Counting on High Levels of Appreciation
Real estate investors can get into trouble by thinking that what happened before in the real estate market is going to happen again. History, however, is no predictor of the future. You can’t rely on the future to produce the same results. Even if the property has been appreciating at a 12% to 20% rate for several years, counting on that rate to continue is an extremely risky proposition. It can cause you to overpay for properties, expecting to realize the difference at the sale from appreciation. If it doesn’t happen, you’re holding a loss. When you plan out your leveraged real estate investments, look at three scenarios: best, worst, and most likely.
Ending Up With Too High a Payment
It can seem like a great investment to control property with a very low down payment. You’re looking at the numbers and seeing a really high return on investment due to your low cash outlay. The problem? Higher payments come with higher leverage. If this is a mortgage, for instance, you can count on having to make monthly payments, and the more you borrow, the higher the monthly payment. Should the market soften or your properties experience higher-than-expected vacancies or credit losses, you could find yourself unable to maintain those higher mortgage payments that seemed fine at the beginning. If that happens, your investment is in jeopardy.
Letting Good Financing Result in a Bad Purchase
Many an investor has overpaid for a property because they found a unicorn high-leverage financing setup. Said differently, just because you can get a property with very little cash outlay doesn’t mean that it’s a good buy. Look at the value of the property in the context of current and expected market trends. Find comparables. What have they sold for? What is selling in the area? If the property is overpriced, appreciation will be minimal or, worse, non-existent. If the market retraces itself for a while, you’re in serious trouble. Your overpriced property will be a significant drag, and you won’t be able to unload it without taking a loss.
Forgetting That Cash Flow Is King
If just one of these “don’t” behaviors sticks in your mind, this is the one. Errors in judgment in one or more of the other items here can be overlooked if you have that one great thing—excellent cash flow. If your rental income minus your mortgage costs and expenses is putting a nice cash return in your pocket every month, then the fact that the property didn’t gain in value this year won’t be as worrisome of an event. But if all your real estate investments are down, your low cash flow could cause serious problems.
