Real Estate Investing just got interesting. Real Estate has been a path to wealth for countless individuals, including our present commander-in-chief. For many, owning rental property, specifically single family homes, is an accessible option for participating in this seemingly lucrative investment. The potential downfalls however are often overlooked, and can be devastating. Below are three of the most common pitfalls I see both new and experienced real estate investors making.
In order to enjoy the many benefits of real estate investing, you have to be able to satisfy the occasionally unexpected expenses. A broken pipe may cause damage that is covered by insurance, but will your insurance pay for your tenant’s hotel bill? What if the damage is caused by your tenant? You can evict tenants who don’t pay, but will you be able to endure the 2-3 months of no rent coming in? There may be things that you as a homeowner are willing to put up with, i.e. a broken air conditioning unit. Your tenant however may not be as tolerant, and may even be able to withhold rent until the unit is replaced. These unexpected issues require an investor to have a source of funds available to cover the needed expenses. As a general rule, an investor should maintain no less than 6-months of rent for each rental property they own. This amount may be higher depending on the proportion of rent to actual expenses of the property.
Not Using a Property Management Company
The “do-it-yourself” approach is often admirable, but not always appropriate. Aside from the burden of being on-call 24/7 for emergency issues, collecting rent, preparing necessary tax documents, and complying with the various legal requirements, there is another significant reason you should not be the property manager. Compassion. It’s a great quality to have in most areas of life, but not so much when dealing with tenants. Slow paying rent, or not paying all together are often coupled with very legitimate reasons. A property management company has the advantage of “just doing their job”. Evicting a tenant is difficult. Owning rental property however requires treating it like a business. This can be mitigated by strong tenant screening prior to selecting the tenant, but ultimately, there still may be issues that require a heavy hand. A typical property manager will charge a percentage of the rent, or in some cases, a flat fee. Ordinarily, the fee charged will more than offset the time you will save. Factoring in even one eviction, or difficult tenant will make the cost well worth it.
Insufficient record keeping
One of the great benefits of owning an investment like real estate is the potential tax savings. In order to take advantage of these savings, it is critical that you maintain records of all expenses. Many investors fail to account for all the various items they purchase over the course of the year. Do you include gardening in the rent? If so, do you account for the cost of the gardener and all related services and supplies? Do any of your repairs improve the value of the property? If so, are you tracking these items for adjusting your basis at the time of sale? Record keeping does not have to be laborious and there are some great apps or programs that you can use. If you do use a property manager (see #2), make sure they handle all of this for you.