Investing in real estate is a great way to build wealth, but like anything else, it comes with risks. Buying the wrong property could mean costs you didn’t plan for, lower returns than you hoped for, or worse — a property that’s impossible to rent or to sell.
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Even a seemingly-perfect property can turn into a money pit. GOBankingRates spoke to expert realtors to learn five common red flags you’ll want to look out for. Here’s what you need to know before you make any real estate investment.
Buying a fixer-upper is even riskier than it seems. It can be appealing to buy a property for less, but the cost of renovation can spiral out of control. You never know if the property has hidden problems, like outdated wiring or structural damage.
“Homes that appear to be fixer-uppers or that are being promoted as such are often a far bigger financial undertaking than investors realize,” explained Cindy Stumpo, CEO and founder of C Stumpo Development. “It’s one thing to have to fix-up the interior design and landscaping of a home, and it’s another thing to have to fix foundational damage, outdated plumbing and mold/water damage.”
Always be sure you get a detailed inspection and a reliable estimate for repairs. Don’t make an offer until you’ve included these costs in your budget. You might find you’d spend more money fixing the property than any potential rental income or resale value.
“You want to identify exactly what will have to be fixed up if you take on the ownership and financial responsibility for a property,” added Stumpo.
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Foundation issues are one of the most expensive and complex headaches you can face. Depending on the severity of the damage, repairs can cost tens of thousands of dollars.
“If you see tons of cracks on the exterior walls as well as on door and window frames, that is a sign that there are some serious structural issues,” said Robert Washington-Broker of Savvy Buyers Realty. “Structural remediation is usually pretty costly and can turn what seemed like a great investment into a nightmare.”
If you find problems with the foundation, it’s usually better to walk away. Don’t think it’ll be an easy fix. Even if you’re planning to just sell the property without fixing the foundation, it’s going to make selling it a lot harder and take a lot longer.
Leaky roofs, warped floors or faulty plumbing can all be the fault of developers who were looking to cut corners and use substandard materials. You might not spot the problem during your initial walkthrough, but later on, it can become a major, costly repair.
“If we can see the signs of cut corners with the naked eye, odds are high that the previous owners likely got cheap with other maintenance items that we can’t see,” Washington-Broker said.
Look for signs of rushed or sloppy work, such as uneven paint, cracks in walls or doors that don’t close properly. Research the developer’s track record by reading reviews or checking whether they’ve faced complaints in the past. Your investment won’t be worth it if the construction won’t stand the test of time.
A high capitalization rate means that your return on investment will be high compared to the purchase price. It might seem like a good thing at first glance — higher returns are better, right? But an unusually high cap rate can be a red flag that the risks might outweigh the benefits.
“A high cap rate is, in fact, generally better than a low cap rate,” explained Graham Hill, real estate consultant at Find Osaka Agents. “However, high cap rates often signal more difficult business models. What you ‘might’ be able to earn comes into conflict with the difficulty of turning that plan into a reality.
“Every investor would like to target high cap rates, but doing so often requires buying ‘under-valued’ property; you need a great price, but why is the property ‘undervalued?’”
Sometimes a property with a lower cap rate could actually be the better investment. It could be because it’s in a great location, where there’s high demand, and it’s easy to find tenants.
“The cap rate is lower — sounds bad — but the returns are consistent — which is very good,” added Hill. “What you might sacrifice in terms of maximum upside, you might make up for in terms of average investment performance, year over year.”
Don’t decide to buy based on the cap rate alone. Think about the location, tenant demand and long-term potential. A lower cap rate in a stable, growing market could be a safer and more profitable investment.
It’s one of the most avoidable mistakes in real estate investing, but it’s also one of the most common. Failing to do your research can leave you blindsided by issues like zoning restrictions or even environmental hazards.
“Even the most picture-perfect property can turn into a flop if it’s in the wrong location,” said Angelica Ferguson VonDrak, associate real estate broker at Sotheby’s International Realty. “Especially if you’re planning to use it as a short-term rental like an Airbnb. A stunning home in an area with little tourist appeal or low demand for vacation stays might sit empty far more often than you’d like.”
Also, some cities have strict rules or outright bans on short-term rentals. If your plan for your investment is to list it on Airbnb, you’d be stuck.
“The last thing you want is to purchase what you think is the perfect rental property only to find out you can’t legally list it,” added VonDrak.
Don’t buy without thoroughly investigating the property, its location and the local market. Understand the local laws and regulations that might impact your investment. If you take the time to do your homework properly, it will help you avoid a massive headache down the line.
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This article originally appeared on GOBankingRates.com: 5 Costly Red Flags in Real Estate To Avoid for Your Investment Property
