If you are interested in investing in real estate, it is important to understand not only the rewards and returns, but also the need to have a good understanding of the risks and failures. Good real estate investment takes skill, knowledge, and patience on details.
A bad real estate investment is anything you don’t make money on. Like any investment, the goal and purpose is to get return. You need to take risks to get returns. Typically, the greater the return is, the greater the risk.
Although risk is inevitable, there are many ways to lower your chances of getting into a bad deal. Investors get into bad real estate investments when they don’t do enough to understand and control the risk. Here are common reasons that lead to a bad real estate investment:
Not Having a Solid Real Estate Investment Plan
A bad real estate investment usually starts when you don’t have a solid investment plan. When talking about investing, the most important thing is to have a solid plan so that you actually know what you’re doing (e.g. what is your plan, what the exit strategies are). You need to ask yourself: what types of property are you looking for: residential property, commercial property, or raw land? Do you want to do rentals or fix and flip?
Even when you start a rehab project, you need to outline the details exactly so projects can go as needed.
Not Having a Great Contingency Plan
In real estate investing, having a great contingency plan is necessary. What happens a lot is you may think everything is going to be perfect. What I’ve experienced—after hundreds of deals— is that few things go according to plan.
There will always be problems and a real estate investor’s job is to be a problem solver. Whoever can solve the most problems is the one that has the most success. So In a situation where things don’t go the way that you’re expecting, a contingency plan is useful.
No Exit Strategy for Your Real Estate Investing
Having an exit strategy is very important in real estate as well. When the deal goes bad, how are you going to offload it? How much of your original investment can you salvage? Just like getting on an airplane, one of the first things is to locate the exit nearest to you. You don’t want to get stuck with a property (and a huge loss) when the deal goes bad.
The question is, when you need to get rid of the deal, what is your primary, secondary, and third exit strategy? For example, if your initial plan is to fix and flip but that doesn’t work out, then you can rent it out, which is your exit strategy. Perhaps you can sell it to another investor. If that doesn’t work out, you can do a lease option, or do an Airbnb. There are different things you can do to have an exit strategy.
Not Doing Enough Research
When talking about property investing, you may need more research, such as understanding the housing market, comparative research to understand the reason behind the price, etc. You also have a lot to do before you actually invest. For example, you need to find good contractors, build relationships with contractors, real estate agents, home inspectors, attorneys and insurance representatives.
Got Too Emotional
Another common reason for a bad real estate investment is that you got too emotional. It’s easy to find a great deal and fall in love with it—but that almost always leads to trouble. When you make decisions based on emotion instead of logic, you have a harder time doing what needs to be done, such as cutting bait before your losses get too large. Emotional investors always believe they can salvage the deal, thinking it’s going to net them a big payday.
Actually, emotion is typically pretty expensive when it comes to investing. That’s why you need to calculate the numbers, create a plan, and craft an exit strategy before you get too involved…and then stick with it no matter what.
Bad real estate deals are often the result of the property being overvalued. When the deal is too expensive, your margin for making money decreases. When you don’t use comps or look at the wrong ones, it’s difficult to make sure the property you are looking at is a good deal.
Again, do comparative research and find properties that are true comps (instead of picking properties that are the result of wishful thinking) and that will help you identify which properties are overpriced and which ones are actually a deal with profit to be had.
Poor Project Management
One of the keys to real estate project management is to get the work done on time and on budget. One common mistake is to rely on contractors too much and so they fail to take an active presence during the rehab. Construction projects should involve teamwork and you need to manage your team well to get things done on time and the way you want them.
When it comes time to value your property, some investors overlook other risk factors involved in the property. For example, no one wants to devalue their property by 5% because there’s some crime in the area. Or they don’t take into account that they’re three houses down from a Burger King (which I’ve actually done before, in my early days). Many new investors want to believe they’ll get full price for the property, and that leads to bad real estate deals. I’ve seen it many, many times. I wrote another post on the topic of how to reduce real estate investment risks!
Underestimate the Cost of Repairs
People can overvalue the properties and underestimate the amount of repairs. Underestimating repair costs can be harmful and lead to investment failure. The repair costs can include materials, labor and other costs. It’s important to accurately estimate the repair cost like re-roofs, re-plumbs and heating or cooling system replacements, and plan for those costs accordingly.
I always get my contractors to line item the repairs and put a cost next to each one. That way there aren’t any surprises and they must stick to the original plan and prices that they signed. It’s saved me many times from losing money on my deals.
Real estate investment certainly involves high risk but can result in high returns. It takes time and effort to be a good real estate investor and avoid the bad investment habits we addressed here in real estate.
To avoid bad real estate investments, you need to do your research, plan the process ahead of time, and gather enough information on the property and neighborhood to correctly value the property.
And that doesn’t mean everything’s always going to go right, but you’ll increase your likelihood of success tenfold.
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