Buying an investment property to rent out may be one of the safest ways to park your wealth and watch it grow. Save for a down payment, buy a sparkling new house, then collect a hefty passive income from your tenants — sounds easy, right?
While owning investment property can be an incredibly exciting and lucrative venture for homeowners, there are some pitfalls and traps newcomers to real estate investment should be aware of.
To help you succeed as an investment property owner, here’s a look at the 10 most common mistakes to avoid as you begin your journey in real estate investment.
1. Buying a Fixer-Upper as Your First Investment Property
The idea of buying a fixer-upper and flipping it for a major payoff is enticing, but first-timers to the investment property world should tread carefully. Fixer-uppers require homebuyers to invest their time, creativity, and cash flow for months before they see a return on their investment. In some cases, first-time investors can be blindsided by the unexpected costs for repairs and renovations and the delays that may stall them from collecting rental income.
If you are committed to buying a fixer-upper, you need to know how to spot a lemon — such as a faulty foundation, a poor layout that requires a complete reconfiguration, or by-laws that bar you from making the changes you need to reap a solid rental income — or have a team with that expertise on your side.
Around 41 percent of Americans would prefer to buy a newly built home and with good reason. They’re move-in ready, come with extended warranties and the latest energy-efficient features, and you won’t need to worry about incessant repairs and maintenance. That also makes these properties coveted by renters.
2. Failing to Set Up an Initial Plan and Exit Strategy
Before sinking your savings into an investment property, make sure you have a plan with solid financial goals in place before proceeding.
In forging an investment strategy for your new property, you’ll need to take a step back and decide how much you’re willing to spend on mortgage payments and other bills, along with how much income you plan on generating each month to offset your expenses and labor.
At the same time, think about your exit strategy. Are you buying a brand-new investment property in the building stages so you can sell it just a few years later after it’s grown substantially in value or are you aiming for long-term wealth with a buy-and-hold rental unit?
Not knowing your game plan — from start to finish — could expose you to costly mistakes.
3. Overpaying for Your Investment Property
Maybe it was the charming reading nook by the window, the walk-in closet in the master bedroom, or the state-of-the-art smart appliances in the kitchen — but now, you’re caught in a bidding war, driving up the initial cost of the property you’ve decided to invest it.
Newcomers to buying investment properties must remind themselves to steer away from making an emotional decision and treat their purchase as a business transaction. You won’t be living in this dream home; your tenants will. Going over your budget will only hurt your bottom line and limit your potential profits.
Make sure you’re buying a property at the right price, so you can charge an equivalent monthly rent that covers your mortgage and other expenses like property taxes and home insurance.
If you can’t rationalize passing that substantial price tag on to your tenants, you may find yourself stuck with an overpriced property that’s hard to rent. Prepare to walk away if the investment isn’t going to pay off.
4. Not Researching the Market You’re About to Buy In
To understand what type of home will yield a solid return on investment, you must do your homework about the rental market you’re buying in. The decisions you make on the property you buy — where it’s located, its size and features — should be based on facts and figures instead of instinct.
Look at how much homes sell and rent for in the neighborhoods you’re eyeing, pore over the demographics and employment rates to understand who typically lives there, and study the crime stats, community planning, and weather hazards the area may be prone to. You may learn you shouldn’t buy a single-family home in a university town, and likewise, it may not be sensible to invest in a luxury condominium in a small town packed with growing families.
The same goes for finding out your potential investment property is at high risk of flooding, escalating the cost of property insurance premiums.
Pay attention to construction in and around the area too. You don’t want to buy a new property that’s in the middle of a major demolition and rebuild zone.
5. Ignoring the Rules
Zoning by-laws, income tax regulations, mandatory insurance policies, local tenant protection rules — as a new investment property owner, you’re about to get closely acquainted with a lengthy list of laws around what you can and can’t do as a landlord.
Before you buy an investment property, familiarize yourself with landlord-tenant laws in your jurisdiction, including rent control measures, security deposits, and repair requests.
You also need to fully insure your rental property, including your rental income. A landlord insurance policy typically covers your property in case of damage from fire, wind, lightning, hail, or other adverse weather, as well as any rental income losses if the property cannot be occupied due to these natural disasters. If you’ve furnished the rental property with high-end gadgets, check if there’s a policy to cover damage to your possessions too.
Finally, do your due diligence with zoning by-laws and homeowner’s association guidelines before you make any physical changes to your investment property.
Ignoring any of these rules could lead to cash penalties or even loss of financing.
6. Forgetting What Tenants Want for a Rental Property
Cast aside your personal preferences for this step, and put yourself in the shoes of the target demographic you’re aiming to rent your investment property to. Which attributes in a rental property will your ideal tenant be looking for?
Is it a family-friendly home in a neighborhood with low crime and highly rated schools? A larger home near the local university that several college students can rent? Or a beachside villa serving as a short-term vacation rental?
Think about what renters would want for a convenient and happy life, such as being close to grocery stores, restaurants, and green spaces.
Also apply this exercise to what’s within the four walls of the home, such as necessities like a washer and dryer, a dishwasher in the kitchen, and loads of closet space. These days, because of the shift to a hybrid work setting, a layout that accommodates space for a home office can make all the difference too.
7. Underestimating Your Expenses (and Rent Pricing)
If you’ve set the rent to cover only your mortgage, you’re making the biggest mistake in the rulebook: omitting the other costs you’re responsible for as the homeowner.
Mortgage payments aside, you’ve got a standard set of bills coming your way in the form of HOA fees, property taxes, and insurance premiums. And then there are the closing costs, maintenance and repairs, and upgrades you’ll need to make to keep your rental unit competitive in the market. Make sure the monthly rent you’ll be collecting adequately covers these costs.
Keep costs in mind when choosing upgrades too. If you shell out for luxuries like heated floors and marble countertops, make sure your potential tenant is willing to shoulder the cost; otherwise, it’s not worth overspending on these renovations.
8. Buying Too Far Away From Home
Take advantage of your “home court” advantage and buy an investment property in your backyard. You’ll have the lay of the land, and you’ll be a short drive away in case anything goes awry. You’ll also be able to take a hands-on approach to managing your investment, from finding your ideal new property to checking out open house tours in person and meeting your new tenants.
Having your investment property close by will make all the difference if you’re just getting started. You may not know how much time is involved in property investments, and you may not want to add a long drive — or worse, a flight — to get certain parts of the process organized.
9. Doing Everything by Yourself
Running your investment property solo — whether you’re a novice or a pro — may lead to mistakes that will cost you money, increase vacancy rates, or turn away great tenants. It takes a village to buy a property, let alone show it to prospective tenants and rent it out.
You’ll need to build a team of advisors who can help you get the job done smoothly and with the best returns you can get. Your investment property team should include a real estate agent, a home inspector, a mortgage broker, an attorney, an insurance provider, a property manager, and an accountant to show you the ropes and impart their expertise throughout the process.
With your team in tow, you’ll know you’ve secured the best financing for your property, along with a building that’s in great shape and priced fairly, and an iron-clad insurance policy.
10. Not Planning for Vacancies
Avoid stretching your budget too thin, so you have some wiggle room in case you face vacancies between tenants or if the rental market takes a turn.
While you’re developing your game plan (see No. 2), make sure to account for a couple months’ cash flow to cover your expenses if your property is sitting vacant.
Some lenders insist that you have about three months of savings in your bank account before they will approve you for financing to buy an investment property.
Carmen Chai is an award-winning Canadian journalist who has lived and reported from major cities such as Vancouver, Toronto, London and Paris. For NewHomeSource, Carmen covers a variety of topics, including insurance, mortgages, and more.