When to Walk Away From an Investment Property
Historically, real estate has been a great investment, but there are times when walking away from an investment property is the best investment decision. The opportunity to hold a property as it gains value or selling at a significant ROI is what all investors picture when taking on a loan to flip a house.
While a strong investment with income potential is certainly plausible, it’s not a guarantee, and no one knows this like experienced investors. A bad investment is always possible, and poor planning can lead to an expensive endeavor with few, if any, upsides.
Instead of jumping in with two feet into any given situation with unbridled enthusiasm, be sure due diligence remains a priority. Not all opportunities will be good opportunities, and there’s such a thing as a bad investment. These tips can help you know when to walk away from an investment property that won’t do right by your portfolio.
Too Much Upfront Cash
When determining how price affects the value of an investment, it’s important to consider both elements of upfront costs: purchase price and necessary renovations. A relatively affordable property can become an expensive property in a matter of weeks if substantial improvements and upgrades are required to create a habitable environment. All properties need repairs at some point, but the upfront costs on some properties can be far steeper than others, creating a pricey situation that likely won’t yield a large return on your investment in the immediate turn.
It may be tempting to throw caution to the wind, but this rarely works out for the best. Instead, steer clear of investments that require sizable upfront expenses in favor of alternatives within your budget.
Some markets are better than others for renters. A high population market with an influx of young people, like New York, Chicago, and Boston may be very appealing as rental markets, even in spite of the competitive and expensive real estate market, while others may not be so desirable. Small towns in rural areas, for example, may be highly competitive in terms of reduced rates and property availability, or a lack of interested renters may make purchasing a property for rental purposes entirely unsustainable.
A beautiful building may seem like it’s brimming with potential, but before you make an investment decision, be sure you’re in a good position to upgrade the property to its fullest potential.
Due diligence is a critical part of the property purchase process, and that includes where you buy property and how you plan to use it. Before making an investment, do plenty of homework on the local area, including answering questions like:
- What is the average price for rentals in my area? Is it enough to keep up a mortgage or support the costs involved with maintaining a building?
- How many people here rent property? Do they generally rent apartments in buildings or rent single family homes?
- What do area renters expect from apartments? What amenities are seen as desirable or necessary?
- What are area norms regarding rent and security deposits?
- How long are common rental agreements?
It’s easy to see the rental market through rose-colored glasses, but experienced investors know better. A supposedly great building in a bad location is still a poor investment.
Risks Outweigh the Benefits
All investment comes with risks, whether you’re buying stocks or purchasing real property. Even the best inspections in the world can’t prepare you for what lies in store and no one can adequately predict the future of the real estate or rental markets in your area. However, some risks are a little easier to identify than others.
There’s no such thing as a perfect property, and investors often interpret this to mean that it’s worth taking a chance on any property that seems like it’s good enough. This is unfortunately a shortsighted strategy, opening investors up to expensive or unsustainable problems that could have been easily avoided by passing on a purchase.
Savvy investors know that there should be a balance between risks and benefits, with benefits always carrying the upper hand. While evaluating a property, keep these points in mind to ensure you’re not taking on an unnecessarily large risk:
- Contractor and inspector feedback. Some red flags that may arise during an inspection are easily managed, but some, like foundation problems, aren’t worth the expense and the hassle.
- The local real estate market. If the property you are considering is priced high in a depressed or saturated area, you may not see the returns you expect.
- Personal observations. While touring properties and listening to agent pitches, keep your eyes open. Inspectors may not see everything so it’s up to you to ultimately determine the potential within a property.
- The cost of potential upgrades. Few properties are ready to use as-is, but there’s a difference between painting a few walls and redoing the entire building.
Lack of Education
Part of intelligence and awareness as both a person and an investor requires a solid understanding of the holes in your own personal base of knowledge. No one knows everything, and an awareness of what you don’t know can be the key to success in property investments. An education in one market doesn’t translate to an education in all markets, and investors who aren’t well aware of this fact may find themselves in hot water quite quickly.
A property that is a great buy in one place might be a horrible buy in another, and it’s up to you to know the difference. Most real estate agents won’t tell you the shortcomings in your strategies; their goal is to sell you a property and make a commission, not to help you build a strong portfolio. The same is true for your attorney; legal advice extends to the laws in a specific area, not the qualitative components of property evaluation.
Before snatching up a great property without considering the shortcomings, do your homework. Take time to get to know the local market, understand the ways in which local residents view property, and learn the trends in pricing and sales. Without a solid understanding of these kinds of factors, it’s easy to overlook a major risk in a seemingly sound investment.
A great investor can identify a lack of education and see the risks involved. When you don’t know the area and you don’t have time or an interest in learning, it’s best to walk away before it’s too late.
Some properties are easier than others. Some are in great shape when you make a purchase and only require a few minor cosmetic tweaks to get things up and running. And, of course, some are not.
Understanding the realities in a creative vision can be a challenge. It’s easy to see the potential in a beautiful property and create an idea in your mind, but there’s often a translation error between conception and reality. An experienced investor knows how to break out the costs and labor required for this kind of transformation in order to truly evaluate the feasibility of proposed changes or projects.
This is especially true in a development deal. Building a concept from the ground up goes far beyond the fix and flip skills most investors possess, and a few mistakes can cost you the success of an entire project. Hiring the wrong team of contractors and craftsmen can lead to critical errors, putting the future of your final product in jeopardy.
Investors without significant experience in development deals should always proceed with caution. If you’re not an expert in property development, it’s best to walk away. A large and costly project is not the time to test your abilities at project management, especially if you don’t already have a relationship with a development team. Vetting – or worse, hiring without vetting – partners and attempting to help them see your vision isn’t an easy process, and without a solid strategy and plenty of practice, it’s going to be hard to bring your ideas to life.
A Bad Gut Feeling
Sometimes, things just don’t feel right. Maybe the real estate agent’s pressure is getting aggressive or uncomfortable. Perhaps the property just seems a little wrong. Or maybe you’re not feeling good about the market and you can’t put your finger on why.
It sounds trite, but the concept of a gut feeling is real. Sometimes, your body sends you signals that may not make rational sense, offering a little guidance that goes beyond the bounds of logic and reason. In some cases, there’s no good reason to listen to what your body has to say, but in others, trusting your instincts can save you from a horrible investment or a tragic financial decision.
If you’re experiencing a bad gut feeling about a property you are considering, take a step back and ask yourself why. Why doesn’t this property feel quite right? What is making me hesitate about this investment? What could go wrong in this investment, and what can I do to minimize risk?
Trusting your gut can help you identify issues you may not have noticed right away, helping you to make a wise decision rather than an impulsive one.
With experience and knowledge, it’s possible to turn almost any investment into a positive opportunity, but some properties are better than others. From red flags like a huge initial investment to a simple gut instinct, there are plenty of indicators that a seemingly-great property is actually anything but. With these tips, you can strategize with profitability in mind, ensuring you don’t mistakenly take a chance on an investment property that is all wrong.
Scott Clift is a licensed real estate broker with Westpark Loans. He has been in the real estate industry since 1994. His team of seasoned professionals specialize in providing real estate loans for investors and other self-employed individuals. When you are ready to invest in real estate, call Westpark Loans to secure your financing at (844) 574 LOAN or by visiting westparkloans.com.