Tuesday, April 29, 2014

The Top 5 Mistakes First-Time Real Estate Investors Make

Many novice real estate investors don't know where to start when purchasing their first property. We reached out to Rick Sharga, executive vice president of Auction.com, about his tips for avoiding common pitfalls.

As the market continues to recover, many people are starting to think again about real estate investing. Have you decided to dip your toe in the water? That's great, but be aware that even though there are many good opportunities out there, real estate investing is a lot more complicated than other forms of investing.

Here are the top five mistakes I see novice investors make when they're first starting out.

1. Lack of a strategy. Most first-time investors don't have a good plan in place. They jump in because they saw someone on late-night cable television claiming that they can buy a house with somebody else's money and flip it and become a billionaire. But there's a big difference between buying a property at below-market value and being able to profit from buying a property at below-market value.

Before you do anything else, decide what type of investor you are based on what you want to do with the property. This will dictate the type of properties you look for — and where you look for them.

Are you trying to maximize the number of turns your money makes in a short amount of time? You're probably a "buy-and sell" investor. Start by looking at what kind of properties are selling. What you don't want to do is buy a fix-and-flip property that then sits on the market for nine months.

If your strategy is to buy a property and hold onto it for several years, make a certain amount of rental income and resell it as prices appreciate, you're a "buy-and-hold" investor. Look for properties that don't require a lot of repair because that determines what you can spend on the purchase in the first place. You want properties that will maximize your rental returns, namely, markets where rental occupancy rates are high.

Think about whether you want to manage the property yourself or hire a property manager. If it's the former, that probably limits you to local properties. You don't want to find yourself managing an apartment building in Detroit if you live in California.

No matter what type of investor you are, be willing to shift your strategy as the market changes to take advantage of opportunities as they present themselves. Don't get locked into a strategy that the market won't support.

2. Overvaluing the asset. First-time investors almost invariably fall in love with a particular property and overpay for it. They don't get good market data on what a property is actually worth.

Do your homework. Visit LendingTree.com, FannieMae.com or FreddieMac.com to research mortgage and refinancing rates. Realtor.com, Zillow and Trulia can give you information about local market and price trends. If you're thinking of investing in foreclosures or short sales, consult RealtyTrac, ForSaleByOwner.com or Auction.com.

Consider working with a professional until you get a better idea of what you should be paying for a property relative to the state of the market. Find a local Realtor®, ideally one who specializes in distressed properties; many advertise their services on Zillow, Trulia and RealtyTrac. (Be sure to ask for references.) Another option is a local appraiser, who can give you a formal work-up on the value of a property.

3. Underestimating the cost of repairs. On the other side of the coin, first-time investors almost always underestimate what it's going to cost to repair the property. The combination of overvaluing the property and underestimating the repairs can take you from a nice profit to a significant loss overnight.

Unless you're a subcontractor or construction professional, hire someone to evaluate the property and give you a written estimate for what it would take to bring the property up to your standards.

Again, your strategy will dictate how much you're willing to spend on renovations. If you're looking for a fast turnaround, you might just want to clean the house out and put a new coat of paint on it. If you're looking to hold the property and rent it — or if you're planning to make it the nicest property in the neighborhood and increase your returns — that could take you to a completely different level of renovations.

4. Not having your financing in order. The wrong time to start figuring out your financing strategy is after you've agreed to buy something. If you're buying on a site like Auction.com, in most cases you have to buy with cash. Do you know that going in? Do you have cash ready? Do you have pre-approved financing lined up before you get started?

By the way, investors who need to finance a purchase are at a significant disadvantage in today's market, where many buyers pay all cash. At a minimum, it's important to be pre-qualified for a mortgage loan so that the seller knows you're serious. CitiBank and Quicken have started to promote "pre-approval" loan programs; Fannie Mae and Freddie Mac have specific programs for investors.

5. Not thinking about property management. Most people underestimate the degree of complexity and the cost involved in managing properties. Do you have cash reserves if the tenant suddenly decides not to pay you for a couple of months? Do you have cash set aside in case the water heater breaks? Are you managing the property yourself, or are you paying a property manager to do it? Who gets the call at 2 a.m. when something goes wrong? If your answer is "no" or "I don't know," you'll need to either hire a property manager or reconsider your strategy.

These five mistakes may seem obvious, but I've seen people make them time and time again in their rush to "buy a property cheap." Do your homework. Think through your strategy and goals. It will pay off even before you bid on a property — and could save you a lot of money.

Rick Sharga is executive vice president at Auction.com. As one of the country’s most frequently quoted sources on foreclosure, mortgage and real estate trends, Rick has appeared on NBC Nightly News, CNN, CBS, ABC World News, CNBC, FOX and NPR. He has briefed government organizations such as the Federal Reserve and Senate Banking Committee and corporations like JPMorgan Chase, Citibank and Deutsche Bank on foreclosure trends, and done foreclosure training for leading real estate organizations, including Re/Max, Prudential and Keller Williams.

Questions for the author about real estate investing? Tweet @ricksharga for his insights.

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