You’ve found an investment property that looks great. You can see the dollar signs in front of your eyes and imagine the figures in your bank account climbing exponentially. The good faith estimate from the real estate agent looks good and you have more than enough money to close.
You are excited. That’s your first pitfall. Whatever you have to do, try to keep emotion out of your buying decision. Always buy investment property by the numbers, by how it will perform for you. Never buy it because “it’s so cute!” or “I just love the neighborhood.”
The day to sign the papers comes and the title company calls you with the amount of money you’ll need to bring to closing. It is far more than what you expected and will all but drain your cash reserves, or even worse is more cash than you have. You have been trapped by one of the pitfalls of buying property.
Several things can happen to mess up what looked originally to be a terrific investment. There is no need for you to get caught in one of these if you know what to look for and you take a few simple precautions to avoid them.
Sloppy real estate agents and sellers
Real estate agents may be good at selling things, but all too often they don’t really understand the importance of accurate figures, especially with investment properties. I have seen many listings for investment property that have no income or expense figures whatsoever. When you ask them about it, they say, “oh, do you want them? I’ll have to get them from the seller.” Grrr.
Does that mean you can just rely on what the agent or seller tells you about their figures? Absolutely not. Check everything. Real estate is the one investment that allows you to personally verify every operating figure and aspect of your potential investment, and you should if you expect to come out alive financially.
What figures do sloppy agents and sellers mess up? All of them, of course, but we’ll look at the most common ones here.
Suppose you are assuming an existing loan or land sale contract. You will be paying the difference between the loan balance and the sale price to the seller. The listing agent or seller him or herself give you a figure that has lots of zeros. When you ask about it, you’ll get an answer such as, “oh, it’s about that much.” Grrr.
“About that much” can cost you thousands of dollars and possibly make the deal fall through. How much is “about that much”? Depending on someone’s individual interpretation, it could be a $10,000 to $20,000 difference between stated and actual. The higher the loan balance, the less money you have to bring to closing; the lower the loan balance, the more you have to bring. I know this can cost you a lot, because I fell into this trap. It only ended up costing me about $5,000 extra, though.
Sometimes sellers really don’t have truly accurate figures. But they can get them-and should. You need to know within $100 how much is owed on the property if you are assuming an existing loan or contract. So write into the sales agreement the following language:
“Subject to the actual balance of existing loan being no less than $x.”
Operating expenses can use you up fiscally and psychologically and drive you into bankruptcy. I looked at a property once that showed a great gross income, but actually lost money. Fortunately, in this case all the figures were on the listing for potential buyers to see.
As an experienced landlord and investor, you also know about how much things should cost. Look for discrepancies in amounts between reported and what you know to be real and for things that the seller did not spend money on that will end up being deferred maintenance and will cost you big time in the future.
You need to know exactly whom you are getting if there are existing tenants in the property. You need to know how much rent they are paying, their payment history, their complaint history; you also need to see copies of all letters and notices sent to tenants.
One of the ways you will be calculating the value of the property is by the amount of rent it fetches. Too many times I have seen notes such as “rents should be higher” in flyers and listings. Hogwash! You the rents are exactly where they should be.
Deposits on hand
You might consider this figure to be a part of the tenant records, and it is, but this is a dollar figure that can be a surprise to the uninitiated. When you are ready to sign all the papers at the title company or lawyer’s office, you will have to, as buyer, pay the seller for all the security and other deposits he is holding. On a large complex that can amount to many thousands of dollars. For a duplex or triplex it could still be $2,000 to $3,000. Factor that into your estimate of closing costs at the beginning of your consideration of a property.
Other things to watch out for
Liens that may be in the offing
The seller may or may not know about them. Or he may have heard rumors, but nothing else. But the surprise may come after you have bought the property and you one day, six months after you took possession, get a notice that the city is going to put sidewalks in front on your complex and you get to pay.
Side agreements with tenants
You will find all kinds of side agreements that owners make with tenants that you never see in writing. He might have promised the tenant that he will redecorate the entire apartment if he renews for a year; he might have told the tenant his last month’s rent is free for a one-year renewal. Who knows?
You need to ask the seller to certify that there are no agreements with tenants, orally or in writing, except those he has disclosed.
Language for the sales agreement:
“Seller certifies that he has made not oral or written agreements with tenants that he has not disclosed in writing to the buyer.”
There is a lot of money to be made investing in real estate and a lot a money to be lost. How you approach the purchase of it and how well you dodge the pitfalls will determine how your investment works for you.