Dennis S. Pellecchia
In the current market, investors face an uphill battle because achieving profitability poses more of a challenge than it did in years past. One way to enhance the probability of a healthy bottom line is to avoid five common mistakes.
1. Inadequate market research
Although national real estate trends are of value, the best market indicators are those in your local market. Make sure you get a handle on local rental rates, occupancy levels, competitive space supply and demographic trends. Moreover, because expansions, cutbacks or relocations by major local employers can significantly affect property prices, regularly monitor the local news for such developments.
Social and historical factors also play a role. Knowledge of a famous former resident, a historical event that took place on a property, or a neighborhood’s reputation as a hotspot for the rich and famous may drive prices up. Value-lowering factors include odors drifting from nearby landfills, factories or farms; a history of neighborhood tensions or violence; and recent flooding.
2. Inaccurate financial projections
Your investing decisions are only as good as your financial projections, so it’s more important than ever to look at real operating figures when purchasing an established rental property. In making your projections, don’t forget to include short-term financing costs, prepayment penalties and cancellation fees that may be triggered in case the property sells quickly. Also, don’t assume you can slash expenses or boost revenue by raising the rent.
3. Financial overextension
Used properly, leverage is a powerful tool for increasing your return on investment. There are high-risk behaviors, however, that you should be aware of to avoid becoming overextended. For example, in today’s real estate world, basing an investment decision on appreciation assumptions is riskier than ever. Just because a property has historically appreciated in value doesn’t mean the trend will continue.
Other high-risk behaviors include getting strapped by mortgage payments that are too high to handle in a softening market and getting lured into deals by the presence of readily available financing. Just because you can get into a property doesn’t make it a bargain or a winning investment option.
4. Lack of planning
Like any major undertaking, real estate investing requires considerable planning. A good plan will outline all possible outcomes of the investment. Some investors are “dirt rich and cash poor” because of bad planning. Through leverage, they have accumulated a portfolio of properties that have nothing in common but their owner. If your portfolio is a mix of winners and losers, review it carefully. You can improve your bottom line now by unloading properties with negative cash flow and focusing on those that fit your larger investment goals.
5. Ignoring financial indicators
When performing due diligence on a prospective property, look for deteriorating bottom lines as well as aggressive revenue recognition policies or deferred expenses. Comparing the property’s cash flow with its earnings statement can be revealing. If the former owner shows net income increasing while cash flow is in the red, watch out. A change in accounting methods or accountants midstream should also be a red flag, and you should question the reasoning behind such moves.
Many of the mistakes that impede profitability can be avoided through prudent planning and attention to financial detail. Work closely with your CPA to avoid making any of these five mistakes.
— Dennis S. Pellecchia serves as chairman of the board at Newton, Mass.-based Braver.