7 Mistakes to Avoid When Buying Your First Investment Property

Buying your first investment property is an exciting time. You’re taking the first step on the journey that has made more millionaires than eCom and Bitcoin combined.

… except when it doesn’t. No one gets every step right the first time, but sometimes there’s a fine line between a mistake we can learn from … and a mistake you can never rebound from.

All investment involves risk, but the risks are magnified when you stumble into “rookie mistakes,” pitfalls that experienced investors know to avoid … or wish they would have avoided when they got their start.

Here are seven mistakes to avoid when buying your first investment property ...

1. Buying Without Cash Flow, Expecting Appreciation

Most people know that you can make money from real estate investing in two ways—positive cash flow from the rental income (if it exceeds the expenses), or appreciation as the home gains value.

The problem with cash flow is that it can be undramatic compared to appreciation. What sounds more exciting—$100 a month, or the prospect of a $50,000 windfall two years from now? Those kinds of appreciation windfalls do happen in hot markets.

So why not get into a deal even if it has negative appreciation? What’s $100 out of pocket if you’re going to make $50,000 two years from now.

This is a trap. We saw it in 1987 and again in 2008—hot markets eventually cool. Even if it isn’t part of a global economic crisis, real estate values move in cycles. If you get unlucky and catch a down-cycle, it could take ten years or more for your investment property to recover its value.

That negative-$100 in cash flow could start to hurt, or even balloon. Positive cash flow provides sustainability that will get you through downturns.

More to the point, appreciation tends to follow cash flow. A negative cash flow tends to be indicative of tepid or declining value. Never sacrifice cash flow on the expectation of appreciation! That’s just too much risk for a new investor—and most experienced investors.

Remember, you need to consider all expenses in estimating your cash flow, including mortgage payment, repairs, property taxes, insurance, property management, and cash reserves for big-ticket improvements like a roof or plumbing repair.

You also need to decrease the cash flow expectation by 5-12% to account for vacancy. We know, this is making it harder to achieve that magic positive cash flow … but if this were easy, everyone would do it!

2. Failing to Budget for Reserves

We talked about considering all expenses when trying to determine if your property will have positive cash flow. One of the biggest expenses you need to budget for isn’t an expense at all … yet. But it will be.

Property owners must set aside some portion of their rental income for a rainy day. Not for property taxes or insurance—those are just ordinary expenses. The rainy day we are talking about could take two major forms:

• Capital Improvements. These are rare repairs or replacements that you expect to last a long time (hopefully until they are someone else’s problem). Capital improvements include repairing or replacing the roof, changing out an HVAC, changing the windows, and upgrading the electrical system—anything to do with the bones of the property.

• Vacancy and Turnover. Not only must you budget to cover expenses in the event of a vacancy, you must also budget for expenses incurred cleaning and repairing the property after the tenant moves out. This is called a “make-ready,” because you are making the unit ready for the next buyer.

So how much should you set aside? Every property is different. Newer or recently repaired properties may be in good shape and never need capital improvements. That said, if you knew you would need to spend $5,0000-$10,000 at some point in the next few years, but there was no telling when, how much would you set aside? A few hundred dollars per month? More?

3. Tying Up Your Cash

Banks usually require a 20% down payment before they will write a mortgage on an investment property, so many first-time investors dutifully commit their life savings to that big down payment, with a little left over for immediate repairs.

The problem with this choice is that it leaves you vulnerable to big repair needs, like a foundation or electrical repair, with little cash on hand to squeak you through an emergency.

There’s a bigger reason to avoid tying up your money into your first deal—after you get the hang of it, you will start to itch to do the next deal. But with your money tied up in the first deal, you may have five or ten years to wait to get that money out.

The dirty secret is that you don’t have to follow the 20%-down plan the bank wants you to follow. That’s for the bank, not for you. Through creative use of vehicles like hard money loans, private loans, or the BRRRR system, you can purchase multiple properties without tying up all your cash.

4. Buying New Construction

New-construction homes are for families, not investors. However, aesthete investors who love their own new-construction home may seek a similar home for their investment property—it’s under warranty, repairs will be minimal, and after all, that’s what they would want to live in.

The problem is, new construction is almost always a lackluster buy. New-construction homes command top-dollar prices because they inspire positive emotions in aspiring homeowners. You could say they have an “emotional markup.”

Suburban new-construction homes may be affordable, but when you have to sell or rent out the home, you will be competing with brand-new homes one development over, depressing values. They also tend to be bigger, making them more expensive to turn when a tenant moves out.

The better buy is usually a fixer-upper in an infill neighborhood, where you don’t have to compete with other new construction, your tenants will dig in to keep a convenient location, and the land tends to appreciate because the supply of property is limited.

5. Not Buying Enough Insurance

Insurance protects your investment from total loss due to fires, floods, and other natural disasters. Investors who get the bare minimum insurance, however, may not cover the spread in the event of a disaster.

Many investors neglect to get umbrella liability insurance, which covers the investor from a variety of risk factors. If a tenant slips and falls on the porch, breaks his leg, and decides to sue the landlord for having a slippery porch, umbrella liability coverage could save your bacon if the judge sympathizes with the cast-wearing tenant.

Talk to an insurance broker who has experience writing policies for investment properties.

6. Failing to Screen Tenants

Many new landlords don’t know how to screen a tenant. They may meet a few prospective tenants and have a “gut feeling” that this tenant is a “good guy” and decide to skip the screening.

However, tenants who have a history of eviction, outstanding debts to landlords, and certain criminal convictions, are much more likely to default on rent or become a serious liability. Tenant screening is now easy and inexpensive to do online once you get the tenant’s identifying information.

Do not skip this step. Make it a policy now. If the tenant has outstanding debts to other landlords, don’t line up to be the next landlord she stiffs.

7. Failing to Start the Eviction Process Immediately

Many investors who manage their own properties become friendly with their tenants. Why not? They see them regularly, the tenant is friendly … why not?

This becomes a problem if the tenant loses a job, falls into financial hardship, and begins skipping rent payments. The tenant may have a sob story to ward off his “friend” the landlord. The landlord wants to believe him. So he delays filing for eviction, and the tenant promises to “come up with the money.”

This is a ticket to foreclosure and bankruptcy for the landlord. If a tenant drags out the excuses for months, the investor, patience exhausted, may finally file for eviction … only to find out that there’s a six-week wait for a court date, and if the tenant appears in court the law may entitle him to drag the process out even further. All of this is time that the investor will have to weather an adversarial, squatting tenant and no income.

Don’t fall into this trap. File for eviction immediately. Tell the tenant you want to help, but it’s policy. Your policy. Forget the friendship—this is a business relationship. You can still work with the tenant to try and get them current as you wait for the court date, but you can’t get back months of dithering and lost income, which is the cost of waiting.

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These tips have been property-focused, but here’s a bonus mistake that targets the mindset of an investor—don’t listen to serial naysayers, even if they are your friends and family. Somebody always has a horror story about a bad tenant or a burst sewer pipe.

By all means be critical. Yes, real estate investment has its risks and challenges … but the risks are often manageable, the rewards are well-documented. With the will and the right attitude, the next real estate millionaire could be you!