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The Top 10 Mistakes That New Investors Make When They Buy Rental Properties

Updated on January 18, 2011

What and Where Not To Buy

Do you know the TOP 10 MISTAKES that new investors make when buying investment (rental) properties across the country? There is so muchmore to consider beyond just cash flow and appreciation. Here they are:

Here they are: 1. Buy new homes - New homes can be fun to live in, but they are rarely the best value as investments. Spec homes generally cost more per foot than neighboring houses (but don't resell for much more), and tract homes are generally found in areas that are the worst areas for appreciation (see #2)...Unless you are picking up new homes at substantial discounts from builders, its best to stay away from these homes as they will rarely cash flow and usually have a two year time frame before any type of appreciation. One successful strategy is to either buy the note on the construction loan at a substantial discount and then either rent, lease option, or owner finance the property. You can also negotiate the builder down and take the property under an option fee and sell the property above the option price.

2. Buy in areas that will have more construction - People buy new houses in up and coming areas because they want to live in a new house. Guest what - all of the people you go to sell the home to in 5 years also come to that area because they want a new house... and now you've got an old house, and the once empty field down the road is now plum full of new houses. This is why these homes and areas don't appreciate well! You need to be prepared to usually hold onto the property or sell the property with owner financing that way your aren't responsible for tenants and toilets!

3. Buy in their own neighborhood - Just because it's a great neighborhood for you does not mean it's a great neighborhood for a rental property. Rental properties tend to be LESS EXPENSIVE than the homes of the owners, and they probably don't have all the amenities. Rents don't double as prices double, thus more expensive properties yield worse cash flow and bad use of leverage. An example of this would be the Phoenix and California markets where prices doubled but rent rates didn't increase. Novice investors were left holding the bag in these markets as they were never able to rent the properties in the past to cover their mortgage payments.

4. Buy for price over location - So you got a GREAT DEAL on a house. Awesome - sell it and take your profits! Rental property ownership is all about long-term appreciation and total return on investment. For that you want close-in up-and-coming neighborhoods. Don't be greedy! Sell your property with a bit of equity in the property for a conventional buyer or sell with owner financing and take the down payment as immediate cash with the monthly cashflow (as you can charge 8-10% on your owner financed note) and the remaining balance and profit to arrive in 24-36 months.

5. Buy for cash flow over location - Yes, you can get great cash flow buying duplexes and four-plexes in slums...but, they just don't appreciate much. When you add it all up, would you rather have $3500/yr in positive cash flow on a slumlord property that has massive turn-over and is only worth $15K more in 10 years, or would you prefer $500/yr cash flow and minimal turnover on a property that will be worth $100K more in 10 years. I'll take 10 of #2 any day.

6. Buy in rental property area - I've actually heard people describe a neighborhood as a "good rental area" because it has lots of rent houses!! That's nuts! A "good rental area" is a neighborhood that has virtually NO rent houses. This allows your house to be a rarity or an opportunity for a family to move into a desirable area wihtout having to purchase. Remember - it's all about appreciation, and neighborhoods full of rent houses, are not as well kept, and just don't appreciate much!

7. Buy for "future potential" - Yes, the highway may go there. Yes, the light rail may help the neighborhood. Yes, the neighborhood may become gentrified. Yes, the dice may land on seven! Don't be a real estate gambler - be an investor. There are plenty of great opportunities in great neighborhoods that will do just fine without relying on possible future demographic changes. With the housing market being like it is, take advantage of the current REO's and short sales to buy properties now. Utilize the path of progress for your commercial deals!

8. Buy for "themselves" - Just because you might prefer living in a large, new, 4-side brick house in a rural area vs. a small, old, 4-side wood house in the city, does not mean that that's a better investment. When you consider that for the same price, you can buy a house in the rural area that is a large expensive house on a cheap lot (that requires a lot of $$ for paint and carpet every time a tenant moves out) or a house in the city which is a small cheap house (that requires minimal $$ in paint and carpet) on an expensive lot - which sounds more appealing? Then consider that they both get the same rent, but the city home appreciates at twice the rate, rents in half the time, and has less turn-over... Hmmm....

9. Buy based on advice from realtors rather than investors - I love realtors - I even married one. However... realtors tend to be better at finding people what they want than what they need. Before you ask a realtor for help finding a good rental property - make sure you understand exactly what a good rental property is. Better yet - become an investor and learn how to find your own rental properties - properties often available at discounts and/or with free existing loans, no $$ out of pocket, and that are not found in the MLS. Expect to spend some time training a realtor and stick to your guns and numbers when it comes to investing than instead of someone who is trained to be an "inside the box," traditional thinker.

10. Condo's, Duplexes, and almost anything other than a small 3/2 - To me owning a rental property is a 5-15 year (or more) commitment and all I really care about is how much appreciation the property will make me during that time horizon. When you factor in appreciation, turn-over, all carry costs and cash flow, it becomes pretty obvious that condo's, duplexes, and just about anything bigger (or more expensive) than a simple 3/2 in an up-and-coming neighborhood just does not yield the best return. Condo's are especially a bad deal currently unless you can get them for pennies on the dollar and either owner finance, lease option, or rent with huge positive cash flow for an extended period of time in a desirable area.

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    • sukkran profile image

      Mohideen Basha 

      9 years ago from TRICHY, TAMIL NADU, INDIA.

      thks for these very useful informations. good hub

      sukkran

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