You have no firm idea what the actual market rent for that type of property, the property taxes, or condo fees will be in the future years upon completion.
2) Failing to Conduct Due Diligence
This mistake is simply a lack of proper due diligence on the market, neighbourhood, the property, etc. and can result in significant negative results.
With the wealth of information available on the internet, there is no excuse to not conduct proper due diligence. An experienced and detail-orientated real estate advisor can also help you with that.
One of the biggest areas of risk is in property presales, limited partnerships, Mortgage Investment Corporations (MICs), or strata titled hotels. This is because in all cases, it is extremely difficult to get detailed information because the investment incorporates a large number of variables and inputs.
Things such the asset management, lack of actual details of individual performance for many properties across a portfolio, property evaluations, and an overall reliance on those in charge of the investment provides lack of control by the investor and leaves you vulnerable.
Your investment will usually be locked in for a period of time with no control or reporting and are based upon future growth.
Can you invest in these vehicles and still conduct proper due diligence? Perhaps yes but only to the degree that information is provided by those that run the investments.
I always suggest conducting due diligence on the management and principals involved, and have that form of investment reviewed by independent professionals such as accountants, lawyers, other real estate advisors and financial advisors.
Not all of these types of investments are fraught with more risk, but you will have less direct ownership and that inherently can increase one’s risk.
3) Ignoring Market Trends
This was one of the reasons I actually got into investment real estate so many years ago. This mistake easily happens because humans can get caught up in the emotional tides that happen with trends and social pressures.
What I am talking about is FOMO (Fear of Missing Out). My father got caught up in this very thing back in the late 70’s when he purchased in an excellent investment property located in North Vancouver, but at the height of the market.
The media was reporting record breaking value increases and because “everybody and his dog” was buying, my father thought that it would be a good thing to do as well.
Many people had made massive increases in property values over the recent previous years. What he failed to realize was that the market trend was peaking.
He also didn’t realize that he had made mistakes # 6 and #7. When the interest rates spiked in the early 80’s he was caught and unfortunately sold at a loss.
The rent didn’t cover expenses and he couldn’t afford the mortgage payments and all the other related costs.
Does my father’s situation sound familiar? I see so many parallels to today’s market. The situation is not identical but the results can be quite similar.
Many investors have made this same mistake, by over-leveraging, failing to plan for contingencies, not having an exit strategy and being too emotional.
Over the last several years, there are so many examples of individual investors potentially exposing themselves to massive financial repercussions by ignoring market trend conditions.
Just take a look at the number of line ups of investors buying condo pre-sales in markets like Toronto and Vancouver, where prices are increased after a certain number of units are sold and then the prices are bid up and bought at many times over asking.
This is all good when the market continues to boom, but inevitably it doesn’t go up for ever. Very few investors considered that interest rates would spike as they did, but to a degree all the signs were there.
The federal government created massive inflation by printing trillions of dollars out of thin air creating unabated spending to spur on the economy because of the shutdown of the economy due to the pandemic.
The government needed to somehow reign in the inflation resulting in massive increases to interest rates. So many people have been caught in this situation, and we have not yet seen the entire fallout from this situation.
If this situation is familiar and you are financially suffering, it is wise to sit down with your tax accountant and financial advisor to look at your situation to make some sound and rational decisions how you can financially move forward.
4) Underestimating Expenses
Just recently, a client asked me to review a potential investment property opportunity so see if it was a good investment.
I was provided was a rough proforma and immediately I noticed several integral items missing, such as a vacancy allowance, landlord insurance, unrealistically low repairs and maintenance expense, negligible rental management expense, no advertising or lease-up fee expenses.
I didn’t question the rental income in this case, but addressing the deductions and expenses were critical to understanding the real cash flow potential. By addressing these underestimated expenses, the proforma was then far more realistically presented so the client could then realistically review the investment potential and how it would fit into his portfolio. This is such a critical step for investing.
This mistake is really only beginning to hit investors’ now as a result of the significantly increasing interest rates and the massive effect on investment property performance.
Many homeowner and investors purchased properties based upon the monthly net potential cash flow after all operating and financing payments.
For some home buyers and investors, this has been a significant change because they purchased with minimum down payments and variable rate mortgages. This is difficult when dealing with the new required mortgage payments.
For example, there are a growing number of foreclosures in various real estate markets where the property owners are left with no alternatives.
In Alberta, some people giving up their homes unless the property was CMHC insured. There is a non-recourse financing provision in that province.
Sadly, these owners may lose their down payment and their credit rating is certainly negatively impacted, but the lenders are limited to getting the property.
Investors are facing this concern too. I know of investors now that have used a HELOC and purchased several properties where all properties were on variable mortgages along with the HELOC financing for the down payments.
They are finding themselves financially supporting several properties at the same time. This is causing financial hardship and stress.
Sometimes you are left with a bad choice or no choice. The investor is stuck with a choice of either continuing to financially supporting the properties (and potentially digging themselves further into debt), or they need to sell one or more properties to stop the financial bleeding.
The challenge is often determining which property to sell. Understanding the overall costs and benefits of each property and the real estate market trends will certainly help with making a more informed rational decision.
This is a time where reaching out to your qualified team of experts can go a long way to finding the most ideal solution.
6) Failing to Plan for Contingencies
Many years ago I met with a client that really wanted to invest in an investment property.
He had the money and a decent job and all looked good until I saw his financial statements. He loved credit cards and using other people’s money.
