The 5 Biggest Mistakes Made in a Real Estate Investment
A real estate investment can be either hugely successful or riddled with mistakes. And that’s the crux of a real estate investment – it’s all about minimizing risk and maximizing potential. But what are those risks? Identifying risks is the first step in dodging real estate investment mistakes.
Evaluating a rental property for investment
The first 3 mistakes have to do with evaluating a rental. I’m always surprised by how many people leave out allowances for vacancy and repairs, and even ignore closing costs. At some point your rental property will be vacant. And it will need repairs. To get the best possible estimate of the return on your investment, you should account for these things.
The last 2 mistakes have to do with ownership of a rental. Take a look at these 5 and make sure you’re getting the best return out of your real estate investment.
Mistake #1 – Vacancy rate
Investors ideally come to a potential rental property with a mix of optimism and realism. Optimistic that the property’s potential can be unlocked with some savvy evaluation, but also realistic toward what that potential is.
Remembering to incorporate vacancy rate into that potential is an all too often overlooked part of the evaluation. Even the best properties in great rental markets should not expect a 100% rental rate. It’s rare for a property to stay rented out 100% of the time, and even one month without a rental payment can make a significant impact on your return.
Maintaining a realistic, or even conservative view of the property’s likely vacancy rate will help keep you from taking undue risk. Be sure to set a vacancy allowance in your calculations that is based in your local city or area vacancy rate statistics. These statistics are easily accessible (check out Fannie Mae and the US Census Bureau) and offer a reference point that you can customize based on the property and the market forecasts.
Mistake #2 – Repair and maintenance factor
That mix of optimism and realism we mentioned earlier can extend to your consideration of repair and maintenance allowances as well. Even with ideal tenants, you can expect normal wear and tear and the occasional non-normal maintenance expense in every rental.
The fact is: Things wear out and accidents happen. You’ll need to replace an appliance, water heater, doorknob, water faucet, or any number of other things at some point, so it’s best to account for that from the beginning. Setting aside a percentage of rent every month to account for repairs will do two things for you: give you more accurate estimates on the net return on your investment, as well as discipline you to set aside funds for larger repairs or maintenance that are sure to come up eventually (roof, exterior paint, etc).
The repair/maintenance allowance will vary depending on primarily 2 factors: the current condition (deferred maintenance), and age of the real estate investment property and it’s systems.
Mistake #3: Forgotten initial costs
There are many investment evaluation formulas out there for investors to utilize. However, they’re not all created equal. Many omit critical upfront costs for the sake of simplicity, or to improve the appearance of investment return in some cases. It’s important to remember that the cost of acquiring the property will include more than just a down payment, and the property may require an initial investment to get the real estate investment property into shape before renting.
In whatever formula you use, be sure to include inspection, closing, and repair costs needed prior to occupancy. This will give you a much more realistic view of the investment property’s actual return potential and the cash investment needed to start realizing that return. Typical closing costs will fall within 1%-3% of the purchase price, and initial repair costs could include things like lock changes, carpet cleaning, painting, appliance replacement, or landscaping.
Mistake #4: Regular inspections
It may seem like common sense to regularly inspect and maintain your property, but very few landlords actually do routine inspections. We get busy, tired, or sometimes just lazy, and don’t take the time to regularly check on our investment.
Sometimes we let the complicated or even awkward nature of entering our tenants’ space get in the way of making sure there are no festering issues with the property. But in actuality, regular inspections will both show your tenants that you’re engaged and responsive as well as improve the livability of the rental. Even the best tenants may not be attentive or skilled in home maintenance, and you simply can’t rely on them to responsibly care for your investment as well as you can.
Regular inspections will help you keep track of issues and provide you the opportunities to address issues before they become real problems. Being regularly present may also encourage tenants to take a little better care of the home knowing that you’ll be checking in a few times a year.
You can set your own reasonable inspection frequency, but we recommend no less than twice a year, or every 6 months. Be sure to abide by state law or local ordinance requirements when providing notice of legal entry.
Mistake #5: Rent increases (or lack thereof)
All investors and landlords should strive to be fair and treat their tenants with dignity and respect, but it would be a mistake to think that means you need to keep your rental rate artificially below market value. If the market warrants doing so, it’s important to make reasonable rent increases each year.
Especially among self-managing landlords, it’s all too common to avoid annual rent increases for the sake of keeping a good tenant. While that can be an effective way to hold onto good tenants, there are other ways to take care of your tenants and encourage them to stay without sacrificing potential rental income.
In fact, making reasonable annual rental adjustments can actually be a good thing for your tenants, because it keeps them in line with the market. I remember the shock on my tenants’ faces when they went looking for another rental and found that we had been hundreds of dollars a month below market rent. Although they appreciated the good value, they had not prepared mentally or budgetarily for the significantly higher rent in the market. I had saved them money in the short term, but put them months behind being able to move to a different rental that suited their needs better (while also cheating myself out of potential rental income).
While it does take some work to determine the right adjustment each year, it’s worth the effort. Your property manager can help you do this, or you can take a survey of online rental resources to determine that amount for yourself. Websites where you can shop current, local rental rates for similar homes are good resources. Try craigslist, Hotpads, and any other sites that may serve your local area.
Real estate investments can be somewhat treacherous if you’re not familiar with the territory. But now that you’ll dodge these common mistakes, you can approach with confidence.
Need more help with maintaining or updating your rental property or real estate investment? Check out our Preferred Contractors page to see a vetted list of contractors and professionals that can help you with anything when it comes to your Portland Metro or Hillsboro area home.