To be sure, there's a lot that can go wrong when you invest in real estate. You can overpay for a property, buy in the wrong area, use the wrong lender or loan product, or overestimate the rent you're likely to receive, just to name a few. The list of mistakes is far too long to discuss every possibility here. But here are three big mistakes first-time real estate investors should know about and take steps to avoid.
Plan for the unexpected
If you buy a rental property that brings in $2,000 in monthly rent, and your monthly mortgage payment including taxes and insurance is $1,500, it may seem like the property should produce $500 in monthly cash flow. But that's not likely to be the case.
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One big mistake new real estate investors make is that they fail to budget for the unexpected -- specifically vacancies and repairs.
At some point, your property will be unoccupied. It may only be for a few weeks between tenants, but it's going to happen. A good rule of thumb is to set aside 10% of the rent to cover vacancies so you don't have to come out of pocket to pay the mortgage when your tenants move out. And you're going to need to spend money on maintenance and repairs over time. Plan to set aside another 10% to 15% of the rent you collect to cover maintenance. When calculating your expected cash flow, don't forget to consider these expenses, or your projections aren't likely to be too realistic.
Don't self-manage just to save money
When you buy your first investment property, you have to choose whether you want to hire a property manager or do it yourself. And if you're not familiar, property managers typically take about 10% of collected rent on a long-term rental property.
To be sure, there are some good reasons to self-manage. For example, maybe you're a retiree and have the time to deal with tenant issues. However, it's important to realize that property managers can provide tremendous value for their 10% cut, and the decision to self-manage shouldn't just be to save money.
A good property manager will market the property, screen tenants, handle complaints and tenant issues, schedule maintenance, pay utilities on your behalf, and more. And a property manager will likely know exactly how to price your rental property, which in many cases can be worth the 10% commission all by itself.
Rental properties aren't the only way to go
As a final thought, it's important to mention that (especially in today's inflated real estate market) rental properties aren't the best choice for everywhere. In fact, in many markets, it's next to impossible to find a rental property that will produce positive cash flow, unless you're willing to buy a property that is in need of major repairs or upgrades.
In fact, many investors are finding that real estate investment trusts, or REITs, are a better choice in the current environment. They have the same general concept (rent properties for income), but unlike buying rental properties, most REIT prices have declined in value, so you might get more value for your investment dollars. Many REITs have long track records of growing profits and raising their dividends every year, so if you're thinking of investing in real estate for the first time, maybe this option is worth considering.
I've got you covered! Real estate investment involves intricate knowledge, and it's crucial to avoid pitfalls. Firstly, budgeting for unexpected expenses is paramount. From my experience, accounting for vacancies and repairs is a must. Allocating around 10-15% of rental income for maintenance and setting aside funds for potential vacancies safeguards against cash flow disruptions.
Regarding property management, it's not solely about saving on fees. Property managers offer invaluable services: tenant screening, handling issues, coordinating maintenance, and setting optimal rental rates. Their expertise often justifies the 10% commission.
Lastly, the article touches on an important point: diversification. Real estate investment trusts (REITs) are an alternative to owning physical properties. They offer exposure to real estate with potentially lower entry barriers and greater liquidity. Many REITs demonstrate consistent growth, making them an appealing choice, especially in markets with inflated property values.
Now, breaking down the concepts discussed:
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Budgeting for Unexpected Expenses: Real estate investments require accounting for vacancies and repairs, typically around 10-15% of rental income.
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Property Management vs. Self-Management: Property managers provide comprehensive services like tenant screening, issue resolution, and maintenance, often justifying their fee (usually 10% of rental income).
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Diversification with REITs: Real Estate Investment Trusts (REITs) offer an alternative to physical property ownership, providing exposure to real estate markets with potentially lower barriers to entry and higher liquidity. Many REITs have a history of consistent growth and dividend payouts.
Each concept underscores the importance of thorough planning, whether it's in anticipating unforeseen expenses, understanding the value of property management, or considering diversification options like REITs.
