We often talk about the best ways to invest your money in real estate, the most effective strategies depending on your investment goals, as well as the do’s and don’ts of real estate investment, but I find that it’s mainly the do’s which are talked about the most…I’m even guilty of this accusation in my own blogs.
Today, I’m going to do something different and focus on the don’ts – the mistakes you should avoid as a newbie in the real estate investment arena. I will of course pair a remedy to each mistake requiring circumvention, however, I still want the mistakes to be in the spotlight today, as they are often forgotten or ignored until it’s already too late. We will focus on residential properties in Guelph for the purposes of this conversation to keep things simple and relevant for you newbies out there!
The first and foremost mistake made by first-time property investors is under-valuing the scope and magnitude of all expenses associated with property ownership. If you are basing expected cap rates on just your mortgage payment alone, you are making a monumental mistake. Say you buy a detached home in a great student location on Kortright Road in Guelph for $400,000. That would translate into about an $1,800/month mortgage commitment. Now, if you could rent the upstairs for $1,450/month and receive $950/month for the basement, $2,400/month in income may appear to be a cool $600 profit right into your pocket. Remember, on top of your mortgage payments you will be responsible for the following:
- Property taxes (varies city to city, but generally speaking, $1,000/year per 100k in Guelph, so about $350/month for 400k)
- Homeowner’s Insurance (be weary of older homes in Guelph’s downtown core especially, but expect on average $100/month)
- Utilities (if the lease doesn’t stipulate an all-inclusive rent then $0, if not, expect $200-$400/month depending on usage/size of dwelling)
- Maintenance (as a general rule of thumb, 2 month’s rent should be set aside for annual maintenance, so in this example that is $4,800/year or $400/month)
- Vacancy (Tenants often leave before a new Tenant is secured, in which case you will be on the hook for all monthly expenses in the meantime)
As you can see from the above points, what initially looked like a $600 profit per month, could easily become a $600 loss depending on property specific costs and the terms of your leases. Always be aware of ALL costs of ownership when investing in real estate.
Additionally, abstain from purchasing a property without undertaking proper due diligence. In hot markets like we’re currently seeing in Guelph right now, it may be difficult to purchase a property with conditions. Regardless, it’s important to be aware that this isn’t your home where you can live with the deficiencies and slowly fix them up over time. This is not only a house that needs to be move-in ready for it’s occupant, but also an investment that can quickly become a very poor one if you uncover issues after the fact. Make sure to check structural components, outstanding liens or work orders, etc. to have all of your T’s crossed and I’s dotted before signing on the dotted line. If competition is stiff, then make sure are working with an experienced realtor who can devise a strategy to cover your butt AND win you the property. One simple tactic is to view the house early and if you plan to put something on paper on offer day, then get an inspector in there before offer day for your peace of mind. Then, if all is well, come in firm with your best and it should hopefully be yours.
Getting back on the topic of costs and lease agreements, a common error that many residential landlords make is having extremely rudimentary and vague lease agreements, or even worse yet, nothing more than a handshake in place. To avoid future disputes, lost income, and possible litigation, it is always a good idea to draft a lease agreement which covers all of the “what ifs” in case there is future misconduct or misunderstanding. My recommendation is to have your lawyer review it before standardizing it for your rental portfolio, as they may quickly recognize some loopholes that need to be closed through enhanced clauses.
When it comes to actual Tenant selection, avoid jumping at the first party willing to sign on the dotted line. Give yourself enough time to market your unit effectively and to learn more about the individuals interested in renting your property. Some great tips for thinning out the pack are:
- Require a credit check for income verification and charge them a small fee (maybe $20) to gauge if they are serious or not
- Ask for at least 2 referrals and call these individuals a second time from a different number to confirm that they were being truthful of their relationship to the potential Tenant
- Require first and last month’s rent up front as a security deposit, it shows that they are serious, have sufficient funds, and protects you if they leave before the end of their term without paying
- Take them out for a beer, get to know them better…heck, you may even be living upstairs and renting the basement out to them, you’ll need to get along. I recommend Baker Street Station in downtown Guelph!
Also, when showing prospective Tenants the property, avoid doing so if the property is not in “showroom” condition. It doesn’t need to be perfect, but (a) the quality of the unit determines the quality of the Tenant, and (b) if the interested party sees that you have little pride of ownership, how do you expect them to treat the unit while they occupy it? Rentals in certain areas and on specific streets are often owned by a few of the same investors. Streets like Cole Road in the South end of Guelph and Willow Road in the West end, for example, are notorious for either being run down by students or young, low income families. When the landlords of these dwellings don’t hold their Tenants to a high enough standard, they are ultimately hurting themselves since a large part of their portfolio is dependent on that sole area. These houses and buildings gain a negative stigma within the rental community, attracting only equally undesirable tenants as future occupants, as well as detracting from future property values. The only way to change this cycle is to hold Tenants to a higher standard, stop deferring regular maintenance, and offer incentives to get a new crowd interested in your unit(s).
Next, make sure once you’ve secured a great Tenant, to treat them in a manner in which facilitates a long term Landlord-Tenant relationship. If you are slow in addressing issues as they arise or you don’t treat them with respect, then lease renewals will be a rarity and formal complains to the LTB (Landlord Tenant Board) could be common. Don’t forget, your reputation is everything as a landlord! There are many unforeseen costs that can eat into your annual profits, but the quickest way to reduce profit is through high turnover. Residential properties typically have the highest turnover rate, which usually translates into at least 1 month of vacancy each time the unit changes Tenants, or even 2 month’s if it needs “refreshing” and you plan to take care of the work yourself to save costs. Therefore, look at every situation you handle properly as money in the bank. A Tenant that renews is saving you literally thousands of dollars at the beginning of their next term. A great store for cost-effective renos in Guelph is the Re-Store. Some items are new and some are second hand, but the savings are well worth it for your small DIY projects.
Another common error newbie landlords make is over-improving the property. This is especially relevant in student housing applications. Many of us can’t afford a turnkey investment property right away, nor does it always make sense to pay the inflated cost of one which has already had the renovations done to it. You may be tempted to either (a) buy it and fix it up before leasing, or (b) rent it out for a year or two and then take your profits and re-invest them into renovations. Although this can often be a great idea, there are a couple of scenarios where it may not be. Option (a) would make sense if the unit was not habitable for a family or student(s) in it’s current state, however, be sure to remember who your Tenants and future buyers will be. If this is strictly a student rental in Kortright East, don’t make it too nice or else the quality finishes will surely be compromised in short order. Moreover, when it comes time to sell, parents buying an investment property for their kids during post secondary aren’t willing to pay extra for quartz countertops and stainless appliances. In this case, it’s always function over form. Option (b) can also be a great option if you want to find higher quality Tenants and generate more income. On the other hand, make sure that the numbers work. What level of investment does the neighbourhood support? Dropping 40k into an entire basement remodel doesn’t make financial sense if it only nets you $200 more per month. The payback period would be almost 17 years in this case. Stick to cost effective and durable products like laminate flooring and countertops, LED light bulbs, re-painting rather than replacing cabinetry, etc.
Finally, don’t forget that you are doing this for one reason and one reason only, to make money! The income the property generates should be more than sufficient to cover the operating expenses, maintenance costs, and vacancies. Landlords should not be subsidizing their investment with their own income. Put aside your 2 month’s rent for maintenance, take care of your Tenants appropriately to reduce turnover/vacancy, and it should be a self-sufficient investment. Lastly, refrain from over-pricing your property. I understand we all have high hopes as investors, but being realistic is the best mindset, as it will create more interest in your property and reduce vacancies.
Best of luck to all you newbies and happy hunting!