The first step in investing is doing your due diligence which means understanding the asset you are about to purchase. Buying a house that requires major renovations costs more on an ongoing basis than a house that needs minor repairs. It also becomes harder to sell and could be viewed as a liability if it falls into disrepair, something more common with houses needing major renovations.
Unfortunately, many people make the mistake of not doing their or their realtor's due diligence when deciding what property to buy. They go by what looks good on paper instead of investigating real evidence before signing away their money for years (or even decades).
Sometimes, a good property on paper can look bad in reality. For example, an investor should investigate the neighborhood and talk to as many neighbors and longtime residents as possible. Don't just ask about crime rates; ask about specific incidents that they attribute to "bad" neighbors or landlords. Was it property damage, noise, or anything else? You'd be surprised at the level of detail people will offer about unpleasant encounters with their neighbors.
In terms of the property itself, you should look into every nook and cranny. Make sure there are no leaks. Check for mold and mildew. Look at the foundation and determine if it's in good shape, or if it needs work (this doesn't mean you should buy the place if it really does require a lot of work; just know that if there is a lot to do, your cash flow may be interrupted until that work is completed). Check the HVAC unit and make sure it's in good repair. Check the windows and insulation. Is there asbestos or lead-based paint? What about underground wiring, if any? Are there fire extinguishers on site, carbon monoxide detectors, or sprinkler systems? You get the idea. What do beginners in investing need to know?
The idea is to learn from your mistakes and get smarter with each investment. However, you'll face criticism or even hostility if you start asking questions that would reveal "problems" with the property. In other words, there's a financial incentive to look the other way when selling a home after it has been owned for a few years.
Investors also need to understand that real estate investing is often more like gambling than traditional investing. Even though you're purchasing a 100% legal asset (that happens to be real estate), it doesn't guarantee positive returns each year. Based on historical data, it's entirely possible that your investment will lose money in any given year (or even decade).
That's not to say real estate investing is a bad idea. It's actually a very good one and should be part of most investors' portfolios. Just be aware that it isn't always an easy or risk-free way to make money.
What do beginners need to know about due diligence in real estate?
There are many variables involved in the real estate markets, making it difficult to provide an exact specific formula for calculating expected returns or the chances of any given investment becoming profitable. Before you buy, you'll want to know as much as possible about the area you're looking at and it’s market:
The first thing you need to do is review the neighborhood. When buying a home, interview current homeowners and renters in the area to determine if the crime is a problem. What kind of problems? Illegal drug use? Noise complaints? Complaints against landlords? Also, ask them what caused these problems. Was it the property owner's management skills, the neighborhood itself, or other factors? Find out if there have been crimes committed against them and how they were solved (if they were). Write down the names and contact information of at least 10 people to interview.
Next, you should determine if there is a real estate agent that specializes in distressed assets (foreclosures and short sales) in the area/school district. That agent should know which homes are being sold for under market value and which ones are not worth what the sellers' list price says. It will help you weed out the good investments from those that won't provide a consistent cash flow.
You also want to find out how long the homes in the neighborhood have been on the market and whether or not there have been price reductions. The longer a home remains on the market, the less value it has. This is because potential buyers assume it will remain "overpriced" and thus, they don't bid as high as they otherwise would. This is why we recommend investing in REO properties (foreclosures) or short sales if possible, as they're usually priced lower than comparable models listed by a traditional agent.
The last thing you need to do is look at the school district boundaries and really investigate what you'll be getting into if you buy a home in that neighborhood. Take a look at the current test scores and determine the trends. Are they improving or getting worse? What kind of freshmen were accepted into college? Are those students able to find jobs in their field when they graduate? How many people are living below the poverty line, and what percentage is that of the total number of residents living in that neighborhood? These are all questions you need to ask before buying a property or putting your money into it.
Some people say they don't want to buy in a bad area, while others claim that providing housing for poor people is noble. If your goal is to provide housing for everyone regardless of their ability to pay, then you should start by investing in low-income neighborhoods. However, if your goal is to make money, you need to learn to invest in the right neighborhoods and avoid buying an expensive home in a bad area.
How does one know what areas they should look into while doing their due diligence?
As we said above, the first thing you need to do is check out crime rates. You'll want to find out if there has been any recent property damage or illegal activities that have been reported in the area (if there haven't been any such events reported, then that's actually a red flag). We can't say this enough: crime is one of the biggest problems facing new investors. Your mindset should be that real estate investing is a business and you don't want anyone assaulting your tenants or stealing their cars.
This is all that one needs to know and focus on as a beginner when it comes to real estate investing and due diligence.
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