The lessons learned from a bad real estate investment can be invaluable. But if you had the opportunity to avoid the mistakes that got you into a bad investment in the first place, I’m certain most of us would take advantage of it.
Below, you’ll learn the warning signs of a bad investment and what a good real estate investment looks like. Plus, four fundamental rules of real estate investing, how to turn a bad investment into a good one and knowing when to cut your losses.
Signs of a Bad Real Estate Investment
Understanding the signs of a bad real estate investment is the first step to turning it around. The following warning signs will show you what to avoid and why.
1. The Numbers Don’t Add Up
- Price: When the price of your investment property isn’t close to comparable properties in the neighborhood.
- Equity: When there isn’t enough equity in the property to afford and exit strategy and a profit.
- Loan-to-Value (LTV): When you borrow too much against a property, including the buying costs, repairs and other expenses. A solid LTV ensures you don’t borrow too much.
- After Repair Value (ARV): When you don’t have enough cash reserves after the necessary repairs are made to sell the property and see a positive return on investment.
- Return on Investment (ROI): When you cannot profit from the property, it’s time to walk away…
2. The Property is Poorly Located
When we talk about the importance of location and neighborhoods in real estate, it’s important to note that you can’t simply buy property in a generally “good” area. Investors who fail to do their due diligence can find themselves owning a property in a depreciating market with low rental demand and high vacancy rates. There are a lot of factors to consider when trying to determine if a potential investment property is well-located or not. Below, I’ll share five qualities of a good neighborhood to invest in.
3. The Property Has Been on the Market For a Long Time
Real estate investors, especially beginners, may find a property that looks like a good deal and want to jump on it right away. However, if a property has been on the market for more than six months, there’s a good chance other investors have already looked into it. This means there’s likely a reason the property hasn’t sold yet.
4. The Property Requires a lot of Rehab, Repairs or Maintenance
When a real estate investment looks good on paper and all the numbers add up, it can seem like a no-brainer to buy the property. However, after digging a little deeper, you may find that the property has serious structural damage or issues with the foundation.
For rental properties, if the plumbing, electrical, and roof require frequent attention and repairs, investors may end up spending way more time and money than it’s worth.
5. Bad Financing
One of the biggest mistakes new real estate investors make is getting bad financing to buy a property. Loans with high interest rates can eat up your cash flow and turn your investment upside down. Financing will make or break your real estate investments.
6. The Seller is Withholding Information
There are some seller credibility warning signs that real estate investors may overlook. If the person or organization selling the property isn’t forthcoming with information or hesitant to withhold essential details, that’s a red flag. They are likely trying to hide something, and if you don’t trust the seller, you can count on unforeseen costs and issues.
For example, if a seller offers some sort of incentive to waive the inspection, that’s a bad sign.
What Makes a Good Real Estate Investment?
There aren’t universal criteria for what makes a real estate investment “good.” However, several factors help determine a “good” real estate investment from a “bad” one. The following factors impact a real estate investment, starting with the five qualities of a good neighborhood.
5 Qualities of a Good Neighborhood to Invest In
Where you choose to buy may be the single most important factor to a good real estate investment. The location of your property will determine the types of tenants you’ll attract as well as your vacancy rate. If the vacancy rate in your neighborhood is high, you may have a hard time filling the rental because demand is low. Do your homework and explore exactly what that neighborhood has to offer and what it may be lacking.
The following are five characteristics of a quality neighborhood to possibly invest in:
1. Liveability and Amenities
Take a walk or drive around the neighborhood you’re looking to buy in. Check out parks, public transportation, schools, gyms, restaurants, coffee shops or anything else that may attract renters. Look to buy rental properties in liveable areas with easy freeway access or public transit stops nearby and a nice offering of amenities.
2. Low Neighborhood Vacancy Rates
A neighborhood with high vacancy rates is a hallmark sign of a “bad” investment. I don’t believe that any investor would knowingly buy a property in an area with high vacancy rates. If there’s not enough rental demand to fill your property with tenants, it may be very hard to turn your real estate investment into a good one. Look for neighborhoods with high rental demand resulting in low vacancy rates.
Investor Tip: You can find an area’s average vacancy rate from the U.S. Census Bureau, a real estate agent or property managers/landlords.
3. Quality Tenants
Investors should know what types of tenants their potential rental property might appeal to. If you buy in a neighborhood close to a university, students will likely make up most of your tenant pool. Rental demands may be low during summertime, which is an important factor to consider.
Generally, we have found that the highest quality tenants are looking to rent single-family homes. These types of tenants are usually long-term renters, often with family’s, who aren’t ready to buy a house, but no longer want to live in a multi-family home. Appealing to and finding quality, long-term tenants will save investors so much time, money and stress, by avoiding frequent turnover expenses and vacancies.
4. Good Schools
If your target tenant pool includes family-sized homes, investors should consider the quality of local schools. The lack of good schools in the area doesn’t necessarily have to be a deal breaker, but it’s another factor to consider, especially because it can affect the value of your investment upon sale. You can find metrics and data for schools at Niche.com.
