Success in real estate investing comes like success in many other fields; through hard work and continual effort. Every real estate investor can tell of a fortunate break here and there, and most are reluctant to take credit for success, but all can attest to the fact that perseverance was a necessary component. Given that, here are 5 ways to persevere and triumph in real estate today.
Recognize Changes in the Real Estate Market
Strategies that have worked in the past may not work today. Mortgage rates have been and continue to be very low. In addition, there is a lack of starter homes on the market. Successful strategies in real estate investing will be based on these and other current market conditions for a particular area. Flip strategies, for example, might focus on cleaning up starter homes rather than upgrades to move homes into higher priced market segments.
Online tools are also playing a greater role in the real estate investment business. Learning to access resources through the internet is a change for many investors. Using video made by drones to market properties was unheard of only a year or so ago, but is now almost a requirement for high-end properties. Finding drone operators is easier on the internet than anywhere else.
Diversify Real Estate Investments
Continuing to do the same size and type of real estate transaction is a comfortable approach, but it can also be very limiting. The type of property for that transaction may not always be available. It is important to stretch investments to a different scale or market segment. This brings diversity to the portfolio as well as economies of scale.
However, it is important not to over leverage properties or invest in unfamiliar strategies. There is a balance in this area that should not be ignored. Starting small is wisdom, staying small is safe, but growing too fast is dangerous. Success means taking measured chances to grow.
Conduct Due Diligence on Real Estate Transactions
Overcoming difficulties in real estate investing can be a double-edged sword. While it leads to success, it can also breed complacency. Experience is a great teacher, and one of the lessons it teaches should be the need to do fundamental research on each and every real estate transaction.
There will always be unexpected developments, but the more groundwork the real estate investor commits to a project the more likely a favorable outcome becomes. Uncovering problems early leaves more time to develop solutions, or can even create the possibility of walking away from a bad investment.
Consider Taxes on Investments
As has been said, “It’s not what you make, it’s what you keep that counts.” Income taxes can become a significant drain on the return earned on investment real estate and have to be included in any calculation. Unfortunately, tax laws are complicated and confusing.
However, they also include some significant benefits for real estate investors. Understanding how to structure transactions to maximize these benefits can improve the after-tax return. Learning to keep an eye on income tax considerations is a must for a successful real estate investor.
Set Aside Time as a Real Estate Investor
Anyone starting to invest in real estate begins with enthusiasm and dedication. However, this can wane over time as the demands of life, and probably a full-time job, begin to take a toll. Often the number of hours spent on evaluating opportunities or developing properties also begins to dwindle.
Success in real estate investing requires dedicating blocks of time to do the necessary research, paperwork and legwork. This can mean pushing other things aside to protect those blocks of time. Discipline in time management is an absolutely critical skill that has been mastered by every successful real estate investor.
This list is not exhaustive. Activities such as always exploring new ideas and developing new networking contacts could have been added. However, the 5 ideas listed here are great ways to grow as a real estate investor. They cover the basics and pave the way for greater success in the future.
“It’s not what you know, it’s who you know.”
While this old saw is not entirely true, it’s not completely wrong either. After all, business is done between people who work for companies, not between companies by themselves. Inter-personal relationships are and always will be an important aspect of any business, especially real estate. Effective networking, getting to know people, is as important in real estate as understanding the local market.
Naturally, a new real estate investor will look to benefit from the knowledge offered by other, more experienced real estate investors. However, there is actually a wide range of professionals that can add value to a real estate portfolio and increase the investment rate of return. This list includes real estate agents, contractors, appraisers, inspectors, mortgage brokers and real estate attorneys, just to name a few.
Meeting Real Estate Professionals Online
Meeting this wide range of real estate professionals is very straightforward on the internet. There is a wide range of discussion forums available that focus on specific areas of real estate investing, real estate lending and real estate management. Of course, like online dating online networking brings the risk that what is being presented is not real. Always be careful when sharing personal information.
Another fantastic place to network is the discussion forum of your favorite real estate podcast. They often offer a menu of forum topics, such as this list of over a dozen specialties from BiggerPockets.com, a popular podcast. They offer forums from General Information and Investor Basics to such specialty topics as Financial, Tax and Legal and Real Estate Technology and the Internet.
