We’ve all done it; we all make mistakes in real estate investing. The 5 mistakes that I see commonly made in commercial real estate investing are poor due diligence, insufficient market knowledge, not running your property like a business, not having an exit strategy and having too much debt.
- Performing poor due diligence. Not paying close attention to the property condition or cutting corners while inspecting the property is a license for disaster. Look closely at the physical items such as building systems, environmental matters and structural components as well as the intangible items such as title, survey, zoning and land use regulations. If you don’t know an answer, find an expert who does have an answer. Get accurate estimates from professionals. Analyzing these inspections can save you thousands of dollars.
- Having insufficient market knowledge. To avoid costly mistakes, do thorough research. Analyzing the demographic trends of population growth, income and employment in the local market, will give you a feel for where opportunity lies. With commercial real estate, it’s mostly about being in the path of progress or going into a marketplace that’s ready for major growth. Know that a great property in a poor market can be a loser and a poor property in a great market can be a big winner. Review the market information, then listen to what it tells you about how, when and where to invest.
- Forgetting to run your properties like a business. You need to make sure that you maintain a nice property appearance, that tenants are satisfied, that the budget is being adhered to, that you know what your competition is doing and manage your cash flow. Being passive with your investments can be dangerous. Don’t think that you can buy an investment and kick back and watch the checks roll in. You should be receiving your payments within the time frames that are called for in your leases. Keep a friendly, but business like rapport with your tenants. Let them know that this is your business. Some people find it easier to tell the tenant that they are the manager and that they are only carrying out the owners wishes.
- Failing to have an exit strategy. Don’t focus on one exit strategy, have multiple exit strategies. An investment plan incorporates all of the due diligence findings and lays out all of the possible outcomes that includes best case and worst case scenarios. Failing to plan is a plan to fail. Your plan should include how to get out if things go wrong, the amount of money you expect to make and how long it will take, the improvements that are needed for the property and their costs and how you will manage the property. The plan will reveal the strengths and weaknesses of the property and should show you how to maximize value in the least amount of time. Make sure that your business plan is updated at least once per year to make sure that you are adjusting your exit strategy as things change in the property, your life and in the overall economy.
- You have too much debt. Over leveraging by putting too much debt can be lethal. Highly leveraged deals do happen, however it needs to be backed up by a solid plan with sufficient capital or cash reserves. Every property should be evaluated to understand the break-even ratio. The break-even ratio is the operating expenses plus the debt service divided by the gross potential income. Typically, anything greater than 80% is an accident waiting to happen. Debt can be a good thing. Let it work for you, not against you. Properties with a high upside where you can substantially increase rents in a short period of time are the properties that can handle a high debt ratio.
In some of these areas you may need help. A local commercial broker can assist you with market knowledge, a contractor or general maintenance person can assist you with due diligence, a mentor may be able to help you get into a business mindset and help you with a business plan and a mortgage broker can probably help you with debt and financing concepts. Having people that you can trust is always a good thing. You probably don’t need them on a daily basis, but having them available when an issue arises can help you immensely and boost your confidence when needed. I believe in being pro active so that you can try to stay in front of problems.
As always, if I can help or be of assistance with your real estate questions please contact me. My way of giving back is to give away my knowledge. Thank you for reading this article.