Investing in real estate can provide great returns from fix and flipping or long-term rental properties. Learning how to invest in real estate can take a long time and many people make big mistakes when they buy their first property or even before they buy a property. I have made many mistakes even though I have also been very successful with my fix and flips and rentals. Some of these mistakes I have made myself or I have seen made by many investors. What are the six biggest mistake I see real estate investors make?
1. Listening to people who have never invested in real estate or want to charge you $20,000
Many people have strong opinions about real estate investing. Some people have good opinions about it and others think of it as a sure way to lose money. Those that have lost money investing in real estate probably made many of the mistakes I list in this article. I think it is good to listen to those who have had a bad experience with investing, because you can learn from their mistakes and decide if buying rentals or flips is right for you. But many people love to talk bad about real estate investing who have never invested themselves or have any idea what they are talking about. Don’t listen to them!
Why should you ignore those that have never invested in real estate?
Surprisingly many people listen to those who do not have any experience in a field, whether it is in real estate or another venture. A person could hear how great real estate is and how much money you could make from ten investors who are in the business, but one negative person who has never invested will cause that person to abandon all thoughts about investing. When you are learning about real estate make sure you learn from people who are investing in real estate now or have recently invested in real estate. The people who are bad mouthing real estate who have never invested either wish they were brave enough to try it or have a cousin’s uncle who lost money. The negative person has no idea why that cousin’s uncle lost money or how much money they lost, but they “know” all investing is bad.
I also hear fix and flippers and rental property owners bad mouth the business all the time. Rental property owners love to tell horror stories about bad tenants, their rental properties losing money and how horrible it is to own rentals. The funny thing is that many of these investors still own their rentals and are buying more! Do they really hate their rentals, do they like telling horror stories for the fun of it or do they want to scare off potential investors? If they hated their rental properties that much, why don’t they sell them? Do not let yourself be easily discouraged from investing in real estate, because of a few bad stories or negative people.
What real estate gurus should you listen too?
Not only are there overly negative people who talk bad about real estate investing, there are overly positive people only trying to sell their real estate programs. They promise to teach you how to buy houses and make millions right away, without having to do any work. The programs cost thousands and thousands of dollars and are taught by people who don’t invest themselves. The programs tend to start out with a free seminar, followed by a three-day work shop that costs a couple hundred or thousand dollars and then they hit you with the big sell. “We’ll teach you the real secrets of investing and give you financing if you spend $20,000 to $50,000 on our program.” Most likely they have not taught you anything useful in the first seminars, because they have saved the important stuff for their coaching program. Guess what? They don’t have any secrets to tell that you can find on the internet for free.
I am not saying there are not great programs out there that will help you invest. There are some great programs that will cost a couple hundred dollars or books that cost $20, but they don’t cost $20,000. You can buy a house with that money and learn much more than that program will teach you. Or hire a local mentor for $5,000 and they will teach you more than the national program ever will. Real estate is very localized and no national program can teach you how to make money in your market like a local mentor. I have a program I sell as well, but it is not a get rich scheme and it is not $20,000. My program is meant to help you learn your own market and figure out the best way for you to invest.
2. Buying strictly for appreciation
When you buy rental properties or fix and flips hoping only for appreciation you are asking for trouble. Rental properties will slowly eat your money away and fix and flips could bankrupt you if you ignore cash flow and buying below market value. I think it is okay to hope for appreciation or plan to have appreciation, but you should not base your business model on appreciation unless you have a lot of cash to back up your plan.
Why is it a bad idea to buy real estate for appreciation only?
With rental properties buying only for appreciation means you have negative or no cash flow. Negative cash flow means you have to spend money on your property every month until you sell it or rents increase. Most people do not have a plan for how long they will have negative cash flow, they assume they will have enough money until they sell. You may think you have an idea of when houses will keep appreciating or start decreasing in value. Maybe an area has great schools, a great economy, strong job growth and has appreciated. How do you know what interest rates will do or if lending guidelines will change or whether the national economy will go into another recession? Maybe there are 1,000 other investors who think the same things you do, and they have already driven prices up higher than people in the area can afford. It is almost impossible to guess how much and when properties will appreciate. Houses historically go up over time, but they also go down in value in some cases in the short-term. Can you afford to keep paying into your rental every month for five years if the market turns? This is why you better have a lot of cash to be able to bet on appreciation.
If you have cash flow and hope for appreciation then you won’t get into trouble. If you make money every month on your rental property then it is not a big deal if prices go down and you can’t sell for a while. You’re still making money every month, not paying out money every month. If you must buy for appreciation only, plan out how much money you will need to save every month and for how long. Use my cash flow calculator to help with this and make sure you will not run out of money waiting for prices to go up.
Why is it bad for accidental rental property owners to wait for appreciation?
Some people become accidental investors by turning their personal residence into a rental when they can’t or don’t want to sell it. If you can’t sell a home, because you owe too much money and you do not have any savings, it might make sense to keep it as a rental. If you do not have any savings you probably don’t have a lot of extra money to spend on your rental property every month. How long can you keep putting money into your rental property before it hurts you financially?
Some people can afford to sell their house, but think prices will increase or feel bad about just breaking even or losing money on their home. How much money can you afford to spend every month and for how long if you are not cash flowing on your property? Holding out for more money in the future may work or it may not and you will have wasted a lot of money every month hoping prices would go up. Most people also under-estimate the expenses on rentals and do not factor in maintenance and vacancies. They only think about the difference between the mortgage payment and the rent. If you are paying out $500 a month and sell your house two years later, you just cost yourself $12,000. Hopefully prices went up at least $12,000, and you did not have something better to do with that $12,000.
