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3 Big Careless Mistakes Usually Uncovered Only After Closing
When the sun is shining and the birds are chirping, we don’t think about whatever weather changes we can anticipate during the day. Only when it starts to rain do we remember that the window at home is left open or the laundry has been left out in the open to dry. It is so easy to keep the windows closed and the clothing kept if we had left the home when it was already raining. In fact, it would be more of a reflex that we do without thinking. This metaphor can be used in real estate investing when it comes to these mistakes.
#1 Overpaying for a fixer-upper
How ridiculous will it be if you purchase a $1m property at valuation and you have absolutely no idea how much you are going to sell it in 6 months or 3 years. Having faith or an assumption that prices are going to rise so high that you will make a profit out of it is not investing. Actually, a 5-year-old can make a decision to buy, hold and sell if the basic criteria of investing is based on faith.
For investors who go for volume by flipping as many homes in as short a time as possible, paying too much for properties is a sure way to put a target board on their backs for creditors to take aim. It might look like calculated risk-taking when things are rosy, but when things go down, the domino effect takes everything else with it.
The prime directive of sophisticated flippers is “Make your money when you buy, not when you sell”. That is a basic sentence that most adults will be able to understand. Which is why it starts to look puzzling when more and more “investors” are buying properties for investment whose motto resembles more like “See whether you can make money in future IF you can sell”. If this hits a nerve with you, I’m glad it did. Because maybe that’s the only way left to slap some sense into you. Rethink your strategy now if you have yet to sign on the dotted line.
Donald Trump once said “Sometimes your best investments are the ones you do not make”. I can immediately remember some investments which I jumped onto in fear of losing out. And those investments did not turn out too well. I’m sure there are some such instances you can recall as well. If you think about it, those decisions are usually made when we thought we have less time than we really had. Now I secretly wish that someone had grabbed me by the neck with beefy forearms and smack me awake from my fantasy mentality. Sometimes I dream about getting on a time machine and stealthily slip a note to myself telling me to run while I could.
The biggest reason why some people are willing to pay a high price for a house is because they have get their emotions involved. They love the view, the neighbourhood, the amenities, the floor plan layout, and the rehearsed script to tell their friends they have bought a second property. Remember that if you are flipping it, the house is just a commodity you are trading. You buy, add value, and sell. That is it.
In every form of investment path we decided to take, we are going to get hit with windfalls and losses. But I would rather lose money for reasons out of my control than for overpaying on the investment I fell in love with in the first place. Remember. Be logical, prudent, and pragmatic.
#2 Deals that come with baggage you didn’t check-in with
Imagine coming out from the airport from your holiday trip to Beijing. You wait for your stylish luggage to come out of the conveyer belt. And you see it fastened to another luggage that does not blend with your fashion sense. On closer inspection, you pry open the protective casing and see a flurry of contraband items having a party inside. The next minute, a customs officer walks right up to you and reads the law to you or play it from a cassette tape. You either go to court or pay the duties. Who would have thought such a happy trip would have such a distasteful ending. This can happen to real estate.
You see. The land your property sits on is probably older than you by a few generations. (I say “probably” because reclaimed land can be younger than you) And it could also have more owners than you can imagine. This is just the land we are talking about. The property sitting on the land will have it’s own history of ownership. During all these transfers of ownerships, you can bet that there were stacks of legal documents prepared that could fill up your walk-in wardrobe to the brim. A simple shaddy signature somewhere along the way can throw the whole legitimacy of ownership into dispute. Which is why there is such a product as title insurance. This is just an example we are talking about.
These surprise “extra baggage” can include
- Second mortgage holders
- Third mortgage holder
- Fourth mortgage holders
- Fifth mortgage holders… alright enough with mortgage holders
- Liens from third parties who you didn’t know exist
- Outstanding property taxes
- Alimony or child support judgements
- Bankruptcies that are unrelated to you
- Plus many more…
Because the house is usually the most substantial asset a person has, when an individual runs into financial trouble, the first thing that creditors go after is it. And they embed themselves firmly onto it like a parasite on skin. At least until they get what they are due.
The most fascinating aspect of this is that the property owner selling you the house often do not know these baggage exist either! Maybe they do. Just that they did not know of the severity of it and the heart trauma it will cause you. Despicable sellers may even outright lie to you.
This is why a thorough title search is so important yet many people feel that it is redundant. If there are skeletons in the closet, you will probably uncover them here. But that does not fully eliminate your risks. Some smart guy whose great grandfather lived on the land 90 years ago can one day throw a spanner into the works. Which is where title insurances come in. Anyway, if you uncover any dark secrets and just not convinced you are getting a clean deal, you can always walk away.
Don’t close on a deal without personally reviewing the preliminary title report. You would of course have a legal representative to help you understand fancy or vague words created to confuse.
These are just issues on the title I am talking about so far. For the fortunate ones who is in a playing field where these title problems don’t really exist, additional baggage comes in the form of repairs and construction you did not anticipate initially. Let’s be frank. most people are not going to go through every inch of a house to look for defects. Even if you do, you can still miss out on flaws that only the owner has an intimate knowledge of.
Leaking roofs, water seepage, pest infestations, cracks hidden behind cupboards, electrical problems, plumbing issues, etc, are things that can conveniently prop up the very moment you officially takeover ownership. Minor defects can be expected and probably fair. So make an effort to learn how to quickly identify serious problems before those problems become yours.
#3 Using your own cash
The term “Other People’s Money” or OPM started to catch on after the screening of Danny DeVito’s movie of the same phrase in 1991. It has now become a catchphrase used in real estate seminars and investment workshops teaching students how to invest in overseas properties that gurus are getting a commission for selling.
The OPM principle is so powerful and unforgiving that by the time you realize you are being sucked into the whirlpool, it is usually too late to freestyle your way out of danger no matter how hard you peddle. You really do need to keep your cash for that rainy day which no common man can predict.
The first place you go to when you need real estate financing is usually the bank. But I believe that being an adult, by now you should know that they are the second most inflexible parties to deal with. The first being overzealous parking attendants.
For most investors who are still fresh, the road ends as soon as they run into the banking roadblock of rejection. But actually there is another slip road to the expressway via “Private Money Street”. For hardcore flippers, this is also the preferred route to get up to cruising speed.
Hard-money lenders have very straight forward terms. You pay much more interest and you get the cash you need. Very suitable for flippers who would probably hold onto a house for no more than 6 months.
If you are a long term rental player, you have to go for private partnership funds. We do not notice these players when we are not looking. But when you do need them, you might just realize they are everywhere!
The lesson here is to avoid using all your money at all cost. If your bank account is going to bottom out from buying an investment property in cash, you will regret the day you made that buying decision when another crisis appears on the horizon.