Locally Building a Real Estate Network
Like politics, all real estate is local, and at some point in the real estate investment process the best way to build a network is to work locally. There are a wide variety of real estate investment clubs, and like the online forums they often have a specific focus. Attending a special focus club is a good way to learn more about that area of real estate investing.
Another way to build a local network is to attend real estate auctions. These are typically attended by real estate investors and professionals. In particular, look to build relationships with those who won the auction. There are several ways to learn where and when auctions will be held. There are subscription services for auctions, and notices are printed in local papers and online.
Networking Tips for Real Estate Investors
Keep in mind that networking is an important part of real estate investing. It is an investment of time that contributes to success as a real estate investor. Although any individual networking event may not produce immediate results, over time networking is worthwhile. Keep this in mind if attending local events seems unproductive and fruitless at the beginning.
The other important aspect of networking to remember is that it is a two-way street. It is as important to contribute as it is to receive. In discussions, offer only helpful comments. Offer to help put chairs away or straighten up the room after a networking event. Remember that networking is about building professional relationships, so behaving professionally is important.
One aspect of networking that might not be worth the time is attending real estate seminars, particularly seminars that charge for attending. The ready availability of information on the internet and through discussion forums means that more quality information is available for free than ever before. In addition, seminar selling is still as prevalent as ever.
Like other aspects of the real estate investment business, successful networking takes time and effort. It may come easier for some people than for others, but everyone can build a robust network. The time spent in creating a network will result in a more profitable career as a real estate investor.
Remodeling a home is a great way to add value to a property, but unfortunately it is also a great way to dig a financial black hole. In order to avoid the pitfalls of pending money that will never be recovered, keep a simple rule in mind. Focus on renovations that someone else will value. A renovation is valuable only if it is valuable to someone who will buy the house.
Keeping the Right Potential Buyer in Mind
Focusing on a potential buyer means understanding who the house would appeal to in the first place. Is it a smaller home in a community of smaller homes? Then imagine a first time home buyer who is starting a family. A household with a new baby may value a fence around the yard more than a whirlpool bathtub. Although a stressed out new mom might disagree.
Considering the needs and values of a potential buyer can be a difficult challenge, but it is the most vital touchstone a renovator can have. Defining the potential buyer involves understanding the home, the neighborhood and the greater metropolitan area. Great healthcare facilities appeal to a different demographic than a great school district. The same difference can be seen between a ranch style house and a two-story colonial.
Kitchen and Landscaping Renovations
While it is difficult to generalize, there are two areas where renovations are always well spent. The first of these is the kitchen, where most homeowners spend the majority of their time. Following the same basic rule of focusing on the potential buyer is critically important when renovating a kitchen. It is one room where it is far too easy to spend more than is necessary, to increase the appeal of a house due to personal preferences.
Landscaping is the other place where renovation dollars are wisely spent. Landscaping adds to curb appeal, which is the all important first impression a potential buyer gets when they pull up to the house. Perfection is not the goal. A nicely maintained lawn punctuated with colorful flower beds expresses a pride of ownership that conveys value to a potential buyer.
Appropriate Renovations for the Property
Personal taste makes a house a home, but it does not necessarily add to resale value. Putting knick-knack shelves up as a type of crown molding might appeal to someone who collects Precious Moments or Disney princess figurines. Many buyers would just see another place that needs dusting. This rule is particularly true when considering wallpaper or wall borders.
The other significant mistake that is easy to make is to put amenities into a house that aren’t necessary. Although upgrades can increase the sale price, expensive bathroom fixtures or high-end kitchen counters and appliances are not always economically rewarding. The worst case scenario is to add features that make the home overpriced for the neighborhood, known as the proverbial “white elephant”.
Of course, there are exceptions to every rule, and every buyer is unique. However, it is a safer economical proposition to appeal to the greatest number of buyers. Renovations that will be valued by a crowd of buyers are more rewarding financially than those that are targeted toward a particular niche, such as model railroaders. After all, the time it takes to find a buyer is a factor in the economics of selling a home.
