Ever hear the Warren Buffett and Charlie Munger adage: “When people are being greedy, be fearful. When people are being fearful, be greedy?” There’s probably not a more fearful investment vehicle today than real estate.
But a depressed market, high inventory and a tight credit market for would-be homeowners could provide a recipe for success for income property investments. Ready to dive into the real estate market by investing in a rental property? The opportunities are ripe, but don’t make rookie mistakes. Follow these tips and you’ll be on your way to securing a successful deal.
(1) Don’t trust the owner’s numbers. Your due diligence should involve checking with unbiased sources to determine the expenses, maintenance fees, leasing commissions and other costs associated with a given property. Double check data provided by the broker or seller. Talk to another apartment owner. Check public records. Confirm all numbers so you know exactly what kind of expenses to factor into the deal. At the end of the day, it’s sad and cynical, but it is very easy to hide numbers in other entities. It happens every day and I learned it the hard way. Learn from my mistake. Remember, the owner has a vested interest in showing you better profit numbers. If an owner’s number seems very high or very low, ask questions because it will show that you know what you’re doing.
(2) Don’t underestimate property taxes. Factor in the right property tax amount, not what the current owner had been paying, particularly if it’s a long-term owner. Your property taxes will be based on the sale price. Check with the county auditor for accurate numbers. Once the property transfers to you, your taxes will always readjust if you are paying more than the county’s tax assessment of your property. It never goes down unless you appeal, but going up is automatic. Make sure a $10K tax bill doesn’t shoot up to $15K because that’s a loss of more than $50K in value.
(3) Give special attention to the big-ticket items. The heating system and roof can be your biggest headaches and most costly repairs. Know what you’re getting into. Have them inspected by HVAC and roofing specialists, respectively, not a general inspector. Issues are not a deal killer, however. In fact, it can work in your favor and give you the negotiating room to improve the deal. And don’t agree to a seller’s offer to make the repairs, but negotiate a credit so you can do the work yourself. The seller will not have the same motivation as you to insist on a proper repair. The surest way to lose tenants is to have leaky apartments and no heat. Secure your tenant base by addressing heating and roofing issues at the time of purchase.
(4) Don’t fall in love. Remove yourself emotionally from the property. Look at a lot of properties before you commit. Don’t go for the one you love and try to make the numbers work. Look at 20 properties, make offers on 10 and hope one is accepted. If you get one or two accepted offers, you’re probably in the ballpark. If you get more than that, you’re probably offering too much. Don’t base your offer on the owner’s asking price. Once you’ve been in the business a while, you will realize there are a million reasons why an owner might want a certain amount for a property, irrespective if it’s realistic or not. Run your own numbers to determine what sale price will work for you.
(5) Always have a reserve fund. Don’t use your entire investment capital on the down payment. Set a goal to have one year of mortgage payments in the bank to get you through turnover cycles and unplanned maintenance expenses. Your financial analysis is for even keel expenses, but even keel is more of a long-term proposition. Short-term fluctuations are the reality.
