Contrary to what some real estate promoters will tell you, it is possible to lose money in real estate. Therefore it behooves any would-be investor to learn from the mistakes made by others. With that in mind, here are my top 10 ways to lose money in real estate:
The more leverage is used, the more risk is involved. Always. That doesn’t mean you shouldn’t use a good deal of leverage. It can be an amazing tool for maximizing growth. However, using other people’s money costs money. That means if you don’t have the reserves to see the project through to an exit strategy of some sort, then you can and will lose money in real estate.
2. Underestimating Costs & Timelines
One rule I have always adhered to in real estate is that everything will always cost twice as much and take twice as long as you expect—and that’s if you’re conservative in your planning. Too many projects and properties go belly up because investors underestimate their development costs and holding timeframes. If you can still stomach the deal by doubling your costs and timelines, then you’ve got a winner.
3. Forgetting the Common Sense Test
Many of us, in the heat of a deal, forget the very thing that has kept us alive for so many years: common sense. So if the deal sounds too good to be true, it probably is. If you can’t comprehend why the person on the other side of the table would sell you a property for such a low amount, then you need to ask more questions. If it doesn’t smell right, walk away. There are plenty of other opportunities out there if you are committed to finding the right deal.
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4. Bad Partnership Deals
Partnerships can quickly turn ugly and cost investors a lot of money. What often ends up happening is that one partner is burdened with the majority of the project while the other partner has fewer duties but receives the same benefits. This is why you should invest with your friends and family, right? Wrong. You should be even more wary of partnership deals with friends and family. If things go sideways, you could lose a valuable personal relationship…and your money.
5. Poor Due Diligence
Due diligence comes down to asking the right questions of the right people. If you don’t know the right questions to ask, it’s easy to find people who will know what questions you should be asking before you invest. The best thing you can do to ensure good due diligence is to retain the services of an experienced advisor, such as an attorney, CPA or someone with extensive experience with the specific type of investment you’re contemplating. And just in case you missed the previous paragraph on common sense, don’t get your due diligence advice from the person selling you the property.
6. Not Getting an Inspection
I’ve only purchased one property without getting an inspection, and I paid for it after the fact. It turned out there was an oil tank buried in the backyard that was leaking. Although I had already sold the property to a builder by the time the oil tank was discovered, I was still responsible for a pro-rata share of the clean-up costs based on the length of my ownership.
7. Buying an Overpriced Real Estate Education
Paying $20,000 for a real estate seminar education is generally a giant waste of money. Instead, consider purchasing five to 10 books and using the remaining $19,800 to invest in your first property. You’ll learn more from your first deal than you’ll learn from any real estate seminar (for more thoughts on seminars, read our article on the good, the bad and the ugly of real estate seminars.)
8. Buying Sight Unseen
This could also fit under the common sense test. Not seeing the property before buying it is a grave mistake unless someone you trust has seen it. You could not only miss something important that may keep you from buying the property at the originally negotiated price, you could also miss out on the opportunity to refine your skills in selecting property.
9. Buying Discounted Problems
Robert Locke, early in his investing career, found himself drawn to discounted properties. Priced at 10 to 15 percent less than comparable homes, the properties were on busy streets or held retention ponds. Locke learned quickly that these were, in fact, not discounts. Rather, they were price reflections of material defects in the properties. Make sure you’re not buying a “discount” that is really priced higher than it should be because of a material defect.
10. Not Factoring in Maintenance Costs
The other day I was reminded of the importance of factoring in a buffer for maintenance costs when a clogged toilet in one of my properties caused minor water damage to the tune of almost $3,000. Homes require maintenance, and this is amplified when they are occupied by renters. Not saving funds for a rainy day can create cash flow pinches and lead to cutting costs and putting off much needed maintenance. For example, water damage that is not taken care of immediately gets more expensive as time goes by and mold begins to grow.