Buying a piece of investment real estate for the first time does not need to be a fraught situation. Understanding the basics of real estate and the terminology of real estate investing can make any beginner more comfortable and confident. Unfortunately, with all the details and things moving quickly, some of the fundamental terms and concepts can get lost, like the difference between “deed” and “real estate title”.
It’s understandable that these two different things get confused because they both are related to the ownership of a piece of property, in this case a parcel of real estate. The difference is that a deed is a legal document that transfers ownership, and the title is the legal document showing who owns the property. Deeds are recorded in the public record.
What’s in a Real Estate Title?
So, the title to a piece of real estate is the important, go-to document to define both the property itself and the ownership. Defining the property itself includes both a full legal description of the property and all the rights that come with the ownership. This second point is important because when it comes to owning investment real estate the investors want to be absolutely certain that they can change or develop the property in the way they are planning.
Development rights, mineral rights and even air rights can be separated from the ownership of real estate. A farmer can sell the rights to construct and manage a cell phone tower on his land while retaining title to the land itself. Rights to the trees on a parcel of land are not necessarily on the real estate title. A careful review of what is included in the title is an important step in buying investment real estate.
What are Some Surprises on a Real Estate Title?
While a purchaser would expect a title to show that “all rights” are included in a title, there are a few things that should not be there. One of these bad surprises is a builder’s lien. This is a legal claim made against the title, and has the same effect as a mortgage lien. It is intended to protect the financial interests of someone who believes the owner of the property owes them money.
Easements are another surprise on a title. An easement gives someone else the right to use the property for some specific purpose. A conservation easement, for example, allows someone else to use the land to grow native plants or to be maintained in a natural condition. Some easements allow others to cross the land to get to their property.
Protection against Surprises on a Real Estate Title
[Protecting against financial] because of accidents or mistakes is the job of insurance. Protecting against mistakes regarding real estate titles is the purpose of title insurance. This is a small insurance policy taken out when the title is transferred that protects the financial interests of the new owner and lender, if any. It is the only form of insurance that protects against loss caused by something that happened before the policy was issued.
Title insurance does not pay valid liens. Rather, before the insurance company will issue the policy it checks the public records to identify any liens or other problems with the real estate title. The report is called various things including a “title search”, a “title commitment” or an “encumbrance report”. Any problems identified on the report have to be addressed by the seller before the title can be transferred.
Getting a clear title is the goal of every real estate buyer. A clear title is the first green light a real estate investor needs to move toward a profitable transaction. There may be other bumps in the road, but understanding what makes a clean title and potential problems can make the first time buyer significantly more comfortable when closing on the property.
Investopedia defines FinTech as a “portmanteau of financial technology that describes an emerging financial services sector in the 21st century.” In other words, FinTech is the use of technology to support electronic banking and financial services. With the ongoing increase in the use of technology, FinTech is a crucial part of the business world. In order for a business to succeed in this day and age, the art of financial technology must be mastered. Here are some of the leading FinTech trends of 2017.
Instant Electronic Payments
A major FinTech trend is instant electronic payment. With PayPal being one of the dominant leaders in the peer-to-peer payment platforms, other companies have begun to create systems of their own. A subsidiary of PayPal, Venmo, LLC, has become very popular amongst millennials, as it allows an incredibly simple transferring of funds from one account to another. With its user-friendly interface, people have an easy time sending money to one another, whether it be a large amount for a good or service, or to split the check at a restaurant.
Accounting Software Automated
For centuries, companies have hired skilled personnel to do the accounting and business keeping for them. Recently, FinTech startups have created softwares to make accounting automated, rapid, and surprisingly easy. An example of this type of software that has grown over the past few years is Quickbooks by Intuit. This software allows the user to connect the company’s bank accounts to the application; from there, most of the data entry from the user becomes unnecessary. The application includes features such as categorization of expenses, profit and loss reports, learning the patterns of the user, and much more.
