Nearly every investor I’ve worked with has shared with me a story of making an investing mistake. While some of those mistakes have been small and some have been big, others have proven to be fatal.
The most fatal mistakes tend to have a lot of zeros behind them. Worse yet, they tend to come later in a person’s life when there’s not much time to make it right again. The closer you are to retirement, the more you have to lose.
As an investor, you need a strategy to increase your capital base, and also to increase your skill. Skill not only helps you grow your wealth, it helps you keep it, too.
Here are seven of the most fatal mistakes that property investors make:
1. Relying On Luck Rather Than Skill
I was in Melbourne last weekend speaking to a room full of Steve McKnight’s “Millionaire Apprentice Protégé” (MAP) students. This is an elite group of investors from our Property Apprenticeship training course.
I shared with them the most painful investing mistake I’ve ever made. I was just out of university. Because I graduated with a degree in finance and was working as an intern for a large investment bank, I considered myself to be a sophisticated stock market professional. The truth was, I had an awareness of how to trade, but I was completely incompetent.
I’ll spare you the gory details, which you can read here. But in a nutshell, I borrowed big off my credit card to go all in on a technology company I “knew” was going to make me rich. I learned a valuable lesson over those next few months: relying on luck rather than skill seldom pays off. In fact, it most often equals pain.
When we use investment strategies that we have little or no training or expertise in, we set ourselves up for failure. Betting big may be thrilling, but your financial future is too important to gamble with for the sake of excitement.
When our investing success depends on factors out of our control, our investment profits are relying on luck, rather than skill. This happens every day in Australia, as inexperienced investors buy properties speculating on future capital growth. Many people wrongly assume that all real estate assets will go up in value. I could tell you many stories from investors I’ve coached who learned the hard way that investors can lose a lot of money in property.
2. Relying On The Advice Of A Property “Professional”
One couple I’ve been mentoring recently came to me with a property deal that they were considering for development. It was a 930m² block of vacant land on which they wanted to build four units.
They said the agent told them, “There is no reason why you couldn’t put four units on this block; there would certainly be enough room.”
The truth, however, was that given the particular council requirements in the area, they would struggle to get a three-unit development approved.
Furthermore, this block was next to two other vacant blocks, each a parcel of a larger subdivision that had just been completed. A previous developer had already harvested significant profit out of this land.
There are always plenty of opinions on real estate. You’ve probably heard agents and property salespeople say things like:
“This would make a great property.”
“You’ll get great capital growth.”
“You could easily raise the rent $50 per week.”
As you may have heard Steve say, “Due diligence is all about separating the facts from the opinions.”
Because real estate is expensive, there is plenty of room to discreetly include large margins to pay sales people. I’ve heard of some marketing groups adding premiums as high as $60,000 to off-the-plan properties to pay themselves a referral fee.
When dealing with agents and salespeople, be mindful of how they are incentivised. Agents receive a commission from the seller upon the sale of a property, so they are not independently representing you. Salespeople who work for builders get paid on commission, as well. While these can be valuable relationships to form, and commissions are a reality of the industry, always take responsibility for basing your purchasing decisions on facts, not opinions.
3. Making Emotional Investing Decisions
If you’ve been a part of the PropertyInvesting.com community for long, you’ve no doubt heard one of our most important mantras: “Buy problems and sell solutions.”
The trouble with a “problem property,” is that it is often unattractive. Many investors pass up these properties because they only invest in homes that they would want to live in themselves.
Investing in a property you would want to live in is an emotional decision. As an investor, you’re not purchasing with your eyes and your heart, but with your brain and your calculator. As long as the deal stacks up, who cares how you would feel about living there? In fact, most often, the uglier the property, the better the profits.
4. Refusing To Sell
Early in our Property Apprenticeship course, we challenge the investors who are currently holding properties to take a long and hard look at their current property holdings.
Many of them find that they are sitting on properties that once offered a good yield, but are now performing poorly.
Because of many years of capital growth that has outpaced the rental market, their equity in these properties has become quite lazy.
