Real estate investment is a growing attraction for many, especially when the stock market doesn’t perform well. Everyone from first-time home buyers to seasoned investors are entertaining the idea of finding the perfect real estate deal. But developing long-term wealth in real estate requires an understanding of some basic blunders that could help avoid costly mistakes.
Here’s a look at some common errors to help you avoid a real estate transaction disaster. Together, Lisa Vander, CEO of Pacific Blue Investments and I share some of the top mistakes that investors and would-be investors often make.
- Leaping into real estate without a plan and vision.
That’s like starting a business without knowing what product or services you’re going to sell; it’s unlikely you’ll get very far with that approach. Or it’s like going on a road trip without the map, “[People] end up with a [real estate] portfolio without any idea of what they’re really up to, or what their targeted goal is, or how long they want to own that property, or what types of different properties they want, or what rate of return they want from the equities they’re building,” says Vander.
- Thinking that you do not have enough money to invest.Even though interest rates are starting to creep up, there are still many good loans available where you don’t have to put 20-30 percent down. But remember, if you’re putting less down, your monthly mortgage will be higher, and if you’re purchasing an investment property, keep in mind that you must be prepared to sustain a negative cash flow for a period of time.
“If you absolutely have no cash, you can certainly get no-money-down deals. You’re just going to pay for it. You’re going to pay a higher point. You’re going to pay a higher interest rate. But if it’s still a good deal you can go with no money down. It just means it’s more expensive to get started in the game,” explains Vander.
- Flipping property too quickly.When appreciation is high as it has been in some markets such as California, often people tend to want to buy real estate and sell it quickly to turn a profit. But the real benefit is in the long run.
“[Investors] will actually hold on to [real estate], keep all of the gain through all of the cycles that [they] go through. Then, at the end of their plan, all of a sudden they’re sitting with a lot of gain, not only [from] tax benefits, but also the equity from appreciation,” said Vander. She adds, over time the loan will be paid down and typically rent will have increased.
- Focusing only on active income.Most of us never forget to think about our active income, the income from our 9-5 job, but we often fail to pay attention to our passive income streams, such as money that can be generated monthly from rentals.
Investor, Margaret Bhola, used to wonder, “What’s going to happen to [my husband and me] when we’re no longer working traditional type jobs?”
Bhola says she took Vander’s course and began to see how to build family wealth and passive income that would provide security for her future. Through investing in real estate she and her family are creating a brighter financial picture.
- Not building a real estate team.Surrounding yourself with the best experts from the real estate agent to the financial planner will help you achieve your desired outcome faster and with fewer headaches than if you go at it alone.
- Spending your return on your investment.Take your hand out of the cookie jar. If you have a positive cash flow on a property, evaluate where the money should go; you might consider taking some equity and combining the positive cash flow to reinvest in another rental.
- Expecting a positive cash flow from all real estate.When you calculate cash flow, appreciation, loan reduction and tax benefits, (including interest write-off and depreciation) having a negative cash flow is not necessarily a bad thing. Vander points out that, “Usually a negative cash flow on a property won’t be for a long period of time.”
Vander compares it to the concept of making a contribution to a 401k, “Every single month you make a contribution to your retirement plan. Why do people consider a contribution to real estate anything different, if you know what your rate of return is for the money that you’re putting into it?”
- Not diversifying your portfolio.A real estate portfolio should be diversified much like a stock portfolio. “You might have a couple of condos, a couple of apartment buildings, you might have a couple of single-family residences, you might decide you want to buy some raw land,” says Vander.
If one market isn’t performing as well, you can still rely on the other real estate investments.
- Not understanding real estate tax benefits.Owning real estate has powerful tax benefits. Strategically using them to your advantage is key to developing long-term wealth. “Most people don’t understand that there is tremendous power and long-term benefit through the use of depreciation and the interest write-off on the loan. And it’s the misunderstanding of the depreciation that is very common among beginning investors,” says Vander.
- Not sticking to your desired outcome.Whether it’s your first home or your fifth investment property that you’re wanting to buy, staying committed to the end result will get you there. You have to keep the vision and the plan firmly planted in your head. Writing down and sharing your goals and fulfillment dates with others will help make you accountable and keep you on track.
Written by Phoebe Chongchua