Why Do Most Starting Real Estate Investors Fail

Interest in real estate investing has never been stronger. More and more people are catching on to the amazing benefits of this lucrative investment. However, it also comes with some risks, especially if you don't know what you're doing.

You don't just buy any property (with no clear set of criteria), without proper financing, and then sit and pray for money to roll in!

It's important that any starting investor understands what makes a good rental property, how to find it, and how to make a profit going in. If you aren’t equipped with the right knowledge and process, you can easily lose your time and money on mistakes that could have been easily avoided.

In this article, we’ll cover 5 of the most common pitfalls that real estate investors fall into and how to avoid them.

5 Pitfalls of Buying an Investment Property to Rent

Before you consider buying an investment property to rent, take a look at these common pitfalls:

1. Failing to Get Your Finances in Order

Most novice investors jump on the real estate wagon without even carefully examining their personal finances. They put a down payment on a property and then get surprised that their financial situation is not fit and that they are not eligible for loans to finance the large sum of capital required to purchase properties. The end result is they lose their down payment, which could be their life savings.

Investment in rental property starts with carefully examining one's financial position and then by getting a loan pre-approval. This helps to have a budget on hand, which is one of the main criteria for selecting the right property that's fit for your investment goals.

Related: Getting pre-qualified for bank loans

2. Failing to Set Your Investment Criteria

One of the most common real estate mistakes made by novices is buying an investment property to rent without a clear set of criteria. The end result might be purchasing something that puts money in other people's pockets at the loss of the investor.

For instance, in a hot market, it’s not surprising to see people on a property buying frenzy and deciding afterward what to do with them. Those investors get hooked with sales pitches of fast-talking real estate brokers promising them quick profits as if they have a crystal ball.

I've seen many wannabe investors fall victim to buying off-plan, parking their money for years to come, and praying to be able to sell for a profit before they register the title in their name. Many of those investors don't even have enough capital to fund the full tag price of those properties, should the bank not lend them when the property becomes ready a few years down the line. Then they fail, lose their shirt, and start complaining about how risky is real estate investing.

It’s tough to succeed in any investment if you don’t know what you are looking for and what you are hoping to accomplish. Below are the main investment criteria one shall be considering when prospecting for investment properties.

All those criteria are discussed at length in The Employee Millionaire; however, it’s important to impress on you some very important points, which most starting investors fail to consider.

Location determines the price of a property, all other things being equal. The wise investor chooses a location first and then picks a property. Getting clarity on location enables the investor to narrow down the search criteria. Investors, who become experts in a certain community, will be able to compare local property values and rental rates, which will enable them to identify great deals from the average ones. Communities that are the best picks for real estate investors are those that are emerging and have an established reputation as desirable. Communities that are sought after by end-users who want to live there are often close to work, schools, hospitals, retail, and recreational centers.

Related: What Does "Location Location Location" Really Mean in Rental Properties Investing

The second defining selection criterion is whether the property is finished (with a ready title deed) or still under construction. The employee millionaire strategy focuses on rental properties and therefore, by default, investing for cash flow requires properties that are finished and ready to be occupied by tenants who will pay rent. It is quite a simple and straightforward strategy. Once you understand the demand for rent and the rental rates in a certain community, it doesn’t require a crystal ball to forecast the future rental income, the expenses, and the net cash flow. This criterion is the most often overlooked by starting investors who only invest for capital gain. They end up locking their money in a property that doesn’t generate any cash flow until its construction is complete before they can sell it for a profit in the event they were lucky enough to have the market on their side.

Having a clear picture of what type of residential property, you are looking for in your defined location narrows down your search even further. The two broad decisions you will have to make here are whether you are looking for single-family homes or multifamily properties. The common wisdom is to start investing in single-family houses with less capital and less risk. Then you can grow into multifamily properties over time.

Property features are those basic descriptors used by any end-user who occupies a property. Features describe the age of the property, built-up area (BUA), number of bedrooms, number of bathrooms, and number of parking lots. Features are what tenants will look into before signing the rental agreement. Assuming the property is in good condition, features will have a major impact on the rental rate and eventually on the investor’s cash flow. The good thing is that those features enable investors to easily compare both the purchase price and the rent with other properties on a like for like basis.

Amenities relate to the pleasantness or attractiveness of a property. They are the features of a property that provide comfort, convenience, or pleasure. Examples are a fireplace, central air-conditioning, a terrace, a view, a swimming pool, or complimentary access to the community gym. Such amenities could be the competitive advantage that differentiates your property from others with similar features, and as a result, may justify higher rental rates.

In the ideal scenario for the employee millionaire, given that each has a job and limited time to spend on repairing a property, investors want to find discounted properties that require no repair. Properties in good condition can be listed for rent from day one, which means your invested capital will start to generate returns as fast as they get rented out. On the other hand, many properties require minor cosmetic repair, causing a large discount on the market price. Those fixer-uppers represent opportunities with discounted prices, which can have a big impact on the return on invested capital. An investor should have a good understanding of both the estimated cost of repair and the estimated time of repair before deciding whether a fixer-upper will be a good or a bad investment choice.

