I’ve been a fan of real estate for most of my adult life. Over the years I’ve learned some important real estate investment mistakes every investor should avoid that I share below.
I follow my local real estate market like a hawk and regularly go to open houses to monitor comps and search for new investment opportunities. My love of real estate continuously also motivates me to work hard. And I feel fortunate to have bought primary residences, rental properties and a vacation property over the last ~18+ years.
Before I get into the main real estate investment mistakes to avoid, I’d like to share my experience purchasing a vacation property. Unless you are really rich or don’t care about financial returns, you probably shouldn’t own any vacation property.
In the summer of 2007, I bought a vacation property at my favorite resort up in Lake Tahoe. The property is in a secluded place with ski-in/ski-out access during the winter. And it has golf, swimming, tennis, tennis, fishing and bike rentals on the premises during the summer. Ah, the good life!
Although Bear Sterns had gone under, I was still hopeful things wouldn’t get too bad. Our government consistently bails everybody out after all. Unfortunately, I was wrong as there was no amount of money the government could inject into the system at the time that could stop the wave of defaults.
Instead of making a lot of money from my job that year, my income got whacked. Then I lost over $200,000 in my vacation property the subsequent year. Ouch.
I thought I was getting a deal for the vacation property at $700,000 because the owner had just bought the place a year ago for $815,000. Surely, a property with over $80,000 in gross annual rental revenue could not go much lower.
Of course I was wrong because the condotel secondary mortgage market shut down. Banks were no longer willing to lend for vacation properties anymore. The only people who could buy were those with enough cash. This was a great reminder why cash really is king.
As the financial crisis worsened in 2009, fellow resort owners started going into foreclosure. As a result, this brought the values of adjacent properties down as well. This is a big problem with owning a condo. You are at the mercy of your neighbor down the hall.
In a real estate downturn, the first properties to get hit are vacation properties because they are non-essential. Meanwhile, you have tons of people shirking on their loans in California because we are a non-recourse state. If you stop paying your mortgage and hand back the keys, the banks cannot go after your other assets!
I’d like to go over some real estate mistake one should avoid making. It’s good to relive financial errors in order to make better choices in the future!
Now without further ado, here are six main real estate investment mistakes that every investor should avoid.
2007 was a record year for corporate profits and my personal income. I remember getting my bonus at the age of 30 and distinctly thinking I could finally consider myself rich.
I felt confident that I would continue to make a similar amount for the next 10 years. What I didn’t anticipate was the beginning of a disconnect between performance and pay starting in 2008.
It didn’t matter how well I performed. I couldn’t get paid well anymore because the overall profitability of the company was down. My pay was reduced for the next two years. It only popped back to my 2007 highs in 2010 after I negotiated an aggressive guarantee since I was getting poached by a competitor.
There really are no income guarantees unless you work in a unionized job or the government. Even still you could unexpectedly get laid off.
Note – If you ever suspect you could get laid off or that your employer is going to have RIFs (reduction in force), please read my book, How To Engineer Your Layoff.
The private sector has become brutal in the way it cuts compensation and staff to compete today. Whenever things are going fantastically well, remind yourself that all good things come to an end.
To avoid making real estate investment mistakes, extrapolate an income for yourself that flattens out or fades lower to be conservative. The median household income of Americans at $68,703 (data as of September 2021) has only risen slightly after practically going nowhere for 20 years.
The second real estate investment mistakes to avoid is rushing your purchase. You need to spend a lot of time looking over the property.
I realize that buying a property is a highly emotional experience. If you find something you like, you start getting nervous that someone else will snatch the property away, especially during hot market conditions.
However, a thorough real estate inspection is incredibly important to insure that there are no hidden leaks, mold, foundation cracks, and other structural issues.
I highly recommend you visit your prospective property at least three times for an hour each. And go at different times of the day and week. You want to observe as many conditions as possible in the morning, daytime, evening, and rush hour. Ask a bunch of questions, and similar questions to see if you can catch inconsistencies from the selling agent.
Please realize that the real estate market is very collusive. Your real estate agent knows mortgage brokers who know title officers who know property appraisers.
Every single industry has seen commission rates drop due to the advent of the internet and technology (think Expedia and travel agents) except for the real estate industry due to the higher risk in selling something so valuable.
