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Real Estate Investing Rookie Mistakes               

Now that I am a somewhat seasoned real estate investor, I can look back in hindsight and identify all of the things that I did wrong and that was counterintuitive to me maximizing my return on investment.  So, I have decided to create this publication to outline some of the things that I think novice real estate investors do that hinder their real estate investment endeavors.

Not Having a Real Estate Plan

The old platitude that if you fail to plan, you are planning to fail is very true.  Real estate is a big commitment with a lot of risks involved.  Devise a plan for your real estate investment approach.  Planning includes analysis as well.  Know and identify your expenses, your risks, your resources that you will leverage to make realize and maintain your real property.  By knowing expenses, you will be better suited to determine what your sales price (if flipping) or rental rate (if leasing) needs to be in order for you to be profitable.  Knowing your risks will allow you to craft mitigation strategies should those risks arise.  But, most of all, by planning, you will know what listings you can pursue and what listings to pursue or walk away from.

On my very first real estate investment opportunity, I did not plan.  The purchase was purely emotional and I did not know any of the aforementioned planning elements.  As a result, and to this day, I am stuck with a rental property that is not generating any revenue.  I actually lose money every month on the property because I did not do the calculations and understand the maximum rental rate; thus, my liabilities are more than my revenue on the property.  Now, I had to retroactively devise a plan that involves a long-term hold of the rental property.

Not Buying the Property as a Separate Taxable Entity

A costly mistake that you can make as a rookie investor is to buy investment property in your name as opposed to establishing a separate taxable business entity as the real property owner.  This will make a big difference during tax time and can save you a lot of money in taxable income.

My very first rental property was bought in the name of my wife and me.  Being as though this was our first real estate investment deal, and we did not do proper research on real estate investing - or the current market for that matter - we did not realize what the repercussions of buying the rental property in our names would have, but we would soon find out come tax time.  When you own rental property in your name, you are now filing the rental income as a part of your current earnings.  So, when you report your wage earnings from your job, now you have to report the rental payments as earnings too.  I’m not talking about the net proceeds of the rent (rental income minus mortgage expenses), I am talking about the entire rent now becomes taxable income for the tax year in question.  So, let’s just say that my wife made $50,000 and I made $50,000 dollars from our “regular” jobs and we calculated our taxes properly on our W-2s and the appropriate taxes - for this example, we will say my wife and I paid 20 percent of our salaries in taxes; thus, we each paid $10,000 each for a total of $20,000 in taxes - were withheld from our checks.  But, let’s say that we collected $24,000 ($2,000 per month for 12 months) in rent.  We now have to add $24,000 as income earned for the tax year.  And, I can pretty much assure you that most people do not pay the taxes on their rental earnings throughout the year.  Additionally, instead of being in the $100,000 tax bracket (my 50K salary plus her 50K salary), which may only require a 20 percent tax obligation from the government, you are now in the 124K tax bracket (50K + 50K + 24K rental income), which may require a higher (25 percent, for example) percent tax obligation.

If you establish the rental property as a separate taxable entity, you can possibly pay minimal taxes, or not pay taxes at all, on your rental proceeds (check with a licensed accountant).  For example, if your taxable entity has only one real estate property and rental income ($24K), when tax season comes around the taxable entity would only claim the $24K as income.  And, the $24K income bracket, along with expenses for the property, would keep the tax obligations lower than what they would be if you commingle the rental income on your personal tax reporting.  I may have simplified this discussion as not to be verbose, but research and consultation from a licensed specialist (Accountant, lawyer, and Realtor) will provide you with specifics on this subject.  Additionally, separate tax entities for your real estate business may shield your personal finances from creditors or potential litigation related to your business.

Paying Too Much for Your Investment

Your real estate deal has to make financial sense in order to be a good investment.  The start of a good real estate deal is going to be the price of the property that you acquire.  Whether you are flipping real estate or leasing it to tenants, the purchase price will determine whether you profit or lose on the deal because the neighborhood is going to have a cap of how much the property can be flipped or rented out for.