All those investment criteria could be grouped into one template that will allow you to compare properties based on a definite set of criteria.

You can download a free copy of this template here.

 3. Not Running the Numbers

Another common pitfall of buying an investment property to rent is basing your investment decisions on emotions and guessing rather than numbers. As a beginner real estate investor, you should resist the temptation of becoming emotionally attached to a house. You should do a rental property analysis to make sure that buying the property makes financial sense.

“Numbers don’t lie. It’s better to miss a good deal than buy a bad deal. Conversely, do not walk away from a good deal.”

Consider investment properties for sale that will generate positive cash flow and the best return on investment. The Employee Millionaire Rental Properties Price Evaluator is the best real estate investment tool for performing investment property analysis. With this tool, you will be able to avoid buying rental property that would end up being a money pit.

Download Your Free Copy of The Rental Properties Price Evaluator 

4. Failing to Perform Due Diligence

Due diligence is about doing a thorough physical and document inspection of a property to make sure it’s a good fit to be part of your property portfolio. Think of it like a major checkpoint done more professionally to double-check the property’s title, its physical condition, and documents related to its rent and operations.

Three different types of inspection during due diligence go hand in hand simultaneously:

• Physical inspection
• Document inspection
• Financial inspection

Physical Inspection

The physical inspection of a rental property is about uncovering things that may become a problem in the future. Those potential problems may have major financial implications on the buyer, which could be avoided if discovered before the final commitment. Any major foreseen expense can be brought on the table in the negotiation process.

At that stage, even before you have submitted your letter of intent to the seller, you should have walked through the property. Likely your eyes are not trained like those of a professional inspector, who can reveal problems that are hidden below the nicely-painted walls.

As an investor, the inspection report can help you identify potential problems or upgrades related to safety and fire, roof, structural integrity, electrical system, plumbing system, HVAC systems, walls cracks, and potential environmental hazards.

A typical report will include all the areas covered in this section, with photos to illustrate the finding and a professional opinion whether each problem is a safety issue, major defect, or minor defect. The report also determines which items need replacement and which should be repaired or serviced. This makes it easier to determine the cost of repair and maintenance by asking a few contractors to quote for the job. 

Once the physical inspection is completed, the buyer usually goes back to the seller and either gets more clarity on some of these items, asks for certain things to be remediated, negotiates for a discount, or in case of structural and other major problems, walks away from the deal.

The golden number that will be part of the inspection report is the appraised market value of the property, which is one of the major requirements by the lender to ensure that the property is worth more than the mortgage amount to be lent to the borrower.

Document Inspection

This is one of the most straightforward parts of due diligence. In the inspection clause of the letter of intent, the buyer usually requests specific documents to be reviewed. The most common documents include a copy of the title deed of the property, copies of rental agreements, a recent real estate tax bill, a copy of the insurance policy, existing service agreements, HoA or master developer rules & regulations, and copies of receipts of repair and maintenance that were done on the property. Document review should not take more than a day or two to be accomplished once the documents have been received by the buyer.

Financial Inspection

When you have analyzed the property’s rental income and operational expenses to compute its NOI (net operating income), many of the numbers were forecast to the best of the buyer’s knowledge based on the available information and based on some common industry practices. The financial inspection part of the due diligence allows a thorough financial analysis based on the real numbers before the final commitment and signing of the purchase and sale agreement. If the numbers still add up and the real picture is similar to or better than the forecast one, the buyer can move on with the deal.

In essence, a financial inspection allows the buyer to validate all the numbers, from rental income to operational expenses, which were previously shared by the seller or their agent.

• Rental income review
• Property/Real Estate taxes
• Property insurance
• Property utilities
• Master community fees
• Property management fees
• Property maintenance and capital expenses

5. Getting the Wrong Financing

Investing in rental properties for beginners is usually a challenge due to a lack of capital to fund those properties. Very few people can actually afford to buy investment properties with cash; and therefore, investors usually resort to property loans, which is an integral part of owning a portfolio of properties.

The caveat is very few beginners research the different financing options available and run the numbers to see whether the investment property will produce positive cash flow or the investor will be struggling to keep up with the loan installments.

The Bottom Line - Follow A Proven Process

If done right, investing in rental properties can be one of the smartest financial decisions you'll ever make in your life. Such an investment vehicle both pays you passive income (from the rent) and builds wealth, so that you can start planning for your retirement.

There are several pitfalls that can derail your career in real estate investing before it starts. You ought to be aware of these pitfalls ahead of time and follow a proven process to avoid them. By avoiding the common real estate mistakes, you’ll be able to maximize your return on investment.