Marketplace Lending for Real Estate Investors
Essentially synonymous to P2P lending, marketplace lending (MPL) is the process of matching lenders and borrowers with each other through online programs. Marketplace lending has recently become popular due to people losing trust in traditional banking after the recession in 2008. MPL gives an individual, who may have not had prior access, the ability to take part in the investment of a property, whether it’s getting a hard money loan for a fix and flip or to crowdfund a real estate project.
This trend is continually growing and is advantageous for its users due to its financial incentives and availability of credit where it was limited in the past. An online platform, such as Sharestates, enables its users to invest in real estate online and reap the benefits.
In addition to accounting softwares, blockchain is another useful method for measuring financial transactions, specifically in real-time. A sizable issue with digital currency is something known as double-spending. An electronic money transaction is essentially a line of code that can be accessed to represent a dollar amount. This code can be duplicated, and the money can be considered double-spent.
Blockchain technology, first used by Bitcoin, provides a database of electronic financial transactions that does not allow an exchange to go through unless approved by its extremely complex software. According to chargebacks911, wider adoption of blockchain technology could potentially help banks save as much as $20 billion annually by 2022.
The Future of FinTech
FinTech is relatively young and will continue to be integrated into all aspects of the business world. Whether it is used for a simple task like transferring money, or something greater like accounting and tracking budgets, financial technology is a crucial part of the work field. Every year there are new trends to be monitored and followed in order for one’s enterprise to be as successful as possible.
Savvy real estate investors know to watch mortgage rates the way a sailor knows to watch the sky. Changes in mortgage rates impact the market prices of homes in the same way changes in interest rates impact the market values of bonds. Fortunately, changes in interest and mortgage rates tend to be much less sudden and extreme than changes in the weather.
Mortgage Rates at Historic Lows
Mortgage rates, and interest rates in general, are still at historic lows following the real estate and economic debacle of 2008. The average rate for a 30-year fixed rate mortgage in July is 3.45%. This is low in comparison to the average rate for the 10 years before 2008 of 6.55%, and even low compared to the average since 2008 of 4.21%.
The average rate includes rates charged those with poor credit and those with outstanding credit. Of course, those with poor credit pay a higher rate. The same is true for borrowers who have a high debt-to-income ratio, and those who make a smaller down payment as part of the home purchase transaction.
If Mortgage Rates Go Up
Mortgage rates move with interest rates in the overall economy. They go up during an economic expansion. When people have jobs that they are confident they will keep, demand for mortgages goes up. Supply and demand are relatively straightforward, so interest rates tend to climb during economic expansions. This increase is also driven by the monetary policy of the Federal Reserve Board (the Fed).
A higher mortgage rate means a higher monthly house payment. This will cause some buyers to look at less expensive houses. Some sellers may need to drop their price in order to attract buyers looking for that type of home. A real estate investor planning on flipping a starter home may find the market price of their home dropping as interest rates climb.
Real Estate Market Sees Fewer Mortgage Apps
The reverse dynamic takes place when consumers are uncertain about the future, such as when the Consumer Confidence Index is weak. Fewer households apply for mortgages because they are concerned about making payments and mortgage rates fall. This is why mortgage rates are currently still historically low. The economy still has not recovered fully from the effects of the 2008 mortgage meltdown.
The lingering effects are shown by the current policy of the Federal Reserve Board. The Fed strongly influences the money supply interest rates through the discount rate. This is the rate the Fed charges banks to borrow money from it. A low discount rate increases the money supply and lowers overall interest rates. A high discount rate does precisely the opposite.
Real Estate Investors Watch the Current Forecast
The Fed is slowly increasing the discount rate from the historic lows it reached as a result of the 2008 mortgage crisis. However, these increases are being implemented very slowly, and the current rate of 1.75% is still very low. The average rate for the 10 years prior to the mortgage crisis, for example, was 4.04%. The rate since 2008 has averaged .78%.
The current CCI is giving off mixed signals, with some elements showing positive gains and others moving negatively. The month-to-month fluctuations are also small and often in opposing directions. This means the Fed is less likely to significantly increase the discount rate, but continue on a slow path toward historically normal levels. Demand for mortgages is also unlikely to show a significant increase so there will be little upward pressure from the private market.
