Investing in rental property can build incredible wealth—but only if you know how to avoid costly mistakes. In this video, we’re diving into the three critical areas where things often go wrong: buying, selling, and managing your rental properties.
Here’s what you’ll learn:
Buying It Wrong: Overpaying, ignoring market cap rates, and letting emotions take over.
Selling It Wrong: The risks of selling too soon, at the wrong time, or without a solid plan.
Managing It Wrong: How to optimize rental income, hire the right property manager, and manage them effectively.
Missteps in any of these areas can spell disaster—but don’t worry, we’re here to help you navigate the minefield with practical tips and actionable strategies. Let’s dive in and uncover what can go wrong—and how to avoid it.
Mistake #1: Buy It Wrong
One of the easiest ways to go wrong with rental property is by buying it wrong. This misstep can set the stage for financial failure before you even get started. Let’s break it down.
1. Overpaying for the Property
When you overpay, your investment’s foundation crumbles. Overpaying leaves you with minimal cash flow and only a sliver of equity. And if you decide to sell, you may find yourself stuck—unable to recoup your investment.
The Solution
Sales Comparables: Before making a purchase, always gather sales comparables. For example, if you’re considering buying a three-bedroom, two-bath house listed at $500,000, how do you know if it’s a good deal? You compare it to other similar properties in the same area. The same principle applies to rental properties: match your target property against others that have recently sold to ensure it’s priced correctly.
Understanding Market Cap Rates: Next, you need to understand market cap rates. When dealing with commercial properties, the market cap rate is your best friend. The cap rate helps you gauge whether you’re overpaying.
Here’s how it works: If you’re in a market with a 6% cap rate (six cap) and your numbers show a 5% cap rate (five cap) for the property, you’re overpaying. On the other hand, if your property pencils out to a 7% cap rate (seven cap) in the same market, you’re buying below market value. Knowing this metric is crucial for making smart investment decisions.
Keep Emotions Out of It: Lastly, don’t let emotions dictate your decisions. As the saying goes: When emotions go up, intelligence goes down. Fall in love with the numbers, not the property’s charm or aesthetics. Make the math your top priority to ensure you’re making a sound investment.
2. Bad Financial Due Diligence
Another major pitfall when buying rental property is failing to do proper financial due diligence. Many new investors make the mistake of trusting the seller’s numbers at face value. The truth? In the vast majority of cases—about 98%—those numbers are inaccurate, often underestimating actual expenses. It’s common for sellers to downplay the operating expenses of a property. Sometimes the numbers they provide are optimistic, and sometimes they’re flat-out wrong. If you believe their estimates without double-checking, your actual expenses could end up being far higher than expected. This discrepancy can wipe out your cash flow and put your investment i jeopardy .
The Solution
Apply a Reliable Expense Ratio: To safeguard yourself from inaccurate expense estimates, use a 35-40% expense ratio.
Here’s how it works: If a property generates $100,000 in annual income, expect operating expenses to fall between $35,000 and $40,000 per year. This formula provides a more realistic foundation for your calculations and helps you evaluate whether the property will generate adequate cash flow. Most seller-provided numbers will fall short of this range, so rely on the formula rather than their estimates.
3. Buying in a Bad Neighborhood
Sometimes, a property in a bad neighborhood might appear like a fantastic deal. The price is low, and on paper, it seems to offer excellent cash flow. However, looks can be deceiving.
The True Cost of a Bad Neighborhood: Bad neighborhoods often attract tenants who are less likely to pay rent reliably. This can lead to frequent evictions and high tenant turnover, which increases expenses for repairs, cleaning, and marketing the unit to new renters. Ultimately, these factors will reduce your income and drain your profits. No matter how attractive the price or projected cash flow might seem, a bad neighborhood almost always equals a bad investment.
The Solution
Price Isn’t Everything: Even after decades of experience, one rule remains true: A good price on paper cannot outweigh the drawbacks of a bad location. Don’t let the allure of a bargain cloud your judgment.
Mistake #3: Sell It Wrong
The second area where things can go wrong is when you sell your rental property. Selling it wrong can significantly impact your profits and long-term financial goals. Let’s explore three common ways this happens and how to avoid them.
1. Selling Too Soon
There’s a saying: Trees that are slow to grow bear the best fruit. This holds true in real estate investing. Wealth isn’t built overnight—it takes time. Selling a property too early, especially within the first few years of ownership, can prevent you from maximizing your profits. If you encounter small to medium issues with the property, patience is often the key. By holding onto the property for at least 7–10 years, you may outgrow those problems and reap the rewards of long-term appreciation and cash flow.
2. Selling at the Wrong Time
Timing is everything. Selling during a high-interest rate market or an economic downturn can limit your pool of buyers and lead to lower offers. If your local economy is booming, it’s worth holding onto the property a little longer to ride out the market waves. Avoid selling in unfavorable conditions to protect your investment’s value.
3. Selling Without a Plan
One of the most costly mistakes is selling without a clear plan. For instance, if you sell a $1 million rental property in a state with both federal and state taxes, you could owe as much as $190,000 in taxes. That’s a substantial hit to your profits. A simple solution is to use a 1031 Exchange, which allows you to defer capital gains taxes. By reinvesting the proceeds into a higher-value property, you can maximize your profits and scale your portfolio. With proper planning, you could potentially upgrade to a $2.5 million property without paying taxes at closing.
Mistake #3: Manage It Wrong
The final area where things can go wrong with rental property is in its management. Managing a property improperly can lead to a cascade of issues, from lost income to increased expenses. Here are the top two management mistakes and how to address them.
1. Not Optimizing Rental Income
Costs are rising everywhere—property taxes, insurance, supplies, labor—you name it. Inflation ensures that maintaining a property becomes increasingly expensive over time. Yet many rental property owners shy away from raising rents, afraid of upsetting tenants or triggering vacancies. This hesitation, while understandable, does more harm than good. Failing to adjust rents to at least market levels means sacrificing cash flow, which is essential for covering expenses and maintaining the property.
The Solution
You don’t need to raise rents excessively, but you must ensure they align with market rates. By keeping rents competitive yet fair, you can maintain positive cash flow without driving tenants away.
2. Hiring Bad Property Management
Hiring the wrong property manager can be a costly mistake. Poor property management is often indicated by:
- High Vacancy Rates: The manager struggles to keep the property occupied.
- Inaccurate or Late Reporting: Financial and operational reports are either delayed, riddled with errors, or absent altogether.
- Declining Cash Flow: As operational issues pile up, your income gradually dwindles.
By the time you realize you’ve hired a bad property manager, it might already be too late. This could lead to significant financial setbacks and a difficult transition to find a replacement.
The Solution
To avoid these pitfalls, focus on two critical skills:
- Hiring the Right Property Manager: Conduct thorough vetting to ensure they have a proven track record.
- Managing the Management: Effective oversight is key. Learn how to keep your property manager accountable, track performance, and step in if things go awry.
Proper property management is a skillset in itself, one that often takes time and experience to master. To help you sharpen this skill, we’ve created two incredibly valuable videos.
The first, How to Find a Good Property Manager, offers practical tips and strategies for identifying and hiring the right person to manage your rental properties effectively.
The second, Preventing Property Management Fraud, is a must-watch if you suspect something might be off with your current property manager. Fraud in property management is a widespread issue, and this video equips you with the knowledge to protect your investments and address concerns proactively.
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