Not Calculating Expenses

As a real estate investor, you have to crunch your numbers.  Before you purchase real estate, you need to be identifying the financial data elements that you need to track.  Additionally, once you purchase a property, you will need to track expenses so that you can forecast future expenses.  For example, you need to capture property cost, monthly mortgage fees, property taxes, property insurance, closing costs, average yearly upkeep like plumbing expenses, turnover costs, state fees, etc.  If you don’t understand your numbers, you risk not turning a profit or being one real estate expense away from being delinquent on property payments.

Not Vetting Tenants

Sometimes, the excitement of putting a tenant into a vacant property overshadows the bigger risk of vetting the tenant.  Your objective should be to acquire responsible tenants.  A good tenant will maintain your property as if it were their own.  A good tenant will alert you to things that need to be fixed and not damage your investment.  A good tenant will pay on-time and give you proper notice should they decide not to renew their lease.  And then there are the bad tenants (ughhhh!).  The bad tenants will break their lease no sooner than the ink is dry on the contract by allowing more people to stay there than they originally stated.  Bad tenants will damage walls, chandeliers, doors (exterior and interior) and other valuables and not notify you.  Bad tenants will not pay rent for months and live in your property rent-free until you evict them.  Then, they’ll move somewhere else and repeat the process.  And, bad tenants will move out in the middle of the night and you’ll have to spend extra money in court fees tracking them down to pay for damages that were done to the property.

Not Conducting Routine Property Inspections

People think that real estate investing is a passive investment stream.  Well, it can be if you are contracting out the management of the property to a competent property management company (see above section).  But, regardless of whose responsible for managing your investment, make certain that they are conducting routine property inspections with the tenant.

Property inspections allows property owners, or managers, to stay informed on the health of the property.  Property inspections are not always an indictment against tenants; it is a means to protect both the tenant and the property owner.  It allows the property owner to identify fixes that may need attention so that tenants are not inconvenienced in the future.  For example, property inspections allow owners to identify a faulty hot water heater that may be on the brink of failing or a foundation wall crack that needs repair.  Or, it could be an opportunity for a landlord or property manager to see a hole in a wall or burns in carpets that were done by a tenant, or possibly catch a tenant running a meth lab on the premises.  This would allow the landlord or property manager to take immediate action to rectify the issue

Hiring Poor Property Management Companies

Similar to vetting your tenants, you should be vetting your property managers as well if you are using a property manager to handle the daily operations of the rental.  Hiring the wrong property management company can prove just as disastrous as having bad tenants because you could wind up with nightmarish tenants AND wind up paying a third party contractor for poor service.

Investing for the Wrong Reasons

Unlike stocks that can be dumped at the drop of a hat, real estate is a much harder asset to get rid of.  Real estate is a big commit because, more likely than not, your credit will be on the line. 

I have seen some people commit to real estate investing for the wrong reasons.  I had a friend that decided to trade and get a bigger house.  In turn, they took their former residence and converted it into a rental property.  He would usually brag about how he was a real estate investor and doing well with the rental property.  Soon afterwards, our other friend - yes, our other friend and not me - decided that they were going to jump into the real estate investing game as well.  Now, if you knew this friend you would have questioned their desire to get into the real estate investing game as well.  They could barely keep their own property in good shape.  They had holes in their walls, loose railings, and broken items all throughout their home that they never had the time, nor the desire, to fix.  And, their real estate investing endeavor went similarly.  The cashed out a lot of equity in their house to buy their rental property, they didn’t vet their tenants, they never conducted routine property checks, and they were poor at managing the property.  They didn’t realize the level of commitment, financial and otherwise, that went into real estate investing.  As a result, the tenants wrecked the property and they wound up letting the bank foreclose on the house.

All of this happened because our friend’s only reason for investing in real estate was because our other friend was investing in real estate and talking about how well he was doing.  If real estate isn’t your passion then don’t invest in it.  There are many other ways to make money in the 21st century.  Find your passion or things that you are skilled at and pursue those as investment mediums.

Summary

As you go forward in pursuing your real estate investment ventures, keep these mistakes in mind.  If you can avoid these novice pitfalls, you will increase the probability that you acquire real property that brings you a good return on your investment and that you don’t regret later on in life.







 
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