Avoid The Four Wrongs of Real Estate
The Four Wrongs of Real Estate
There is no more polarizing issue in the personal finance community than real estate. For every land lording success story, there is an equally compelling sob story. Although few would claim that property ownership has no place in wealth generation, there are a number who won’t touch this asset class with a ten foot pole. The undeniable truth is that real estate has two major benefits that are hard to deny. For one, it can be an incredibly inefficient market. Good deals are out there to be found. For another, it is one of the few asset classes that is truly uncorrelated from the stock market. You just don’t get this same diversification from REITs. Whether, condos, single family homes, or multi-unit buildings, there are profits to be made. But you not only will make nothing, but also lose if you become a victim of the four wrongs of real estate.
Don’t let this happen to you. It is not rocket science, but requires a little forethought and effort.
Wrong Property
There is no substitute for buying the right property. Time and again, amateur investors don’t put enough thought and effort into doing due diligence in the first place. Of the four wrongs of real estate, this one can really bite you in the back of the pants.
The property needs to be physically sound. That means hiring a top-notch home inspector to evaluate every nook and cranny. You want the guy who has the biggest reputation for breaking up deals. You need to be aware of any weakness in the foundation, insufficiency in the roof, and loose screw in the furnace. The more you know the better. Although you may decide to still buy a faulty property, you will know the scope and cost of work required.
The property needs to be fiscally sound. Whether you calculate the cap rate or are an adherent to the 1% rule, you have to run the numbers. This is a rather exact science. if you read a few blogs and peruse a few books you should be able to get the hang of it.
Wrong Location
Location means everything. No matter how good a property is, it’s worth nothing if you can’t rent it. So you need to understand the neighborhood. Of the four wrongs of real estate, this is the one most overlooked. An investor sees dollar signs and doesn’t realize that he got such a good deal for a reason.
Is the block crime infested? Is the neighborhood decaying and unlikely to attract good paying tenants? Has the area gone from hot to not and properties are going unrented?
Often perspective landlords forget to spend some time at the property before buying. They miss the train tracks half a block away that disrupts the quiet, or the water purification facility that makes the neighborhood smell.
Wrong Tenant
This is so important. Do your due diligence people. Credit check, background check, and a call to previous landlord is the minimum. I often make perspective tenants send me pay stubs and bank statements also. You can’t be too careful here.
When it comes to the four wrongs of real estate, this one can be the most devastating. Getting a dead beat or destructive tenant can cause a world of economic and emotional stress. Once they are in the unit, it can be very hard to get them out. So be smart and do the detective work upfront (can you say Facebook stalking anyone?).
Wrong Expectations
It ain’t perfect. Real estate, like any other business, can be down right lousy at times. Units sit empty. Pipes burst. There is no way to know what unexpected pain is going to come your way. So do yourself a favor. Have a guy (or girl).
Retain a really good handyman and know a few stellar electricians and plumbers too. It only is a problem if you have to think about it. Get used to the idea that when something goes wrong, help is a speed dial away. The money you spend for repairs will be well worth the hassle and worry.
Final Thoughts
Beware of the four wrongs of real estate. Being a good landlord is a state of mind. Get to know the property and neighborhood before you buy. Weed out potential tenants by doing the proper due diligence. And finally, manage expectations.
Real estate can be a lucrative investment and round out a nicely diversified portfolio. But just like everything else, you have to spend a little time to learn what you are doing.
Like you said, this is the one area that seems problematic to many of us. We are gonna have to make a final decision on this soon, though. We are moving out of a house we have been in the last ten years. We know it’s a fine house for starting medical students and residents and near the hospital. So the likely tenants would be solid. The location is good. The house has been fine for us for ten years.
The one problem is that management part. I simply don’t trust a management company because of the horror stories I’ve heard and am not sure either my wife or I have enough time to manage a property with our full-time jobs.
I want to want to do it. I just need to be convinced it’s not gonna be a ton of extra work. I am okay with some, but not an additional part time job.
You might just have to try and see what happens!