There will inevitably be some sort of conflict of interest with so many moving parts to a property purchase.
Another of the most important real estate investment mistakes to avoid is not running enough numbers. Before each property purchase, I create an entire spreadsheet with three different income and expense scenarios, especially for vacation and rental properties.
I’ve got the Bullish, Neutral, and Bearish scenarios to work with. Only if I can survive for at least five years with the bearish scenario will I pull the trigger and buy the property I’m considering.
Part of my assumptions in a bearish scenario now include a total loss of primary income, a 40% haircut in property prices, and 2% higher interest rates. Although if asset values are taking so much, interest rates will be going lower, and not higher.
My 2008 bearish property price downside scenario was 20% too optimistic! The unexpected positive was that I was able to modify my loan for free down to 4.25% for a 30-year fixed jumbo from 5.875%.
This was thanks to a Department of Justice lawsuit that forced Bank Of America to allow on-time payers refinance lower due to a drastic drop in interest rates.
I do wonder whether Bank of America would have done anything to help if the government didn’t step in.
Property often times blinds us. We begin to think irrationally once we’ve found our dream home because we fear if we don’t act fast, someone else with take our home away.
Realtors also blind us into buying or selling property that we otherwise shouldn’t. Despite telling my real estate friend I wasn’t interested in selling my home, he found a way to get me to list my house for three and a half weeks on the market.
It was a pain to always show the house and keep everything super clean. To claim some of my authority back, I decided to price above market so that if there was a bid, I wouldn’t feel bad selling. You can read more in, “Lessons Learned From Not Selling My House.”
Every prospective home buyer should bring along at least two other people with them to inspect the property. At least one of these people should be a homeowner who will provide both the good and bad of homeownership.
If you have a chance to speak to the neighbors, do it. Ask them what the pluses and minuses are for the property’s location.
Maybe firetrucks wail their sirens constantly past 10pm. Or perhaps the block tends to flood when it rains. Maybe there’s been an increasing amount of burglaries over the years. Or maybe your neighbor knows that the liquor store across the street is in contract and will be torn down and replaced with a respectable office building.
Your neighbors can provide all the candid detail which the selling real estate agent and fancy brochures cannot. Of course your neighbor probably wants the property to be sold for top dollar.
But more often than not, you will be able to glean some fantastic information that will save or make you a lot of money.
The easiest and best way to check the sales prices of comparable homes is to punch in your desired property onto sites like Zillow.com.
You can see sales history and home value estimates to get a ball park figure of the properties’ worth.
From there you’ve got to do your own calculations on mortgage cost, rental yields, and so forth to get a best guesstimate on value.
Vacation properties should be purchased primarily for lifestyle purposes only. When I bought my vacation property, I imagined a scenario where the family and close friends could go up and play.
I wanted to always feel at home while on vacation and I really do every time I go up to Lake Tahoe three hours away.
However, my purchase was a very poor economic decision if we just focus on the numbers. I’m here to help you not make the same mistakes.
Fortunately I was finally able to enjoy my vacation property with my kids. We went up in the middle of the pandemic nevertheless, and were able to enjoy the amenities off-peak. It was a nice change of pace.
Owning your primary residence is a wonderful situation once you’ve found your ideal home. It’s a place where you’ll probably spend at least 10 hours a day.
You’ll likely build equity over the long term as well as generate lots of happy memories if you buy within your means. Don’t let good times in the housing market convince you to make delusional financial calculations.
Always buy a property to enjoy first, income second, and capital appreciation a distant third. If you do, the only thing that will change with the markets is your financial ego.
Here are some further recommendations to grow your wealth.
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Check the latest mortgage rates online through Credible. They’ve got one of the largest networks of lenders that compete for your business.
Your goal should be to get as many written offers as possible and then use the offers as leverage to get the lowest interest rate possible.
This is exactly what I did to lock in a 2.375% 5/1 ARM for my latest refinance. For those looking to purchase property, the same thing is in order.
If you’ve found a good deal, can afford the payments, and plan to own the property for 10+ years, I’d get neutral inflation and take advantage of the low rates.
Updated for 2021 and beyond.