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It looked easy and success stories flooded your way: Tales of investors flipping homes left and right, parcels of residential property bought at auction for a song and tantalizing details of record profits flowing in faster than tornadoes in the spring. It’s easy to get excited at the thought of making a financial killing as a result of residential real estate investing.
But think before you act. A few suggestions for getting off to the right start include making friends with reputable realtors, securing a line of credit before you shop for investment property, making sure money you earmark is free and clear (being liquid is essential) and don’t forget to get buy-in from anyone with whom you have financial ties. Many a divorce has resulted from residential real estate investing gone bad.
Importantly, have the right mindset from the get-go and be realistic: in this day and age of fluctuating markets and cyclical property values, you are best served by reading everything you can get your hands on before embarking on your investment journey. Toward that end, these three topics represent some of the most dangerous landmines people face when they jump in.
1. If It Can Go Wrong, It Will. Chances are, your parents already shared this life lesson, and over the years, you saw for yourself how easily things can fall apart without warning. Assuming that amid the victories you enjoy on the road to real estate investment success will come the occasional catastrophe, prepare yourself for when (not if) things go south. What can go wrong in the complex world of residential real estate? Plenty. Here are a few scenarios:
You find the perfect place, buy it and discover that the neighborhood is being bulldozed to make way for a new highway. Simple Fix: Contact the city government to ensure the property is in good standing prior to investing.
You believe every detail of the inspection report offered by the property’s seller only to discover that the building is ready to fall off its foundations thanks to termite colonies. Simple Fix: Walk the property yourself before investing! If this isn’t a financially viable option, always hire a 3r party to conduct a property walk with timestamped photos.
You buy the perfect place, spend money restoring it and get ready to pop the champagne bottle until traffic increases at the place down the block—where the drug pushers live. Simple Fix: Always familiarize yourself with your market’s neighborhoods prior to investing. One of the best risk analysis tools on the market is RentFaxPro.
You rent to students. They turn your pristine house into party central (oh, and they forget to pay the rent for months, too).
Want more? Thought not.
The truth is, all of these risks can be mitigated properly, prior to investing. Make sure you consider the worst case scenarios and find out how to avoid them.
2. Property Management 101. If managing the property in which you invest is not on your list of things you care to do, take the route paved by others: hire a property manager or management team to oversee day-to-day operations. Finding the right caretaker(s)can be as important to your success as buying into a prime neighborhood. Follow these rules and your chances of getting the right management on board will increase exponentially:
Don’t hire relatives. If this is the only way you can get into the residential real estate investing field, perhaps you need an alternative investing strategy. Imagine having to chastise your cousin, fire your mother-in-law, reprimand your son or admonish the nephew who promised to look out for your investment as though it was his own. Such situations can make the family’s Thanksgiving dinner a veritable nightmare.
Don’t hire a management firm juggling too many other properties. As the new kid on the block, you could get short shrift. Even if you receive assurances, it’s incumbent upon you to dig out your inner skeptic when you talk to management sales professionals and assess the amount of attention your investment will get. Play it safe; contract with a small-to-medium firm and then sign the shortest contract possible to test the waters.
Do hire an on-premises property manager. If you can afford a full-timer to manage the building from a small office on premises, this situation is ideal. Having one person serve as your eyes and ears daily—or 24/7 if that’s part of the arrangement—can help you keep a lid on things that go wrong in real time. From noise disputes to kids riding bikes in hallways, nipping problems in the bud immediately can help you sleep better.
3. Prioritize Insurance. If you know the marketing mantra—that success hangs on location, location, location—knock it out of your head and substitute insurance, insurance, insurance. Locations come and go. Neighborhoods morph from trendy-chic to urban slum in a heartbeat. Prepare for every eventuality under the sun by indemnifying yourself against worst case scenarios.
What type of insurance should you buy? Your agent or broker can help you decide, but here are four coverage types you may wish to consider:
Fire Insurance. Sounds like a no-brainer, but even concrete buildings can go up in flames. Find out how close a fire rescue facility is to your property during your investigative phase, too.
Building and Contents/Landlord Insurance. This coverage protects investors against catastrophes arising between the day the contract is signed (purchase date) to the day of possession (closing). You get what you pay for, so ask a broker to help you mix and match coverages that can run the gamut from building destruction to lost rent compensation, liability claims and even tax audits.
Flood Insurance. Policy prices are rising as a direct result of an increase in claims throughout the U.S., but your mortgagor may not be willing to lend you money unless you have flood insurance.
Umbrella. Adding an umbrella policy to your other coverages adds a safety net, so if you don’t mind paying a little more, a few million dollars-worth of umbrella insurance added to your bundle could save the bacon if your investment suffers a particularly bad or catastrophic event.