The Physician Philosopher,
Saying you “don’t trust management companies because of the horror stories I’ve heard” isn’t much different than someone saying “I don’t trust doctors because of the horror stories I’ve heard.” Most property managers will do a good job for you. If you need to be convinced to do it, then don’t. You should only make property investments because you want to and the property is likely to make you good money. I’ll tell you it is not difficult to manage property. I managed 64 units as a full time general surgeon and I can live on the income today. Automate everything you can.
Dr. Cory S. Fawcett
Prescription for Financial Success
I’ve made an active decision not to be a landlord. Too much concentrated risk in one asset for my taste. I suspect that’s why you hear such mixed results. on a single unit basis much of the results are luck. A company could randomly shut down killing the local housing market, you could find some maintenance nightmare missed during the inspection, your tenants could wreck the place… You can reduce the risk of these things but they always exist. If your first property is the nightmare you never come back.
No question. Real estate has risks. It’s a matter of mitigation.
I personally got turned off with direct ownership having had 2 previous condos (lost in divorce which I didn’t shed a tear over) that really wasn’t worth my time for the amount of money they cash flowed (after debt service, HOA, random expenses, and then whatever I got to keep got a 39.6% haircut for taxes). I still have a guest home on my property which I rent, it has been a pain sometimes but also has periods of no issues whatsoever. I prefer now to go to private syndication to still have real estate exposure without the hassles of active management.
Although I like actual real estate, I think syndication gets the job done.
I’m all about passive investing. With my commercial property investments I invest in private equity funds through larger reputable sponsors.
I also have a single family rental which is outsourced to a fantastic property management company. The occasional repairs get taken care of and I just get a notification that it’s been done. No hassle for 3 years so far. *knock on wood*. Monthly check in the bank. I get monthly drive by photos and q 6 month “safety checks” where they check everything in the home with photos of everything for documentation. So far so good. Real estate doesn’t have to be a hassle if you have systems. It can also be very passive for lazy people like me.
It sounds like you’ve got great systems in place.
We all have our own versions. That’s what makes RE so much fun.
We bought our rentals close to hospitals and universities in HCOL areas. We also only rented to folks who had more to worry about than our rental ie career bankers, police officers, senior government employees or university profs. We have been renting out properties for the past 22 years and sticking with quality renters have been wonderful.
These people were extremely high functioning and took care of the homes even better than I would. They also would contact our plumbers and electricians themselves. We were never really bothered.
My husband even managed these rentals during his surgical residency. So managing them while we were working was not an issue. But you have to like it. If you don’t then I think it would be a bad investment.
It’s usually about the person who invests rather than the investment solely. We have bought a few properties from investors who simply managed it to the ground. And when we took it over, we could cash flow it.
There are plenty of different approaches with RE. And all valid if it ends up working for you.
I like your style. You have avoided all the wrongs.
Our halfplex is vacant and we were in the carpet store getting ballpark figures. The guy helping us had a rental where then tenant had a goat in there without telling him. I thought I had heard it all, but that one was new!
We would probably be better off to sell it right now, but we are going to make the fifth “wrong” of real estate, and rent to my niece. Story will follow in a few years, stay tuned.
A goat? Now that’s odd!
I don’t own real estate except some REIT. One thing I like about it especially early in an investing career, is the deal is leveraged. In many ways it’s like buying a zero coupon bond and letting someone else pay for it.
I had some honest to God beautiful beach front condo’s on the Gulf of Mexico near St. Pete. The condos were leveraged and rented by the month to tourists and vacationers through a management company also part owner. Eventually property owners would move there to retire. As owners retire the management company profit goes down. The management company decided to “renovate” which basically shut down the cash flow for abut a year and a half. By the end not many of us “owners” were left as we were on the hook. They were happy to buy us out…. not at a loss but cheap. The condo’s are still on the beach beautifully renovated and being rented and making the management company a mint. The property has appreciated incredibly as it’s really true, beach front they aren’t making any more of it. I held on till the bitter end and forced the management company to buy me out dear. If they wanted total ownership it was going to cost them and I was making enough I could service the loans forever, and come stay there whenever I damn well felt like it. In the end I just about doubled my money in a six year pissing contest. It was the 90’s and FL property was exploding, but what a huge PITA. I decided I didn’t need anymore icebergs in my portfolio, though I really dug beach life. The sunsets were spectacular.