When real estate values are climbing and the economy is doing well, everyone wants a good investment. The truth is, not every real estate investment is good. You have to learn to tell the good ones from the bad ones. Here are eight ways to know if a real estate investment is not good enough for your pocketbook.
- The numbers don’t add up – Depending on the type of property, you should consider the mathematics of investing. Specific numbers to consider include:
- Price – Is the listing price out of sync with recent sales prices of comparable properties in the same neighborhood?
- Equity – Important for buy-and-hold investments, there should be enough equity to afford you a reasonable exit strategy and a profit.
- Loan-to-Value (LTV) – A solid LTV ensures you don’t borrow too much against a property. You must factor in the cost of acquisition as well as repairs and have enough left over for a solid return on investment (ROI).
- After Repair Value (ARV) – ARV ensures you have enough room after the necessary repairs to sell the property and see a positive ROI.
- Return on Investment – If you can’t profit from the investment, walk away.
- It’s a bad location – It’s not enough to ensure a property is in a good neighborhood today. You also have to look at the future value of the neighborhood. Are other properties in the same neighborhood dilapidated or falling apart? If you’re buying a rental property, does the neighborhood offer enough amenities to attract renters? If it’s a fix-and-flip property, do the schools have a solid reputation for academic and sports achievement, is it a low-crime area, and are there plenty of shopping, parks, and other family friendly venues? Even if the property looks good, make sure the neighborhood is good.
- It’s been on the market too long – If a property has been on the market for six months or longer, other investors have probably checked it out. There’s a reason it’s not selling.
- Too much rehab or maintenance for the trouble – Sometimes, a real estate investment can look good on paper and still be a bad investment. If a house has structural damage, foundation issues, or other problems that will require a long inventory cycle or cost so much they’ll eat into your profits, then your best bet is to walk away. For rentals, if the plumbing, electricity, and other infrastructure will need constant and frequent repairs, it could be a bigger headache than it’s worth.
- The seller is withholding information – A seller that won’t divulge the last time the roof was repaired or who isn’t forthcoming with other information is probably trying to hide something. If they won’t let you hire an inspector so you can do your due diligence, then you don’t want to buy that property.
- Bad borrower – Bad real estate borrowers come in a variety of types. Do they have bad credit? That may not necessarily mean they will default on a loan, but it does mean they are a higher risk than a borrower with pristine credit. What is their track record? A borrower on his first rehab project is a higher risk than a borrower who has rehabilitated hundreds of properties. A sponsor with no experience and several other negative factors could be a bad borrower, or at least pose too high a risk for any reasonable investor. Look at all the risk factors on the borrower just as you do on the property. If the risk is too high, don’t loan money to that borrower.
- Other investment particulars – A first lien position is preferred to mezzanine or common equity. An occupied property is a better real estate investment than an unoccupied property. A development partially completed is a better investment than one rising from the ground up.
- Platform reputation – Finally, consider the reputation of the platform offering an investment. A platform with no track record is a high risk.
When it comes to judging the value of real estate investments, it’s all about comparing risk factors. Be sure to do your due diligence.
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