TV shows and Internet success stories frequently lead people to believe that investment in active real estate, rather than passive investment, is simpler and more successful than it really is. It’s true that many hopeful investors have received lucrative returns from their successful investment in real estate, but many others have lost money as well. Although it can be lucrative, investment in real estate, whether active or passive, is by no means a “get rich quick” scheme.
Seeing homes transformed into HGTV shows has drawn many to invest in real estate without understanding the full range of risks and responsibilities. This can affect the expense, time commitment and overall profitability of an investment in real estate. In particular, active real estate investment requires a great deal of expertise in financing and real estate, as well as large time and monetary obligations.
In this article, we discuss three common errors encountered by first-time real estate investors, and the best ways to avoid them. Hopefully, once you know what to watch out for, you can choose the investment strategy for real estate that best suits you.
Fails in the House
House-flipping is one of the most in-vogue methods of investment in real estate today, but is also one of the most risky. Many famous house-flippers earned considerable fortunes from their flips, but countless ordinary investors also lost money. If you watched an HGTV show, then you probably understand how a flip of a house works. An investor buys a home they believe to be underpriced in need of rehabilitation, adds value to the home through renovations and additions and then sells the home for a profit. Although the process is straightforward, house-flipping requires several moving parts throughout, from start to finish, which can affect your investment positively or undermine it.
What Could False?
House-flipping comes with many uncertainties leaving a lot of room for mistake. Investors who can buy homes usually hit bumps on the road during the renovation and sale phases. Although you can fix any established home problems, you have little influence over unknown or mysterious causes, such as the secret decay of an old building, mold concealed behind walls, unforeseen actions of mother nature, or housing market changes.
You perform due diligence on a promising single family home and believe you can sell the home for at least $200,000 above what you paid with renovations totaling no more than $150,000. You buy the house and the supplies and you hire a crew. You get to work, ripping drywall down and ripping up floors. On the first floor, everything goes according to plan; you’ll move on to the basement. The project hits a snag when you start tearing the drywall in the basement: you discover dry wood rot from a leaky pipe, previously concealed behind the drywall, in the basement support beams and mold.
You know right away that you’ll need to remove two support beams, a massive project you didn’t budge for. Before you can do that, you need to hire a mold specialist to evaluate the scope of possible removal and remediation. He has no availability until next week, and you will have to pause all of your renovation work until his inspection is complete. Finally, he says after the inspection that he needs to schedule a team to come in and remove the mold safely.
A week later, the crew announces that they have removed the mold with success. They also perform additional, complete home inspection for further molding. Happily, it turns out the rest of the house is clear. Your renovations are already a few weeks behind schedule, however.
With the toxic mold removed, the affected wooden supports can now be replaced, and the pipes that caused the leak repaired. You have to move up the work schedule of the plumber so that he can finish his repairs, before replacing the wooden supports. As a result, your electrician and drywaller’s work schedules must also be shuffled, so they can arrive at a later date. Yet your electrician is unavailable, so you are seeking another, at a higher cost, to prevent more delays. With the cellar schedule sorted, you now have to determine what renovations you can do in the meantime, and schedule the rest of your crew to work around the cellar repairs to keep progress.
Such unexpected but required repairs, replacements, inspections and delays have added thousands of dollars to your costs, and weeks to your timeline. You must either skimp on attractive features, such as granite countertops, or bear the cost and hope of selling at a price that is even higher than anticipated. Either way, as the problem gets prolonged, your potential return dwindles — or completely disappears.
How to Evade This
House-flipping is a high-stakeholder, high-pressure investment in real estate which involves a high risk level. To avoid unnecessary risks and keep on track of renovations, successful house-flippers frequently use expert services, including home inspectors, accountants, project managers and real estate agents. A team of real estate and financial experts can mitigate, but not eradicate, the risks involved — where certain risks can be avoided, some are out of your control. Before you purchase, an expert may be able to help you find a home with structural issues, but they can’t always predict if you may face labor issues, cause delays, or a bad snowstorm while making roof repairs.
While a team can keep the project running smoothly, a house flipper ‘s profits can add up and eat away the cost of its services. That’s why many flippers cut down on their team of experts or opt to go solo. While this is possible, it requires extensive personal real estate and financial knowledge as well as hands-on management, because the investor will be responsible for the success of the flip.
A rental property investment, while not as adrenaline-pumping as a house flip, can be an attractive way for people looking for regular cash flow to invest in real estate. However, with myriad responsibilities for tenants and the property, the prospect of regular rental income also comes. The investor must manage many different types of obligations, from finding renters and collecting rent to ensuring legal eviction and fixing broken appliances, just as with other real estate investments do. With this wide array of ongoing responsibilities there are numerous possibilities for errors.
What Could False?
A rental property ‘s success depends on many factors including tenant-to-landlord relationships, tenant income, rental market rates, and more. Because this type of real estate investment is heavily dependent on tenancy, an owner must continually address the renters’ needs and the rental property itself.
You are buying a duplex rental property in an area that your due diligence has led you to believe will yield a rental price of 12 percent above your monthly mortgage. After taxes, benefits, and daily maintenance expenses, you assume that you receive about 5 percent annually, not considering any possible appreciation of assets, which you believe may be 2 percent or more per annum. You buy the property and you get it ready to rent. You find applicants for each duplex unit and you approve both applications after background and credit checks, collect security deposits and sign one year lease agreements.
Both tenants move in, and you are getting monthly rental income on a regular basis. Routine property maintenance is performed and rent is collected, and your investment is going well.
One day, the tenant upstairs informs you that he has bugs in his bed. You as the landlord are responsible for exterminating pests, because you can’t prove how the bedbugs were introduced into the building.
While exterminating you have to find and pay both tenants for alternative housing. Insurance covers some of the costs but not all of it. After the extermination the tenant upstairs finds that his unit still contains bed bugs. He decides you haven’t resolved the issue, breaks his contract, and sues you for damages. You are still legally responsible for the infestation because you can’t prove where the infestation originated.
The bed-bugs are gone after a second round of extermination. The tenant downstairs is upset, but decides to stay as long as the bed bugs are no longer present. You will consider a suitable potential renter after two months to rent the empty Upstairs house. She asks if the unit has a history of past problems like mold, asbestos or bed bugs. State law allows you to report the bed bug history, and the prospective tenant withdraws the demand.
You’ve now lost money due to multiple exterminations and relocations of tenants, and a vacant rental unit for at least 2 months. In addition, it will now be more difficult to attract suitable tenants in the future , due to the criteria for disclosure of the building’s past and state law.
How to Evade This
Some landlord issues may be avoided and others may come along with the territory. The application screenings and reference checks can sometimes avoid problematic tenants. Background checks will screen out those with a history of irregular housing, bankruptcy, or illegal activity that may threaten police searches or seizure of property through civil forfeiture. Some tenants, however, can pass the application process and still pose problems for you as a landlord: late rent, constant maintenance needs or police visits. Worse still, distressed tenants will haunt other tenants and make them want to leave. Knowing your rights and obligations as a landlord, as well as the grounds and procedures for tenant eviction in your state is the key safeguard against problematic tenants. Some states, like California, give the tenant the right during the legal proceedings to continue living in the rented space, which can easily last a year.
Other issues such as emergency repairs or bed bugs in rental properties are unavoidable, especially over the long term. Insurance can help defray costs but not all of these common issues. In addition to the costs, you as the landlord are responsible for managing these matters. You can hire a property management company to pay a fee to take some weight off your shoulders. But, with this option, you are also giving up some control over your investment, plus a portion of your return on investment every month.
Horror tales at Airbnb
Airbnb rentals can be a lucrative way to earn extra income and meet people of interest, but the home-sharing economy comes with its own set of risks. Those risks leave room for issues that can affect not only your return on investment, but also your property. The success of an Airbnb rental, like the rental properties, depends heavily on occupancy. Unlike traditional rental properties, renters undergo less screening, leaving even more responsibility and risk to the property owner.
What Could False?
Airbnb rentals come furnished by the owner as opposed to traditional rental properties. This means that the owner’s property within the house is also at risk of being damaged or stolen, in addition to the home itself. An Airbnb host may request a government ID or social media account from a guest to verify their identity, but they cannot screen any other information such as criminal history or inconsistent history of the housing.
While Airbnb offers theft and damages host guarantee insurance, the policy does not cover cash, or items in the home’s shared areas. It also provides limited coverage of such valuables as jewelry, collectibles, and artworks. A host must provide a police report to request reimbursements for amounts over $300 and may be required to provide further documentation such as photographs, proof of ownership and receipts to prove the value of an item.
In addition, it’s important to be aware of the short-term rental regulations in your city. Homeowner groups may fully prohibit them, and there are current city bans on forms of short term rentals in certain cities , such as New York.
To earn extra money you rent out your spare bedroom for four days. At 7 PM you agree to meet with your guests at home. They arrive much later than expected and you wake up at 3 AM to let them in. Even if their stay is off to a rocky start, you’ll show them around and explain the rules of the house.
You go to work the next day, and a couple of hours later you get a text message that the dishwasher and washing machine are not working. You ‘re shocked because they worked right before you left this morning. You arrive home in the evening and look at the washing machine and dishwasher, and you can’t figure out what is wrong. You also notice on the counter a large burn spot. You are asking your guests what happened to burn the counter and when they arrived they say it was like that. You call a dishwasher repairman and a washing machine. He can fix the dishwasher but he tells you that it is necessary to replace the washing machine.
Contact Airbnb regarding the damage in your home, providing photographs as evidence. You may not have sales receipts for the products, however, showing the dishwasher and washing machine ‘s worth. To assess the cost of fixing or removing the countertop, you will need to contact a contractor. Because the damaged items are in common areas of the home, they are not covered by Airbnb’s insurance policy on host guarantee. Also, you’ll need to file a police report if you want to make a claim for any property valued above $300. Airbnb will contact your guests for a comment about the matter you posted. They deny any wrongdoing, and are offended by the charges and leave.
The cost of repairing the damage done to your home is far greater than the profits you’ve earned from renting it out. Overall, you lost money and suffered several major headaches.
While this may sound like an unusual scenario, a lot of Airbnb hosts have had their own horror stories of bedbugs, house fires, prostitution, police raids, and more.
How to Evade This
It is difficult, if not impossible, to determine the desirability of accepting a particular Airbnb guest, due to the nature of guest screening on Airbnb. Property owners carry an inherent risk of damage or loss to property when renting out their home on Airbnb. Some ways of deterring theft and damage include storing all valuables in private spaces and putting all important items like birth certificates and jewelry in a safe. Banning the use of electronic items such as kettles, televisions and washing machines can also protect you if an item breaks during a visit to a guest. However, responsibility for proving that the guest at Airbnb caused the damage falls on you, the owner of the property.
Some Airbnb hosts use cameras to ensure guests abide by house rules, and to get proof on camera if not. However, if you set up cameras yourself, it’s necessary to ensure that you abide by state laws. In California , for example, filming occupants inside a home is illegal for a property owner, so cameras have to be pointing away from windows and transparent glass doors so as not to violate this law.
The developer holds an variety of time obligations, financial responsibilities and risk sets for many successful real estate investments. While investment in real estate can be a useful source of income, it is important to understand what each investment involves, and weigh the risks and rewards before starting.
If active real estate investment isn’t right for you, you can still get a lot of real estate benefits including income, appreciation, diversification of portfolios, and tax benefits through passive investment. Thanks to advances in technology and federal regulations, the traditional barriers to real estate investment have been dramatically lowered. With as little as $500, you can invest easily, online through Fundrise, in a diversified real estate portfolio and skip the hassles and pitfalls that have traditionally gone hand in hand with real estate investments.