The challenge was that he had racked up so much debt that he was making minimum payments on all the credit cards. I asked him why he wanted to invest in a property. He gave me the usual answer of increase his net worth; build a real estate portfolio to provide him a monthly income, etc.
The challenge was that he had not included any contingencies into his plans. I chatted with him about the idea that if he purchased an investment property and did not pay down his debt he was putting himself in a very precarious financial position that could cause his financial world to crumble if anything went wrong in his job life.
I recommended that rather than buying an investment property that he:
- Pay down most of his debt to improve his credit rating and provide him with more monthly money to eventually invest
- Get rid of his high interest rate credit cards and
- Keep maybe one or two, and
- Pay off his credit cards monthly, and
- Put money aside on a monthly basis for an investment property to buy at a future date.
The sad result was he paid off the credit card debt as I suggested, but never got rid of the additional credit cards eventually racked up the debt again and never bought a property.
7) Not Having an Exit Strategy
A couple of years ago, I ran across a situation that demonstrates this mistake in combination of other such as Mistakes #2, #5, and #6.
There was a time when there was quite the promotion of condo presales a growing area of a large Canadian city.
Many investors were very excited to jump on board and tie up typically more than one unit with the idea that they would sell them at a higher price when finished and maybe have one paid for by the increases in the others that were to be sold.
So some of these investors had a single exit strategy, but was it realistic? Sure, f everything went perfectly.
Life happened and when it came time to sell there were a number of market forces that prevented the values to increase enough, high competition from other investors with the same idea, the anticipated demand wasn’t there, and the investors were required to close on the properties.
Not everyone had the necessary funds and or credit room to get financing to close. It became a real financial nightmare for some of these investors as they didn’t consider any alternative outcomes and as such didn’t have additional exit strategies.
The ones that overleveraged themselves had to scramble to find solutions at the eleventh hour. In retrospect, if the investor had determined several scenarios, they would have come up with more than one exit strategy that would have saved them stress and money.
8) Being Too Emotional
There are easily times where emotional well-being can override profits.
Using myself as a real life example, I too became emotional with one of my investment properties.
For a condo property I owned, I was on the board and found myself in a consistently non-harmonious environment.
Key fundamentals of running the property were not aligned between board members, the property management and staff that were inherited.
For me, the situation grew consistently more frustrating. I became drained and mentally exhausted. As a result, I took a large loss through unnecessary expenses and frustratingly wasted time. It was definitely taking its toll on me as I was fighting a board that was inexperienced and deaf to reason, and a heavy handed property management company that would not utilize my knowledge and experience.
I needed to step back from the situation to assess what was going to be the appropriate course of action. Could I have stepped off the board? Yes, and I did. Did that change things? No! The excessive spending and increased fees for staff for less work continued.
For the sake of my emotional and mental health, I eventually decided to sell despite potential profit, because my personal well-being was more important than profit.
In this case, I did sell at a financial loss but it wasn’t a significant one and it was certainly less important than my health.
In short, I cut my financial losses to preserve my health and happily continued to build wealth elsewhere.
9) Ignoring the Importance of Location
Just because it is cheap does mean that it is a good deal. There are always good and not ideal locations in any given real estate market.
In addition to the type and quality of property, understanding the development of the neighbourhood is very important in determining where to invest.
For example, I know of some investors that have purchased a 2.5 storey multifamily in an okay location, but was predominantly a lower level demographic neighbourhood.
In this case study, they purchased because the price was good, looked good on paper, and the investors were told that certain progress was happening and didn’t conduct all the necessary due diligence themselves.
These investors quickly found after that they had closed on the property, that it was going to take more effort – and cost more to maintain to actually work or even be profitable.
The property was not in the best neighbourhood, and the investors assumed it would positively hang over time.
They didn’t consider the possibility of an economic downturn and the pandemic after they purchased. The reality of these two twists became all too apparent when combined with the fact that the property was only appealed to a lower paying tenant in a lower demographic neighbourhood.
The result is that they are now trying to sell at a loss and get out before it continues to be a financial drain.
Ideally, for this property to work, it would require a large investment to upgrade the building infrastructure, suites and amenities or for a developer to redevelop the land into something new. Unfortunately, there is currently no progress now or in the foreseeable near future.
10) Failing to Diversify
Putting all your eggs in one basket by investing in one type of property or location can be rewarding, but it can certainly increase your risk and limit potential returns when things are not great in that market or that type of property.
For example, I know of many investors buying only older 2.5 storey walk-up multifamily buildings and on the surface it can look very lucrative.
They are priced lower; they don’t have all the “extras” such as pools, gyms, and elevators. Less to go wrong! Right?
There are two sides to this coin. Yes, they are cheaper and less to go wrong in theory, but the building infrastructure is older, meaning more maintenance is required and it is significantly less energy efficient, which means higher operating cost.
Because it is a walk-up, you are not attracting a higher-level tenant, as the property doesn’t have all the modern conveniences like elevators, higher level in-suite finishes and appliances, in-suite laundry, gyms, energy efficiency that a higher-level tenant wants and is willing to pay for.
The building will attract lower rents and that generally results in lower quality tenants which are more difficult to deal with.
The building itself is depreciating and your real long-term value is only in the land.
It is through these real life experiences and mistakes that an investor life’s most powerful lessons are learned. Hopefully by sharing these examples, you can gain a better understanding of how easily these real estate investment mistakes are made and prevent them from happening to you!
From my years of experience of making some mistakes myself as well as through client’s stories, I am happy to work with you to identify them early and avoid these situations. If you would like me to look at your real estate situation, please feel free to get in touch with me @ [email protected]