An extended period of low mortgage rates that is slowly ending can be an excellent environment for real estate investors. Some buyers may feel that they have to purchase a home before a significant increase in rates. Rates that are low relative to historical levels mean real estate prices that are relatively higher.
However, the risk in the environment is an unexpectedly large increase in rates that pushes buyers out of the market and forces sellers to lower prices to lure them back in. Although the current outlook does not suggest this will happen, the economy has been known to surprise even seasoned observers. Even experienced sailors sometimes get caught in a storm.
Real estate deals come in a variety of packages from “ground up” investments to value-added or rehabilitation projects. Each type of investment has its own associated risks and rewards. A ground-up real estate investment typically involves more risk, but they may also provide better rewards. That’s because the developer has much more planning and work ahead of him than with valued-added or rehab projects.
For instance, if a developer is taking an existing commercial building and adding a new wing to it, the project won’t take as long as building the building from scratch. There is already an existing structure to tie the new addition to, which makes the initial groundbreaking simpler and less complicated. By the same token, rehabilitating a building that has already been built involves a different level of thinking and costs much less than building from the ground up, hence there is less risk involved.
Common Risks Associated With a Ground-Up Real Estate Deal
Ground-up construction can often be risky because so many factors are unpredictable. The process can be long, and by the time a project is started and finished, many of the basic facts and assumptions may have changed. The following risks make ground-up real estate deals difficult to manage even for the most experienced managers:
- Price of materials may change – Prices fluctuate. A real estate project expected to take months to complete may cost more than originally estimated due to changes in the price of materials, especially at the later stage of a project.
- Weather conditions – Weather often interrupts ground-up real estate projects and could delay construction or building plans for days or weeks if seasonal weather patterns get harsh. This is one reason planning is extremely important in ground-up construction projects.
- Subcontractor scheduling – Subcontractors could show up to work late or get in each other’s way. If one project is delayed, that could put an important contracting team out of sync with the rest of the construction crew, and in some cases it could lead to halting a project for a few days or weeks until the scheduling is worked out.
- Change orders – Many times, architects or real estate owners change their minds about how they want a project to be developed. Multiple change orders can drive the timeline of a project backward significantly.
These are just some of the risks associated with ground-up real estate projects. In the end, you want someone with experience and a track record working on such projects to ensure that risks are mitigated and investor dollars are protected against unnecessary risks.
The Most Important Considerations for Investing in Ground-Up Construction Projects
Every construction project is different. In general, however, you want to pay particular attention to the following considerations when evaluating a ground-up construction project as an investment.
- Loan-to-Value Ratio – It is very important that you crunch the numbers right on any real estate investment, but if millions of dollars are at stake, you don’t want to miscalculate LTV.
- Lien Position – The best position to be in on a ground-up project is in the first lien position. You want your profits before everyone else or you run the risk of losing your investment.
- Borrower Track Record – It is best if you invest in a borrower who has managed ground-up construction before. The more experienced the borrower, the less risk you are taking as an investor.
- Borrower Experience – Even if a borrower has a good track record with project management, you want to ensure he has the requisite experience to see your ground-up construction investment through. A borrower who has spent 20 years on residential construction but has no experience in commercial could prove to be a high risk if you are looking at a commercial real estate investment.
- Credit Score – The borrower’s credit score is also important. If a borrower is sub-prime and is borrowing millions of dollars for a project, that increases the risk.
- Location – Finally, location is very important. Ground-up investments in rural or emerging markets are higher risk than core urban markets like New York City and Chicago.
Every investment should be evaluated on the merits of the project as well as the experience and track record of the borrower.
As a real estate investor, imagine showing the Addams Family home to potential buyers. The snarling gate, the encroaching, thorny vines, the crumbling, rambling exterior skirted by the dead trees and lawn. Folks would run for their lives instead of placing offers. First impressions are lasting impressions which is why the following 2017 curb appeal dos and don’ts include all of these offenses and more.
Do Preen the Lawn and Pathway
Nothing is more inviting than a green, manicured lawn. Especially when patterned with the clean lines of a curving pathway. Cement paths regularly become coated with mold and mildew. Renting a pressure washer or hiring someone with a washer easily cleans away the grime. Consumers can also clean mold with spray-on products and brushes.
