Ten Mistakes of Commercial Real Estate Investors
1. Ignoring local market conditions
There are two levels of due diligence required to evaluate a real estate investment--the market and the property. And of the two, local market conditions are more important. A great property in a bad market can be a big loser. Analyzing the demographic trends of population growth, income, and employment in the local market will tell you where opportunity lies, or not. Those conditions will make or break your investment. Investing in an area with declining demographic trends is destined for trouble.
2. Inadequate property due diligence
The second level of due diligence is the property condition, including physical items such as building systems, environmental matters and structural components, and intangible items such as title, zoning and land-use regulations. Approach the property like an open book exam. If you don't know the answer to a question, find an expert who does know to give it to you. Get accurate estimates from professionals of what it will cost to fix what is wrong. The time spent on due diligence is minimal and can save thousands of dollars in unexpected repairs.
3. Fudging the math
Real estate is a numbers game. Value is dependent on net operating income—gross revenue minus operating expenses. It is critical to get the real operating numbers, not a projection of potential gross income and estimated expenses. You’ll need to confirm and verify every element of income and expense. Value the property based only on actual income, not projected income. If you overestimate revenue and underestimate expenses, your profits will suffer or turn into a loss. Risk increases with every assumption made. Do not assume you can save expenses by cutting corners or that you can raise rents the day after you take possession.
Borrowing too much money is often fatal. Highly leveraged deals do happen, but unless it's backed up by a solid plan with sufficient capital, it can be disastrous. Using 100% financing for entry level deals is like believing gravity doesn't exist as you jump off a building. You can argue all you want, but you're going to hit the ground—the only question is how hard. The proper use of positive leverage can significantly enhance your profits, but it’s important that it is a function of the deal structure and a thought-out investment strategy.
5. Failure to have an investment plan
An investment plan incorporates all of the due diligence findings and takes into account the possible outcomes of the investment, best case to worst case. Ask yourself why you think you can do a better job running this property than the seller did. If you can't answer that with specifics, you won't do better, and probably not as well. Your plan should answer the questions of how the property will be managed; what improvements are needed and their cost; how much money might be made (or lost); how long it will take and how to get out if things go wrong.
6. Failure to mind the balance sheet
There are four ways to make money in real estate: cash flow, appreciation, equity growth, and tax benefits. The operating statement shows just one of those--the cash flow. The balance sheet shows the other three. Just as one adjusts rents and expenses to improve operating performance, the balance sheet should be managed to best utilize the assets.
7. Bad deals and bad partners
You are not going to be right every time. You’re going to wind up with properties that don't perform as expected, or that the market direction moved against, or ones you just don't like. Learn to spot a losing position quickly and get out. A deal that goes sour on several fronts at once is a candidate for the "learning experience" pile. Sometimes the problem may not be the property, but the people. When problems arise in partnerships, especially those that started as friendships, things can get sticky and uncomfortable. If your partners are driving you crazy, exercise a little civility and be willing to call it over. If a good buy/sell arrangement was not included in your partnership agreement, make your own. Close the deal quickly and move on. Life’s too short.
Swinging for the bleachers in high-risk, home-run-type deals that require more capital or expertise than you have is a sure recipe for disappointment, frustration, and can end in disaster. It takes hard work and perseverance to achieve success in any field, and real estate is no different. As you increase your knowledge and capacity, the big deals will come, and you'll know you're ready when you automatically focus on the pitfalls before the rewards.
9. "Dirt-rich, Cash-poor"
This refers to the situation of having more land than cash and is a common outcome for an investor who accumulates a bunch of properties that have nothing in common but their owner. If you have multiple properties and are using the gains from some to cover losses in others and losing the battle, it's time to get off the treadmill. Identify improvements that you can make immediately and do them. Dump losers and anything that has needs that can't be funded in the next year. Then focus your energy and resources on creating maximum value in the remaining properties that fit your big-picture investment goals.
10. Not using local market knowledge
You read the national media and magazines and think you’ve got a sense of what the "market" is doing. But in reality, all real estate is local. The value of your property – or your investment - is determined by local market conditions - rental rates, occupancy levels, competitive space supply, demographic trends, etc. By collecting a few local demographic statistics (job growth, population growth and income), you can get ahead of the curve.
Bonus advice: Use Bremner Real Estate, a Buyer Representative, For Your Investment
If you use a conventional broker who represents sellers, you’re accepting a built-in conflict of interest. Will he show you all the available properties, or only his listings, or those in his office? A Buyer Agent will save you money, help you avoid problems, show you all the available properties, and look after your interests, not the sellers.
John P Bremner J.D. has more than twenty years experience in commercial real estate, as a real estate agent, a principal investor, and as an attorney. Bremner Real Estate provides the Buyer with a seasoned professional, respected by peers, and able to negotiate on your behalf without the conflict of interest that accompanies conventional brokers. Call 415-234-6093, or email firstname.lastname@example.org, to discuss your investment plans.