Last week, I met with a relatively new real estate investor who had enjoyed a few investment wins, intermingled with some rather dramatic losses. With a bad investment still fresh in his mind, one of his first questions involved strategies to help minimize the risks, while maximizing his chances of seeing a solid return on investment when buying, renovating, and selling a house. I outlined the following issues, which tend to account for a fairly large portion of missteps amongst residential real estate investors.
Risk #1: Overpaying for the Property
Overpaying for a piece of real estate can be rather devastating for a new investor. At best, you’ve learned a lesson that you can apply to future investments and you simply proceed with greater caution in the future. But at worst, you may find yourself forced to maintain the property as a rental holding for several years in an attempt to recoup costs. And when the time comes to acquire a new property, you may be extremely hesitant to pull the trigger due to your negative experiences and a hyper-awareness of the risks of residential property investment.
Fortunately, overpaying for real estate is a risk that can be curbed with the right research and due diligence. Getting a home inspection is critical, as this will provide you with the information you need to make an informed decision about how much you’ll need to spend in order to achieve full market value when it comes time to sell. Tools such as property valuation software can also be extremely helpful for deciding how much to offer the homeowner, the cost of repairs or rehab, and the likely sale price once the improvements or repairs are completed.
Risk #2: Underestimating Rehab Costs
As I mentioned above, underestimating rehab and repair costs is often to blame in cases where a novice investor has overpaid for an investment home. It is common practice for some new investors to take the after repair value of a property and then deduct the cost of repairs from that figure to arrive at a fair offer price. But if you miscalculate, you risk dramatically reducing or even obliterating your profit margin.
The good news is that this problem can easily be avoided or minimized by working with a reputable and licensed contractor. An experienced contractor can pinpoint the main problem areas and provide you with an accurate estimate of how much it will cost to get the home into a condition that will maximize ROI. Having a trusted contractor on your team is essential, as there are a fair number of less ethical contractors who may quote you a low estimate just to get the job. Then, once the project is already underway, the price will increase, which places you in a very sticky situation.
Risk #3: Overestimating Sale Price
Wishful thinking will not serve you well in real estate investing. An unrealistic expectation about sale price can cause you to overspend on the property itself and/or on the rehab based on the misguided belief that you can recoup your money and turn a profit. If your figures are unrealistic, you could find yourself stuck holding a property for months or even years because you haven’t received an offer at or near your asking price. Or, you sell the property for far less than you had anticipated, barely breaking even—or worse.
This is yet another risk that can be fairly easily managed with research, due diligence, and the right tools. HomeVestors® proprietary software ValueChek™, combined with the insights of an experienced Development Agent, can provide you with the guidance and information that you need to help you confidently make a sensible offer to the homeowner.
Risk #4: Under-insuring or Failing to Insure the Property
Once you’ve acquired a property, it’s vital that you protect that investment with insurance. All it takes is a bit of bad wiring, an unrealized roof leak, a sudden act of nature, or an on-the-job injury involving a contractor and you could find yourself facing a massive—or even total—loss.
Insurance provides you with an easy and affordable way to secure your investment. But you must obtain the right amount and type of insurance coverage to fully mitigate these risks. Therefore, it’s important that you work with a trusted insurance agent who can recommend the right coverage for your precise situation.
Risk #5: Underestimating Property Management and Holding Costs
The costs don’t drop off the moment you close on a piece of real estate. And the continued costs are not limited to repair expenses either. Do not erroneously assume that holding costs are concerns that are exclusive to investors with long-term holdings. Virtually all investors must accurately account and budget for holding costs.
This is true even if you’re planning to buy, renovate, and sell a house quickly. For instance, you’re going to need to keep the lawn mowed or you could face fines from city code compliance officers. Landlords also have responsibilities in the winter; if a property is in a location with cold winters, then you’ll need to keep the house heated or take measures to winterize in order to prevent damage to piping and other home systems. If you realistically cannot maintain the home in an appropriate manner, you’ll need to consider the costs of hiring a property management company.
These are just some of the expenses you’ll need to account for while you maintain and hold a property. Even if it’s just a matter of 12 or 16 weeks, the costs can add up quickly, cutting into your profit margin.
Smart Investing to Mitigate Risk
The reality is this: there are lots of potential pitfalls and risks associated with investing in residential real estate. And while some of those risks—such as those associated with market fluctuations—cannot be controlled, a majority of risks can be effectively mitigated. It just takes the right insight, knowledge, and guidance. That’s precisely where independently owned and operated HomeVestors® franchisees have a competitive edge with the tools and resources necessary to help identify the good investments while avoiding potentially bad ones.
If you’re ready to increase your chances of success as a residential real estate investor, get in touch to learn more about becoming a HomeVestors® franchisee today.
Each franchise office is independently owned and operated.