In snowy climates, keep paths shoveled for a more inviting façade and curb appeal. An inexpensive but quality lawn-care program includes fertilizer, extra plugs of sod, and weed killers.
Don’t Get Carried Away with the Landscape
Buyers prefer low-maintenance landscapes. Many buyers see dollar signs with elaborate gardens bursting with a variety of plants, shrubs, and trees. As tempting as it is to showcase that green thumb, keep the garden simple. A hedge of evergreen bushes balanced with a low row of flowers is a simple, yet attractive look.
For an easy, weed-free garden, install professional grade weed fabric throughout the landscape. Cover this with a few inches of red cypress mulch. Weeds have a tough time fighting their way through the weed fabric and mulch. Also, it’s best to stay clear of adding water features to the landscape. While appealing, these structures require regular upkeep that may deter potential buyers.
Do Clear Clutter, Replace Bulbs and Trash Bins
For properties with front overhangs and porches, clear away any décor and furniture obstructing the view of the structure or impeding foot traffic. Less is more regarding exterior décor. Some suggestions include small benches, swings, bike racks, and appealing trash cans that fit the façade.
Remember to replace or repair light fixtures and bulbs. Opt for trendy fixtures featuring LED bulbs. They’re brighter and last much longer than standard incandescent counterparts.
Don’t Paint Bold Colors
When selecting paint colors, choose shades that will appeal to the broadest audience. Buyers need to envision themselves occupying the property. Covering the exterior with flashy pastels will deter more buyers than draw in. Select neutral colors that complement exterior features like columns, bricks, paths, and gardens.
On a side note, also select neutral colors for interior painting. Giving the entrance of a building a bold facelift is the latest curb appeal trend. This includes bright red, yellow, and green doors. Pick the shades on the lighter end of the color spectrum. Dark colors project negative, ominous tones.
More Curb Appeal Dos and Don’ts
- Do light up the gardens and paths
- Don’t use dimly light solar lights
- Do refresh address numbers
- Don’t break the budget on curb appeal
- Do repave cracked driveways and sidewalks
Real estate investing is generally considered a very stable income vehicle. But this actually hinges on the investor’s position within the capital stack. In this article, we’ll explain the capital stack and why all investors must learn its importance.
Debt Vs. Equity Financing
Before illustrating the capital stack, investors should first understand the difference between debt financing and equity financing. Lenders like banks, credit unions, and crowdfunding sources provide debt financing in the form of loans for real estate projects. Often, commercial and residential real estate purchases use more debt financing than equity financing.
Equity refers to cash or capital directly invested into the project. Investors, realtors, developers can all fund equity financing with cash. It’s important to remember that debt financing usually covers the majority of real estate purchases. Capital stacks usually consist of senior debt, mezzanine debt, preferred equity, and common equity with senior debt encompassing the largest share of the investment.
Picture This Capital Stack
Imagine an object like a triangle or a prism, with an open, narrow top and wide, closed base. Now, imagine this object is empty. In order for a real estate investor to purchase property A at $500,000 (list price plus rehab cost), he needs this object filled with that much money. The investor secures a loan from lender X (debt financing) for 80 percent, or $400,000, of the list price, he drops this money into his prism piggy bank.
He then secures another $50,000 from lender Y (debt financing), which he also deposits in his prism. The investor fronts $25,000 (equity financing) using his own cash and collects another $25,000 in cash (equity financing) from the developer. This also drops it into his piggy bank.
To recap, the investor now has a prism with four levels of capital:
- Level 1, the bottom level, (Senior Debt) from lender X: $400,000
- Level 2 (Mezzanine Debt) from lender Y: $50,000
- Level 3 (Preferred Equity) cash from the investor: $25,000
- Level 4, the top level, (Common Equity) cash from the developer: $25,000
The investor now uses the money in his prism piggy bank, from top to bottom, to purchase the property, rehab it, and pay for any associated renovation fees. Then, he sells the property for $600,000. Visualize the investor pouring this money back into his empty piggy bank. The senior debt, or bottom level, takes precedence, therefore, the $400,000 plus interest, returns to Lender X.
