Friday, December 15, 2023
With the way the economy and real estate market are heading, it’s becoming increasingly difficult to profit in realms that previously were far more lucrative. It’s harder and harder to keep one’s capital and not risk it while still making decent profits.
This is why avoiding these three investment pitfalls is even more crucial than ever. Narrower margins require conservative perspectives. Here are a few things we urge our clients to consider with their investment strategies to protect their capital.
1 Avoid Over-Leveraging
Overleveraging in real estate means an investor borrows excessive amounts of money to finance a property investment, often beyond their financial capacity or the property’s actual value. Examples are taking out a mortgage that covers a large percentage of your property’s value, such as 90% borrowed with only 10% as your down payment. Another is using multiple mortgages or loans to finance several real estate properties without having enough cash reserve. A third example is buying a property with a short-term, high-interest loan, even if you intend to hold the property long-term.
While leveraging other people’s money to make a deal work at such a high rate of return can seem tempting, it’s a perilous decision. You put yourself at the mercy of the market. If mortgage rates suddenly go up, you might not qualify when it comes time to remortgage. Or, if the market experiences a drop, you may end up with more mortgage than investment!
When you are over-leveraged, you do not have a safety net for the investment. Then, if things spiral financially, you have fewer options available to you. You might be forced to sell during unfavourable conditions or worse! I have a friend whose relatives in the States had to walk away from their homes of 5 years after the 2008 market crash. They bought their family home with only 5% down, and when property values dropped, they learned all their built equity was negligible. They had to pack their belongings, lock the door, drive out the laneway, and abandon their home to the bank. Many, many families tragically experienced this pain during that decade. When you keep a healthy margin of debt, you can re-leverage to give yourself a cushion to open your options.
How do you avoid overleveraging? Keep a moderate loan-to-value ratio, such as keeping 20 to 30% down all through the lifetime of the investment. You can also keep sufficient cash reserves to cover unforeseen expenses, mortgage payments during vacancies, and other financial obligations without relying solely on property income. Another option I recommend is going with fixed interest rates, which give you stability and predictability with your mortgage payments.
2 Exercise Caution with Speculation
You might ask yourself, “Isn’t every real estate investment speculation?” Not really. If you have been watching the market and do due diligence and intend to make money over the long run, that isn’t considered speculative investing. For example, if you buy a rental property expecting to keep it for 15 years and watch it increase in the historical market rate of 5% on average each year, that is a proven model that works repeatedly. Real estate speculation aims for high returns within a relatively quick period outside of the norm. For example, if you assume land in one area of a city will suddenly increase in value, buying that land intending to capitalize on a quick boost in value would be speculative. It is much more risky because you expect market conditions to move outside the normal, often while highly leveraged, to make the purchase possible.
While the allure of short-term gains may be tempting, it’s essential to approach these transactions with caution. Our rule of thumb is only to speculate if it’s an investment that you can easily afford to lose. You might win big, and you might lose big. Be prepared that your finances will be fine even if the worst happens. Having an established financial safety net to cushion potential losses is critical. Long-term, stable investments should form the backbone of your real estate, with speculative ventures potentially considered as a supplementary strategy.
3 Maintain Property Management
Effective property management is a cornerstone of successful real estate investing. When looking at the physical property, investors must address tenant concerns, conduct regular maintenance, and stay proactive in resolving issues. Since interest rates have gone up, many landlords are facing crunched cashflow. When there is a physical maintenance issue, they often have to access money through loans, lines of credit, or draining their cash reserves. While this isn’t desirable, it’s essential to look at the cost of not doing the maintenance work. Which poses the greater risk?
The answer to this question is situational. However, generally speaking, the better the condition you keep your property in, the higher the chance of attracting a tenant at a better price. And you are more in control of your options overall. If you delay maintenance, you may face future damage to the property. Let’s say you take too long to change the property’s shingles. If leaks begin, you now have to pay the expense for the roof along with replacing insulation, removing mold, replacing drywall, repainting, etc. In the long run, taking out a line of credit at 10% for a few months may be cheaper than dealing with the fallout.
The same can be true for late payments from tenants. I know this is a tricky one since, right now, so many people struggle to afford rent. If you can afford to reduce or keep rent below market value, that is awesome. And if you are already at risk yourself, you may need to take action quickly on late payments. Time and time again, I get calls from worried investors asking for advice. They say, “Oh, my tenants are so behind on their rent! What do I do?” And I ask, “Well, how far are they behind?” And they say, “Five months” or “Six months.” And I’m going, “How did they let this go for so long?”
Procrastination can really bite you in the backside in this area in particular. Appropriate action is necessary if you need those rent payments to afford your investment. If your tenant doesn’t pay rent on the first when their rent is due on the first, I recommend giving a notice of eviction on the second day. Sounds harsh to provide an eviction notice so soon, and the reason is that it is a long process if the tenant continues not to pay. The sooner you give the notice, the quicker you are protected. After the notice is given, the tenant has a certain number of days to rectify the money shortfall. If they don’t, you continue the eviction process. If you wait three or four months, you are behind by thousands of dollars , and your investment is seriously jeopardized.
I strongly urge landlords to stop getting references from the potential tenant’s previous landlord. Instead, call the landlord two apartments before. Why? A landlord can forgive a tenant who hasn’t paid, so they can tell you there is no rent owed. Why would they do that? So that they can get rid of the tenant. Why? Because that landlord procrastinated too long to evict the non-paying tenant, they are in big trouble and need to use other means to get the tenant out quickly!
Real estate success doesn’t just hinge on making the right purchase. Maintaining your investment is a critical part of the process. Conservative leveraging, avoiding speculation, and prioritizing property management are investment habits that protect your real estate for long-term success.
If you are curious about these examples or want to learn more about investing wisely, check out The Wealth Formula: Build Wealth Even if You Are Down to Your Last Dime. It’s a guide built on personal lessons learned by Yetta and me. It’ll help you identify what’s important to you and understand how to build achievable, sustainable wealth. Through stories and analogies, you’ll formulate a plan to apply the principles to achieve a LIFE exponential.
You can find a copy of The Wealth Formula here:
