The world of real estate investing is more diverse than people think it is. There are dozens of approaches to take that a real estate investor must be aware of—buy-and-hold, fix-and-flip, mortgage wraps, seller financing, short sales, passive investing, private lending … the options are endless.
But property is property. Ultimately, a few unifying factors need to guide every decision a real estate investor makes, regardless of the strategy. Here are three things every real estate investor needs to know.
It happens every 10-15 years—values are skyrocketing, everyone has a cousin who made $50,000 flipping a house with no repairs, and people start whispering the dreaded words that represent investing poison—“The value of real estate always goes up!”
Oof … okay. No. No, it doesn’t. If you need to be reminded, rewind the clock to 2008. Or 1981. Real estate lost a ton of value in both of those recessions.
It doesn’t have to be as dramatic as a national or global recession, either. Local markets tend to run in cycles. As companies open up shop and job growth ensues, people move into the market or upgrade their housing. Builders rush to fill that need. Inevitably, the market gets overbuilt, and property loses value to “correct” the overpriced market.
This creates a wave-like cycle of “buyer’s markets” and “seller’s markets.” In a buyer’s market, too much property is for sale. Due to the high supply and low demand, prices plummet. This is a good time to buy.
In a seller’s market, too few properties are on the market and demand is high, pushing prices up. This is a good time to sell.
Over a long enough time-frame, the value of real estate usually does go up, on a gradual trend line, despite these cyclical peaks and valleys. But if you purchase a buy-and-hold property in a buyer’s market, you could sell in 3-5 years for a tidy profit. If you mess up the timing and sell during a seller’s market, however, you could end up holding the property for fifteen years to make the same profit.
This applies less frequently to fix-and-flip investments … but if you time a flip wrong, the effects are more dramatic. If you buy at the top of a seller’s market, local values could end up crashing before your flip is done, and you could have wound up investing a fortune rehabbing a property that is now worth less than you bought it for! Flippers really can’t afford to ignore market cycles in real estate. As a real estate investor, you should have a firm understanding of the entire process of real estate investing.
If a fix-and-flip or a commercial property reposition goes swimmingly, producing a double-digit or even triple-digit return, you might be tempted to think “Wow! That was easy! Real estate investing is a sure thing!”
Not so fast. You may have just gotten lucky, or made a very prudent investment decision. Now is not the time to get cocky and assume you have the magic touch. The truth is, the higher the potential returns, the higher the risk. This principle can be mitigated somewhat, but never eliminated entirely.
The most obvious example of this is buying all-cash vs. buying with a mortgage. If you have no mortgage payment, you are almost guaranteed a healthy monthly cash flow … but that cash flow will still probably be a small fraction of what you invested. Meanwhile, if the property appreciates, your gains will be proportionally smaller because you used no leverage.
Meanwhile, with a mortgage, even a small appreciation in property value could double your money … but if a pipe bursts and you use the mortgage money to fix it, you could end up losing the whole property.
Another example is buying a brand-new property vs. buying a fixer-upper. You could potentially add a lot of value in the rehab process … but if the rehab goes badly, the real estate investment could be a total loss. By comparison, the lower-maintenance lower-performing new build is a bird in the hand.
“What could possibly go wrong?” is the Achilles’ heel of real estate investing. Many moving parts have to come together to make a property habitable. A lot can go wrong.
You can hire professional inspectors to scan the foundation, poke the roof, scope the sewer drain, or tug on the electrical outlets. But as thorough as you try to be, a veteran real estate investor knows that something unexpected always arises. A tree root puncturing a sewer pipe, mold growing between wall panels … something
It pays to be extremely conservative on your rehab budget or your deferred-maintenance budget. Smart real estate investors plan for it to cost 15-30% more to manage their property than they expect. If that kind of buffer negates the profit of the deal … don’t make the deal!
Being prescient as a real estate investor is an acquired skill and you can develop it as you grow in your investment journey. However, keeping these pointers in mind will surely help avoid certain pitfalls of real estate investing. With a steadfast and smart approach coupled with a bit of luck, you might just make it big as a real estate investor.