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The news in real estate circles has been particularly bad since the subprime and financial markets collapsed this summer, but that doesn’t mean the market is completely without opportunities. There are still plenty of great deals to be had for the smart, well-prepared and strategic investor.
In this climate, it’s crucial that an investor takes the time to really examine their goals and financial reality when considering a real estate investment. Here are some tips to help you get off on the right foot, as well as some mistakes to avoid at all costs.
First, the do’s:
1. Have a plan.
It sounds simple, but it’s astonishing the number of investors who jump into a long-term real estate commitment without taking the time to determine what it is they want from the property. There’s never a good reason to purchase a property without having a clear understanding of how it can be used to your financial benefit.
This advice is true across the board in real estate, whether you’re buying a house or storage space. It’s also particularly important when considering a 1031 exchange. You want to make sure that you have a plan not just to dispose of one property, but to reinvest in another one. You have to start the ball rolling early on, a minimum of 30 days before settlement on the relinquished property. Otherwise, you’ll be left scrambling.
Investors who wait until they only have a few days left to identify a new investment property often don’t find their next purchase, leaving them with a large tax liability – typically 21 to 24 percent. It’s always detrimental to take a hit like that, no matter what the dollar amount.
2. Build a team
There are a number of professionals an investor should have on their side before completing a real estate transaction. A CPA who knows the ins and outs of investing in real estate is a good place to start. A good tax attorney is also helpful, but a real estate attorney might be more appropriate.
If you’re serious about investing, you’re going to need an advisor to help navigate all the different properties and the investment options out there. Trade Up 1031, for example, does a lot of demographic-based investing. We look at job growth rates, area-specific household income, positive economic indicators, and the demand for the types of property an investor is considering.
At the very least, a potential investor will need a team to cover the basics, to look at the physical condition of the property and to determine if it matches your investment strategy. When you ignore the simple things, they often come back to haunt you.
3. Do Your Homework
When you’re considering purchasing a property, you want to stack the deck in your favor. Fully evaluate not just the building, but the neighborhood it’s in. Is it visible and accessible? Look at the demographic data and physically inspect the property. Get an appraisal.
In the current market, it’s especially important to shop around for the best deal if you’re considering carrying debt. Don’t jump in.
4. Create Multiple Exit Strategies
It’s all well and good to say you’re going to hold on to a property for a certain amount of time before selling it. But it’s important to prepare for market changes, especially if you’re hoping to turn around a property in a matter of weeks or months. What happens if it won’t sell? Are you prepared to rent the property? What other options are available to you?
This is an area where doing market research will come in handy. You’ll have realistic expectations, know what type of improvements will increase the property’s worth, and understand who the buyers are in your area. It’s also another reason to consider a good advisor who can offer solutions to problem scenarios before they arise.
5. Budget Realistic Time and Money
Whether you’re considering the amount of time it’s going to take to sell a property, or the amount of money you’ll need to make repairs, it’s crucial to understand that it will probably take longer and cost more than what you’re expecting.
Consider the timeline of your investment. If you’re anticipating completing a 1031 exchange, be conscious of the 45 day identification period, the time you have to find a new property to invest in without having to pay capital gains tax. You’ll need 180 days to make sure you can complete a successful tax-deferred exchange.
Just as there are basic requirements to real estate investing, there are mistakes to avoid at all costs. Taking a realistic approach, and in some cases preparing for the worst-case scenario, can help you avoid disappointment and financial disaster.
1. Don’t Expect to Get Rich Quick
This is true of any investment. There will always be a risk and reward balance. Typically, the greater the risk involved with an investment, the greater the potential reward. If you want to see your money grow rapidly, be prepared to take a few hits along the way.
The up side to investing in real estate is that it has proven to be a powerful income generator and wealth builder, but typically only in the long term. It’s important to give your investment time to grow. Becoming inpatient with a property can mean less stability in your financial portfolio and a potential loss on your investment.
2. Don’t Assume You’ve Found the Best Deal
You’ll make the most on your investment by purchasing the right property at the right time for the right price. This is yet another area where an advisor can help you sift through thousands of property listings and select the one that’s going to work for you.
Advisors often have access to properties that are off-market and will never get listed in traditional press. A property that isn’t advertised to a large audience is often going to be your best bet for investing. You’ll get a better deal by not competing with a large number of bidders, and a lower buying price will give you a greater return on the investment.
3. Don’t Duck Due Diligence
You can’t see a property once and know what type of investment you’re in for. There is a lot to consider before purchasing a property. Making a profit is just the tip of the iceberg.
Due diligence is the accumulative process of evaluating an individual property. It can’t be done overnight. Many investors fail before they ever get a chance to succeed because they lack the patience and knowledge to really investigate a potential investment. Sometimes you’ll feel the pressure to move quickly on a deal, but that fast-track approach is no reason to skimp on research. If you do, you’re looking at losing not just profit, but any money you put into the purchase.
4. Don’t Expect Perfection
Investing in anything demands caution. Understand the worst-case scenario and be prepared to deal with it if the worst happens.
The best way to set yourself up for success is to understand what could go wrong and how you are going to handle it. For example, you might not be able to lease a property as quickly as you’d like, or for the price you had in mind. Recognize this may happen by creating sufficient reserves. This caution and risk-management will give you the certainty of riding out ill-market conditions and weathering any crisis.
5. Don’t Spread Yourself Too Thin
Sometimes less is more. If all of your money is tied up in numerous properties, you’re bound to run into problems.
Define your investment criteria before you go looking at any and every property under the sun. Every investor should know what type of property will work for them. What kind of property can you afford?
There’s also a question of how much property you can keep up with. At what point will you have to stop doing maintenance work by yourself and hire a third party? Are you prepared for any unforeseen renovations? This is an area where it pays to be realistic.
The real estate market has historically operated in peak and valley cycles. However, the truly successful investor can navigate through the ups and downs of any cycle. Know your do’s and don’ts and you too could be one of the investors who prospers in all investment climates.
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