Why is it bad to buy fix and flips for appreciation
Buying fix and flips for appreciation is asking for trouble, because the market has to increase to make money. This is how many flippers went bankrupt after the last housing crisis. They thought the market would always go up and all they had to do was buy a marginal deal to make money.
When the market stopped increasing in value and then went down, those flippers lost a lot of money and could not pay back a lot of money. If they would have bought a deal that could have made money without appreciation, they could have sold their flip quickly and still made money or at least broken even. I continued to fix and flip through the housing crisis, because I bought houses cheap enough to make money even if the market went down. I also sold my properties very quickly and did not hold on to them for long periods of time.
3. Underestimating the repairs needed on investment property
It is hard to estimate the amount of repairs a house will need; whether it is a flip or a rental property. I have bought houses and fixed them up for a long time and I still underestimate the repairs needed. I always add about $5,000 to the repair costs that I estimate on my deals. There are always repairs I did not see or could not see when I first make an estimate.
One problem with estimating repair costs is you can’t see everything that needs to be repaired in a home. Once you start repairing a house, then you see the entire picture and everything that needs to be done. It is impossible to see all the repairs until you start the work in some cases. I don’t like tearing walls out of old houses because I never know what I will find behind that wall. Usually the more repairs I make on a house, the more new repairs I find that need to be done.
New investors also tend to underestimate the cost of repairs and do not confirm the costs with a contractor. I do not have my contractors give me a bid before I buy a home, because after close to 100 flips I have a good idea of the costs. If you are a newer investor, you need a contractor to tell you what the costs will be. Or better yet, you should have two contractors give you a bid for work needed. Again, even with a contractor bid, you may not see all the repairs needed until work starts.
Here are some more mistakes that investors make when repairing homes
- Over improving a home. Don’t make a house much nicer than other homes in the neighborhood. It costs more money and you won’t get that money back. If you sell a house for more money than other houses are selling for in the neighborhood it may not appraise. If it doesn’t appraise, you will have to take less money in the end anyway.
- Buying old homes without experience. The older a house is, the more repairs it will need. When you buy an old house as a rental, it can eat all your profits away with maintenance. A flip’s profits can be eaten away because of the hidden costs; electrical, plumbing, foundations, etc.
- Using bad contractors. It is hard to know when you get a bad contractor until the work is started. Bad contractors will charge too much, take too long and may even rip you off. If you think you have a bad contractor keep a close eye on him and don’t bad afraid to fire him.
- Doing the work yourself. Many flippers and rental property owners want to do work themselves to save money. The problem is unless you are a contractor, it may cost you more money to do the work yourself. It takes longer, the work is not done well and it is stressful learning and working on houses in your spare time.
4. Not having enough money to complete a flip or hold a rental property
Another huge mistake investors make is trying to buy a flip or a rental property without enough money. When buying a rental, you need money for the down payment, closing costs, repairs and carrying costs. You also need money for reserves in case there are vacancies or maintenance. If you don’t have enough money for reserves you may end up missing payments and possibly lose your rental property. Skimping on repairs will make a property hard to rent and increase your vacancies as well as lower your rent.
On a fix and flip not having enough money means you can’t finish the flip. I bought a flip a few months ago from flippers who got themselves way in over their heads and needed to sell ASAP. I was happy to buy it off them for a huge discount. You have to have enough money to buy a flip, pay for carrying costs, pay for repairs and plan to keep the property for at least six months.
5. Partnering with someone without having everything in writing
I partnered with my dad for years in our real estate business as well as fix and flips. We have a great relationship and were very successful, but we still had disagreements. From the beginning we had everything in writing even though we were family. Having everything in writing made our disagreements much more manageable. In the end I love working by myself and being able to make all the decisions as well as keep all the profits.
If you enter a partnership put everything in writing no matter who you work with. The money, the responsibilities, the exit strategies; everything has to be in writing. When you enter into a partnership, you also have to plan for everything. What if one person sells out? What if one person starts slacking on their responsibilities? What if one person stops investing the money they promised they would. All of these issues cause partnerships to turn bad. They turn families against each other and make friends enemies. If possible, avoid a partnership, but if you have to make sure everything is in writing!
6. Overpricing fix and flips once they are finished
I see new investors try to get the very most money out of their flips by pricing them too high. Usually a flip costs more than they thought, it took longer than they thought and they are making less money than they thought. To make up for their miscalculations they overprice a home to make up for it. Pricing a home too high makes the situation even worse. It increases the carrying time, increases the costs and may cause a home to sell for less than if it was priced right to begin with. When a house is overpriced, it may stigmatize a property because it sits on the market for an extended period. When a house sits on the market for a long time people wonder what is wrong with it even if the price is good after a couple of price changes. I tend to see offers on my houses after three weeks on the market if it is priced right. If I have no offers in the first month, I lower the price right away. The longer I hold a property, the more money it costs me and the less money I make.
Real estate investing has been very good to me, but I have made mistakes as well. I have overpriced homes before and it always costs me money. I have held on to bad contractors for too long or underestimated repairs and it has cost me. I have also learned a lot from my mistakes and made my business better by making those mistakes. Don’t be afraid to invest in real estate because of the things that can go wrong or people who discourage you. Make a plan, do your homework, listen to the right people and start making money.