Then, lender Y receives $50,000 plus interest, followed by the $25,000 paid back to the investor and developer. The equity financiers, the investor and the developer, receive the remaining money, with the developer receiving a bigger portion because of his position at the top of the capital stack.
Capital Stack Position
Where does Sharestates lie within the capital stack? In the safest position, the senior debt or first lien position. While the bottom of the capital stack doesn’t earn the highest rewards, it holds the lowest risk. This position is usually backed using the property as collateral. Therefore, if the project is a bust when the property sells, the first lien position/senior debt receives its money first, then the mezzanine debt, followed by the preferred and common equity positions.
Yes, the top positions reward the biggest returns but also expose the equity financiers to the highest risk. What if our investor spent more than his $500,000 piggy bank because of unforeseen damages? And what if the property sold for less than $500,000? The loss incurred falls upon the equity financiers at the top of the capital stack.
When real estate values are climbing and the economy is doing well, everyone wants a good investment. The truth is, not every real estate investment is good. You have to learn to tell the good ones from the bad ones. Here are eight ways to know if a real estate investment is not good enough for your pocketbook.
How to Know if a Real Estate Investment is No Good
1. The numbers don’t add up – Depending on the type of property, you should consider the mathematics of investing. Specific numbers to consider include:
- Price – Is the listing price out of sync with recent sales prices of comparable properties in the same neighborhood?
- Equity – Important for buy-and-hold investments, there should be enough equity to afford you a reasonable exit strategy and a profit.
- Loan-to-Value (LTV) – A solid LTV ensures you don’t borrow too much against a property. You must factor in the cost of acquisition as well as repairs and have enough left over for a solid return on investment (ROI).
- After Repair Value (ARV) – ARV ensures you have enough room after the necessary repairs to sell the property and see a positive ROI.
- Return on Investment – If you can’t profit from the investment, walk away.
2. It’s a bad location – It’s not enough to ensure a property is in a good neighborhood today. You also have to look at the future value of the neighborhood. Are other properties in the same neighborhood dilapidated or falling apart? If you’re buying a rental property, does the neighborhood offer enough amenities to attract renters? If it’s a fix-and-flip property, do the schools have a solid reputation for academic and sports achievement, is it a low-crime area, and are there plenty of shopping, parks, and other family friendly venues? Even if the property looks good, make sure the neighborhood is good.
3. It’s been on the market too long – If a property has been on the market for six months or longer, other investors have probably checked it out. There’s a reason it’s not selling.
4. Too much rehab or maintenance for the trouble – Sometimes, a real estate investment can look good on paper and still be a bad investment. If a house has structural damage, foundation issues, or other problems that will require a long inventory cycle or cost so much they’ll eat into your profits, then your best bet is to walk away. For rentals, if the plumbing, electricity, and other infrastructure will need constant and frequent repairs, it could be a bigger headache than it’s worth.
5. The seller is withholding information – A seller that won’t divulge the last time the roof was repaired or who isn’t forthcoming with other information is probably trying to hide something. If they won’t let you hire an inspector so you can do your due diligence, then you don’t want to buy that property.
6. Bad borrower – Bad real estate borrowers come in a variety of types. Do they have bad credit? That may not necessarily mean they will default on a loan, but it does mean they are a higher risk than a borrower with pristine credit. What is their track record? A borrower on his first rehab project is a higher risk than a borrower who has rehabilitated hundreds of properties. A sponsor with no experience and several other negative factors could be a bad borrower, or at least pose too high a risk for any reasonable investor. Look at all the risk factors on the borrower just as you do on the property. If the risk is too high, don’t loan money to that borrower.
7. Other investment particulars – A first lien position is preferred to mezzanine or common equity. An occupied property is a better real estate investment than an unoccupied property. A development partially completed is a better investment than one rising from the ground up.
8. Platform reputation – Finally, consider the reputation of the platform offering an investment. A platform with no track record is a high risk.
When it comes to judging the value of real estate investments, it’s all about comparing risk factors. Be sure to do your due diligence.