Five Mistakes First-Time Rental Investors Make (And How To Avoid Them)

You can also buy the worst house in the best areas

Most people get into real estate investing because they want to grow their wealth or generate passive income. But when you’re just starting out as a buy and hold investor, it’s easy to make some mistakes which can delay or totally derail your plans to reach those financial goals.

We’ve learned a lot from the mistakes we made when we were just beginning our property investment journey, and even more from our experiences working with hundreds of other first-time landlords over the years. We thought it would be a good idea to share some of that hard-earned wisdom, so that you can learn from our blunders, and hopefully skip the part where you make them yourself.

Here are 5 mistakes commonly made by first-timers, and some tips for how they can be avoided to help you get off to a smooth start:

1. 1. Not Knowing the Market You’re Buying In

Many investors don’t take the time to really understand the market they choose to target. (reference our previous blog on Location)

Therefore, they think they’re buying a class B property, or in a class B neighborhood, when really it’s a C. 

A quick overview:

• - Class A: This covers the newest buildings, best neighborhoods, and affluent communities, so it goes without saying these represent the most expensive properties in the market.
• - Class B: This might include slightly older, but recently upgraded properties. Expect lower rental rates and higher maintenance costs, but generally solid neighborhoods.
• - Class C: As with class B, these properties will be older, too, so expect them to require significant refurbishing, a lot of maintenance work, and to be located in lower-demographic areas.
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Solution: Do Your Research

The difference of a few blocks can mean you’re in a completely different class of neighborhood, so it’s imperative to know your market inside and out. Drive around the area and do extensive research online - Niche.com is a good place to start, but for a more in-depth overview of the process, you can check out this article for a step-by-step guide on how to carry out due diligence on a specific location.

If you’re unfamiliar with your target area, you can always get the input of someone who is. Talk to local agents, PMs, or other landlords, and if you can, take them out for a coffee and really spend the time going over a map with them. Just keep in mind that every person has their own definition of property classes, so don’t take any single viewpoint as gospel. Just because someone tells you it’s a B property, doesn’t mean that it is - always verify this for yourself!

Knowing the actual class you’re buying into will help you anticipate the quality of tenants, total operational costs, cash reserves needed, and maintenance requirements - which leads us to our next mistake often made by new buy and hold investors...

1. 2. Buying the Wrong House

Many new investors don’t understand the type of property they’re buying, even if it’s located in a good neighborhood. You can end up buying the worst house in the best area, which could turn out to be just a tear down - not even because it’s in bad shape, but because the layout is poor, so they're not economically viable in today's market. Or you could buy a house that doesn’t fit with the neighborhood, like purchasing the only 2-bedroom rental in a predominantly 3-bedroom area.

Solution: Understand the Market

It’s important to ensure the house you’re buying is in good physical condition, but also to understand where the property sits within the context of the market it’s in. Compare it with other houses in the area (and beware if there are no comparable!), and find out what types of properties are in high rental demand there.

1. 3. Not Putting Enough Cash Reserves Aside

If you don’t understand the class of the market you’re in, you risk underestimating the amount needed to cover things like vacancies and repairs. C properties come along with things like higher eviction rates and tenants who are harder on homes, which can eat through your reserves quickly if you only budgeted for handling class B-type issues.

Solution: Budget for Your Property Class

You need to identify your actual property class - and its associated risks - to allocate enough cash to cover your operational and maintenance costs.

In general, the lower the property class, the higher your reserves should be. For a brand-new class A property, you might be fine setting aside just 2-3 months’ of rental revenues in reserves, while for a class B, you could potentially need up to $20,000, or up to $50,000 for a class C. As you can see, these figures vary widely - so it’s imperative to know how much to set aside for your particular property type, if you don’t want to be blindsided down the road by expenses which you’re not financially prepared for.

