Buying an investment property is only the start of your property investment journey, not the end of it.
Buying a house is a type of investing, so the common mistakes of investing also apply to real estate.
This discussion is about purchasing residential property and is based on :-
a) experience in the residential property market,
b) studying others, and
Financing & Finances
- Overpaying based on irrational reasoning.
- Taking out an unnecessary mortgage.
- Buying a home that you can’t afford, especially without job security.
- Over-allocation of assets into real estate.
- Not taking transaction costs into account when considering affordability.
- Liquidity / Resale.
- Not buying a home with a view / low crime / good school district / public transport for a premium
- Buying a home with extremely wacky / unconventional architecture.
- Buying a home with a terrible layout.
- Buying something in an up & coming area that will take 10 years of renovation by means of the influx of more affluent residents.
- Due Diligence on the Property & the Agent.
- Not checking comparable valuations with extreme anal-retentive-ness.
- Skipping inspection.
- Not checking for pending assessments for apartments.
- Not checking body corporate documents in full.
- Not getting a lawyer to read over title agreements.
- Working with an agent who has too many clients.
- Working with an agent with no track record.
- Working with an agent who is overly pushy or with a hidden agenda.
- Buying an investment property before primary residence.
- Negative Gearing an investment property.
- Buying an investment property for tax purposes instead of for investment purposes.
Overpaying based on irrational reasons:
In real estate, it is very easy to fall in love with a property for trivial reasons.
People might pay $50,000 premium for a re-modeled kitchen that may have cost only $10,000.
That’s why savvy real estate investors typically wait to remodel / refurbish right before sale.
They want to get you to pay extra for emotional reasons.
The areas that typically gets updated are
- counter-tops, etc.
None of these are extremely hard to do it yourself and usually are not worth paying extra $30,000 for.
Of course, it is okay to pay extra for nicer finishes, etc, but only within reason.
In any investment, most of the money is made at the time of purchase, not later on for any modifications/ renovations/ updates.
In other words, the price you pay for a house will likely ultimately dictate how much you make/lose on the house on resale.
Taking out a mortgage when you already have debt – especially credit cards.
There’s no point creating new debt if you already have debt which is costing you more in interest than your investment can possibly make. (e.g. credit card interest is usually about 20% p.a. No property will appreciate in capital value by that much).
Taking out unnecessary mortgage when you can afford to put down a bigger down payment
It blows many people’s minds, but it is not always favorable to take out a mortgage any larger than you have to.
Mortgages are not free money! (to state the obvious).
Cash is, and always has been, king.
The interest rate % on your mortgage is the interest you will have to earn / do better than if you’re going to show a return on your investment.
For example, if you take out a 15 year mortgage at 3% and do absolutely nothing with the money (and even worse, lose it in the stock market), you are worse off by taking out the loan.
On the other hand, if you paid in cash, you are effectively earning the full imputed yield on your investment.
Buying a home that you can’t afford, especially without job security
Remember, affordability is not decided by your financial planner.
Only you can decide whether you can afford a place or not – or whether you want to.
Even if you have a job & income, you may be uncomfortable about your future prospects.
If so, don’t take out a big loan when there are layoff rumors at your company / during recessions.
Over-allocation of assets into real estate
If your net worth is $300,000 – let’s say – it doesn’t make sense to use all of it as a down payment to a $500,000 home.
In the above example, your allocation to real estate will be 166%!
Think about what your nest egg’s allocation will be post-purchase prior to doing anything crazy.
Not taking transaction costs into account when considering affordability
A lot of homes look like great investment opportunities – until you take into account the transaction costs and stamp duty and future capital gains tax.
Big transaction cost items that people forget about are:
- resale commissions.
- title transfer fees.
- mortgage fees.
- extra insurance.
- potential future assessments / charges / maintenance costs.
- vacancy costs.
- stamp duty.
- legal fees.
- tax on capital gains.
Also … if you do experience a capital gain on your investment over time – remember before you sell that, when you buy, even though you make a capital gain you’ll likely pay a similar amount higher for any property you might want to transition to. (e.g. In a rising market ALL properties are likely increase in value by a similar percentage).
Liquidity & re-sale-related
You should always think of future re-sale value prior to purchase.
Buying a home with a view / low crime / good school district for a premium.
Good attributes like higher floors, low crime, good schools, public transport, etc, can make it much easier for you to sell the property.
For example, it can take much longer to sell a property with no view versus one with a view.
… if that ocean view comes at a reasonable premium, consider it.
Buying a home with extremely wacky / old / unconventional architecture.
Thinking of buying a house that ‘turn of the century’ design?
Thinking of buying a rainbow colored townhouse?
