| Time and time again I see the same mistakes being made by real estate investors. These mistakes create a poor foundation for the investment and can cause serious financial hardship over the life of the investment. Two of these mistakes deal with improper analysis of the subject property prior to purchase, and the last mistake has to do with having a clearly defined exit plan.
1) Vacancy – Vacancy is an often overlooked, minimized, or completely ignored property cost. Vacancy is a very real part of any real estate investment and must be taken into consideration when analyzing property. Vacancy rates vary from city to city, and many times from neighborhood to neighborhood. Good property managers track vacancy rates and are a good resource to determine local rates. Typical vacancy rates range from 5%-20% of the gross scheduled income (GSI). Sellers of investment property rarely use rates higher than 5% in their sales literature, if they list vacancy at all. As such, it is always prudent in real estate investment analysis to include an allowance for vacancy characteristic of the local market.
2) Maintenance and Repairs – Routine maintenance is a natural part of any investment property and must be taken into account in your analysis. But when purchasing an investment property, the first thing to determine is if any deferred maintenance is required. Many times maintenance rates are estimated without any consideration given to the current condition of the property. It is quite common for owners to sell homes in disrepair or when they know large expenses are looming, so it pays to have the home professionally inspected prior to purchase. Maintenance rates generally run from 5% -20% of the gross operating income (GOI). Expenses tend to be higher for older houses that have not been well-maintained.
3) Exit Strategy – Exit strategy is by far one of the most important elements when purchasing investment real estate. One must assess the motives and struggles of the current owner so they can determine the likelihood of being in the same situation when they are ready to sell. Check carefully to see if you are buying in an area consisting predominantly of rental homes. If you are, your primary strategy may be selling to an investor, who will likely expect a discount. If on the other hand, your investment resides in a solid retail neighborhood, you will likely need a real estate broker to sell it. Sales costs generally range from 6-8% if you are using a broker and 1-3% if you are not. Be aware that your buyer will likely require inspections that could reveal defects that can cost thousands of dollars to remedy. Planning and understanding your exit strategy and costs are key to building a good foundation for your investment.
Jeffrey King, a real estate investor for over 20 years, co-founded Meridian Pacific Properties and helps clients acquire positive cash flow properties for their personal real estate investment portfolios. |
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