Furthermore, if you think you’re in a different class than you really are, you won’t be mentally prepared for these issues, either. We’ve seen plenty of first-time rental owners who are shocked by the problems which arise in class C neighborhoods - like their water heater getting stolen by a tenant - and this can end up being a bad experience which puts them off of investing. But if you know what you’re getting yourself into, you won’t be caught off-guard when things like this happen, since you’ll be prepared for these types of issues from the start.

1. “Gut Feeling” Tenant Screening

Some new landlords who self-manage their rental properties allow their emotions to get the better of them when screening tenant applicants. You may meet a potential tenant who wins you over with a touching story about their life and become emotionally biased towards them - even if, on paper, they may not seem as ideal as other tenants.

Having the best quality tenants for your property type is probably the biggest contributing factor to a profitable rental business. Lower-quality tenants can cost you thousands in repairs, legal fees, and lost rents, so acting on instinct like this can easily lead to disaster.

Solution: Be Rational, Not Emotional

When it comes to selecting a tenant, don’t get emotional, and make sure that your screening process is designed to help you assess applicants based on purely rational factors. The two most important things to consider when screening potential tenants are:

1. Will they be able to pay their rent, on time, every month?

2. Will they look after your property, and minimize the amount you have to spend repairing damages?

Set up screening processes which give you the most robust possible answers to these questions. You should look at things like their credit history, job stability, income and current debt payments to assess whether they’re likely to pay on time, and gather in-depth information from previous landlords regarding their rental history to get a sense for the way they’ll treat your property while living there.

Remember that you don’t need to like your tenant as a person - likability is nowhere near as important as their ability to meet these criteria.

4. Lack of Proper Management

A lot of people think that having a rental property is like buying stock, but it’s not that kind of investment. You can’t just sit back and expect your properties to manage themselves.

We’ve seen too many first-time landlords hand the reins over to a property management company and wait for the checks to start rolling in, only to be unpleasantly surprised later on when they find out their property has been damaged, or lease terms broken, or rents unpaid, without them being informed by their manager.

Solution: Manage Your Manager

Whether you self-manage or hire a PM, you have to have a system of accountability and processes in place to make sure it all runs smoothly.

Set up strict rent collection procedures, and have a plan for how to deal with any late or missed payments. Carry out interior inspections at regular intervals and do drive-by inspections quarterly, if possible. Document everything - ideally on video - to help protect yourself in the event of a dispute, or ask your property manager to.

Staying informed is crucial for success, so you should keep track of everything, even when working with a professional PM, if you want to avoid any nasty surprises. If you find that your property manager doesn’t have adequate systems in place for reporting on your properties’ performance and consistently communicating with you, then you’ve probably made the next mistake on this list.

5. Not Evaluating Their PM

Too many new landlords put their trust fully in their PM to manage every aspect of their rental business, without properly screening the property management company itself.

If you went for the cheapest PM out there, rather than making sure the company provides the best service for your needs, then you might very well end up being disappointed with the level of service you receive.

Solution: Thoroughly Screen Your PM

A good rule of thumb is to screen your PM in the same way that you would screen your tenants. Find as much information as you can about a PM company’s expertise, processes, and organizational structure, so that you can be sure they work in a way that fits with your management needs.

Speak to other landlords in your area who are current or past clients of your PM to get an insider’s view into how they operate, and ask for a probationary period of 30-90 days at the start of your contract. This will give you time to see if the relationship works for you, and let you end the agreement without any termination fees, if you decide it’s not the right fit.

Knowledge is power, especially when you’re just starting out. There will always be unexpected issues that crop up with your rental investments, but if you can avoid making any of these mistakes, you should be well positioned to deal efficiently with any problems that arise on your journey to building a property portfolio.

This is what we know from our experience, but if you have any other insights or lessons learned which we didn’t cover here, share them below!

You can also buy the worst house in the best area, which would just be a tear down, not even because they're in bad shape, but because the layout is poor, so they're not economically viable in today's market

Make this number 2 on the list: Buying the Wrong House (or not understanding what they're buying). E.g. buying the only 2 bedroom in a mostly 3-bed area, I'll struggle to rent it out

Or buying a boarding house in an affluent area? Who's the market for this here?