Remember, not everyone shares your tastes – stick to basics, if a new buyer wants to turn it into ‘trendy’ that’s their problem/cost.
Adversely … buyers beware.
- Buying a home with a terrible layout
- Does your dream property have a living room split into two small dens?
- Is the living room shaped like an S?
- Is the bedroom in between the kitchen and the living room?
- Terrible layouts obviously come at a discount and are harder to sell.
- Buying something in an up & coming area that will take 10 years to gentrify’.
- Gentrification takes time and is unreliable. Maybe purchasing the best house in the worst street in the assumption the rest of the street will ‘catch-up’ might better be left to a purchaser with more experience.
Due Diligence – Related
- Not checking comparable valuations with extreme anal-retentive-ness
- Understand all the comparables in the neighborhood.
Ask your agent to provide you with a list of all sales within the past 6 months.
Analyse them on a per-sq/ft or sq/meter basis, per building basis, block-basis, etc.
Reduce it to a number.
- Skipping professional inspections before purchase.
- There’s simply no excuse for ignoring inspections.
- Pay a professional to check the property and provide a written report.
- If you neglect this you deserve to pay the $50K to fix that termite problem.
- Not getting a lawyer to read over title agreements, etc
Documents can be 200+ pages long.
- You won’t have the time to read through everything – or understand 100% of what they say.
- Just pay a little extra for a trained eye to sign off on it.
Working with an agent who has too many clients
- An agent who has 100+ clients won’t have the time for you. To him, you’re just a number.
- Working with an agent with no track record
- On the other spectrum, don’t work with an agent who got his license 3 months ago.
- He simply is too green to help you maneuver around the jungle.
Working with an agent who is overly pushy
- Pushy agents are the worst, because they can amplify all your emotional weaknesses that cause stupid financial decisions.
It’s like having a financial advisor that always pushes you into the latest growth stocks that you have no business investing in.
If your agent is constantly pushing a lemon, maybe it’s time to establish what their TRUE motives are.
It may be ‘your’ agent or adviser is more concerned about what fees they’ll make from organising your loan than they are about what you’ll do with it once it’s finalised.
(Loan ‘establishment fees’ can be about .75% of the loan amount – which are paid to the person who organised the loan for you).
Is buying an investment property before primary residence really a good idea for you?
Maybe you don’t rush into buying a home if you don’t plan to live in it.
Don’t forget – investment properties come with an annual land-tax liability.
Check the loan documents BEFORE you sign them – check to see if there’s an early-termination fee. (One example is a loan that charges 3 month’s interest of the entire original loan amount if the loan is terminated, for any reason, within 5 years.
Add that to the other ‘fees’ when doing any calculations).
Buying in a lower socio-economic area is NOT generally a good practice – particularly if rental income is critical to support your investment.
Many people buy an investment property in a suburb they think they can afford, rather than a suburb that offers better investment opportunity.
e.g. They buy a property in outer suburbs rather that near a city because they are one third of the price and, maybe, new.
While they might look like a suitable investment there are some things to consider.
New houses in new areas invariably come with unexpected ‘establishment’ problems, many newly-built properties incur significant additional cost for ‘establishment’.
Is the location of the property near open space where more properties are planned for construction? – if so, it means that when you decide to sell in the future you’ll likely find that the capital growth of your property is minimal because it might still be more desirable for a purchaser to purchase a new home nearby for a similar amount to your sale price than your ‘second hand’ property. (While your home will be more ‘established’, you’ll have spent significant capital on making it so, which you may not recover).
Do not buy on emotion.
Properties generally fall in to one of two categories – those you by to generate an income (from rent) or those that generate capital growth an their eventual sale.
Decide whether you’re investing for income (from rent) or capital growth (on the eventual sale of your property).
Lower socio-economic areas = more risk on rental income.
Remember – as a landlord, you have to be able to support the cost of property repairs, maintenance, insurance, rates, property taxes.
None of these can be ‘put off’. If taxes need to be paid or repairs need to be made you may have little warning or time to actually come up with the money to pay them.
If you are depending on income from rent to support your investment costs you really need to consider whether investing in a lower-income environment where rental payments from tenants who are likely also living week-to-week offers you real rental-income security.
While your tenants might be ‘nice’ people the fact is, if the local industry suddenly closes and your now-unemployed tenants have no ongoing income you’ll have no rent.
Also – be aware that, if this situation occurs you might need to be emotionally able to move on a whole ‘nice’ family and find new rent-paying tenants in as short time as possible or you may find yourself defaulting on your loan agreement.
Seek professional help with both your financial situation and property selection.
But … do not be influenced by property ‘consultants’ who are really in the business of making fees from providing/arranging loans for would-be property investors or for selling properties for developers – or both.
Remember, buyer beware.