For example, if you bought a property 15 years ago for $300,000 and your rent was initially $350 per week, your gross rental return (GRR) was about 6 percent. If that same property today is worth $600,000 and only returning $450 per week, your GRR is about 4 percent.
That $300,000 growth in equity has become lazy, because it’s not working as hard as it used to for you. Perhaps it would be time to sell in order to put that equity to harder work somewhere else.
The problem is, many investors refuse to sell their properties. Sometimes it’s a fear of missing out on future growth that keeps people holding on for too long. Many people also have a fear of paying capital gains tax. Who hasn’t heard their accountant say that they should never sell?
Other times people refuse to sell for emotional reasons. Perhaps it’s their first investment property, so it gives them those warm and fuzzy nostalgic feelings. Maybe it’s a property that they inherited from a family member. There’s nothing evil about holding real estate for sentimental reasons. Just be careful not to consider it an investment property.
5. Buying At The Wrong Time
Because most investors lack a high level of sophistication, property sales people tend to promote the “time in” rather than “timing” approach to market cycles.
In other words, rather than encouraging people to buy at the right time, they tell people to just buy at any time, because, “If you hold long enough, you’re bound to see some growth.”
Feel free to follow this advice if you want to buy, hold and hope. This is the only strategy the untrained masses can rely upon. If however you want to be proactive and maximize your growth potential, you’ll need an awareness of property cycles and the clues that forecast when a market is beginning to trend upward, and when a trend might be topping out.
6. Never Increasing Rents
Many landlords are afraid of upsetting their tenants by asking for more money. This is obviously a short sighted approach to property management. While keeping rent low does offer some cash flow security and may minimise periods of vacancy, the cost over the long term can be even greater.
Unless you’re increasing rents in pace with the market, you’ll gradually see your gross rental return erode, especially during periods of significant capital appreciation. When it comes time to sell, this will make your property quite unattractive to the investor market. To an investor, your property’s value is directly correlated with its rental yield.
You’re also not doing your tenant any favours by failing to increase their rent with the market. Tenants should learn to expect fair increases in rent. Otherwise, they may eventually begin to feel entitled to a lower than market rent. Then, when you do finally decide to raise the rent, the gap between their rent and the market rate will be so large,they will get an even greater shock.
Instead of charging below market rent, the better strategy is to use your investing skills to inspire your tenant to be willing to pay more. Remember, it requires almost no investing skill to charge a below market rent. Smart investors know ways to build extra value in the eyes of their tenants.There’s lots more information in this article I recently wrote, “11 Ideas to Increase Rents.”
7. Having No Long-Term Cash Flow Plan
Many investors buying properties today are working out their repayment budget on historically low interest rates. They unrealistically assume that interest rates will stay low forever and could be setting themselves up for significant pain down the track.
The average standard variable home loan rate in Australia from 1990 to 2010 was 8.54 percent. That’s about double what’s available today. How would your cash flow situation change if your monthly interest expense doubled? Now is the time to begin to devise a strategy for dealing with interest rate risk.
Save yourself from financial ruin by having a buffer. Rework your budget on your existing properties at an 8.5% interest rate and see how your cash flow situation would look. There’s lots more information on interest rates in this article, “6 Strategies for Mitigating Interest Rate Risk.”
While small mistakes are a natural part of the learning process, we all want to be sure to avoid making the fatal mistakes. When I look back on my biggest investing blunder, I can clearly see now that my failure can ultimately be attributed to one thing: trying to go it alone.
The number one regret I hear from the students in our Property Apprenticeship course is, “I wish I would have done this training before buying my last property.” My mistake happened, because I lacked a level of skill that matched the degree of risk I assumed in the deal.
I lacked the skill, because I was too proud to admit I needed a coach or a mentor. Whether you seek training from us or from someone else, have the wisdom not to go it alone.
If you can think of a fatal property-investing mistake that I missed, or if you have any insights to share, please take a moment to leave your thoughts in the comment section below.