5. Low Crime-Rate
Even nice-looking neighborhoods can have high crime rates. Performing your due diligence is essential to a good real estate investment. This should include visiting the local police station or online resources like BestPlaces.net or City-Data.com to understand crime rates within different neighborhoods in your investment area. Look at rates for vandalism, serious crimes, petty crimes, and whether the rate of overall criminal activity is increasing or decreasing.
Additional Factors For Finding a Good Real Estate Market
Strong Job Market
Markets with solid job growth and employment opportunities draw more tenants. Paying attention to major companies moving to the area will cause an influx of workers and keep rental demand high. Depending on the type of business moving in, this may also cause housing prices to rise or fall. The U.S. Bureau of Labor Statistics or a local library has area rates for job availability.
Future Development Potential
One of the things we look at before buying in any real estate market is future development projects. If you notice a lot of construction happening, that’s a good sign of a growing market. A growing market generally means real estate values and rents should also be trending upward. For information on new developments coming, check out the local municipal planning department.
Investor Tip: While gathering information on future development in the area, make sure you are also aware of any new developments that could hurt the value of surrounding properties. New housing developments, for example, could compete with your property.
Cash Flow & Growth Potential
A factor that negatively impacts a real estate investment is failing to run the numbers accurately. For investors looking for cash flow, if a property doesn’t already have cash flow, it may not be a good investment for you. Another quality of a good real estate investment is that it generates long-term rental income.
Investor Tip: Understand future growth potential and where real estate values are headed to determine if a property will be cash-flowing. Check out average rents for comparable properties in the area to get a more accurate estimate of how much you can charge renters.
Solid Condition of the Property
New investors tend to vastly underestimate how much a property’s condition can impact their investments. For instance, a property may be ugly and outdated but have a solid foundation and is structurally sound. You can fairly easily increase the value of a property with some cosmetic improvements.
To determine the overall condition of a property and gain a better idea of the potential financial impact, consider the following:
- Age of property
- Quality of structure
- Previous updates
- Cost of renovation
- Cost of necessary repairs
- Time it takes to get property “rent-ready”
- Cost of ongoing maintenance
Investor Tip: The above factors will help investors estimate expenses related to both upfront renovations and ongoing maintenance and, more accurately, determine if it is a good, cash-flowing real estate investment.
Excellent Property Management
A real estate investment is only as good as the property management. Finding a great property manager is worth their weight in gold. Property management expenses are tax deductible for rental property owners. So, if you are thinking about managing the rental yourself, consider paying someone else to handle the following:
- Finding quality tenants
- Keeping property filled
- Collecting rent
- Managing Repairs
- Day-to-day maintenance
Investor Tip: Find a good property manager before purchasing to avoid scrambling to find one after the fact.
Understanding Property Value
The value of a property is essential, but what’s even more important is paying attention to the value of the property compared to how much you’re paying for it.
Understanding Market Trends
Understanding real estate market trends can be tricky because, well, they are trends. While trends give an idea of where the market is likely headed, there is no exact science to predicting constantly changing markets.
Understanding the factors that impact the health of a market should always support projected trends. The following factors will positively impact the real estate market:
- Incoming developments
- Revitalization efforts
- Growing population
- Growing jobs and salaries
Other Factors That Impact a Real Estate Investment
Additional factors to consider when investing in your real estate property include the impact of property taxes and insurance costs for high-risk natural disaster areas. Keep these factors in mind and figure out how much these costs will cut into your return on investment.
Property Taxes
Higher property taxes are not always a bad thing. Especially if your property is in a great neighborhood that will attract long-term tenants. But there are also really crappy areas with high property taxes. Tax information is available at the local municipality’s assessment office to see if property taxes will likely go up in the coming years.
Investor Tip: If a town is in financial distress, tax hikes may destroy any chance of producing rental income.
Natural Disasters
The cost of insurance will cut into your returns, so you should know how much to expect to pay. Insurance costs could be through the roof if your investment property is located in a high-risk area, i.e., prone to earthquakes, flooding, hurricanes, tornadoes, etc..
Smart Real Estate Investing: Turning a Bad Real Estate Investment Into a Good One
To avoid finding yourself stuck with a bad real estate investment, stick to these basic rules.
4 Real Estate Investment Rules
- Understand your costs and risks
- Carefully plan a strategy
- Know when to cut your losses
- Learn from your mistakes
When to Sell an Investment Property
It’s not always possible to turn a bad real estate investment into a good one. Sometimes, cutting your losses and selling an investment property is best. If you are faced with any of the following scenarios, it may be time to sell the property and move on to the next investment.
- Major life event
- Better sources of passive income
- When your cap rate is below the risk free rate of return
- Where there is a large supply of property in the pipeline
- Excessive tax hikes
- When you exceed the tax free profit ($250k / $500k)
Final Thoughts
Turning a bad real estate investment into a good one starts with recognizing the warning signs of a bad investment. While investors never want to end up with a poor rental property, there are ways to turn an investment around or entirely avoid making the mistakes that got you there. The more information you have before purchasing a potential investment property, the better decision you can make.
For more investor tips, free resources and personalized investing advice, join RealWealth at no cost and start your path to building real wealth and financial freedom.
