If you’re able to successfully build up a portfolio of investment properties, be they rental, commercial, or properties to flip, then there is significant potential for real earnings.
However, there’s also a significant risk of losing money by not managing your finances properly.
Margins can be thin at times without the right strategies to make the best of your money, so here, we’re going to take a closer look at some of the mistakes you need to be aware of and how to best avoid them.
Underestimating The Cost Of Ownership
The purchase price never tells you the full story. Beyond your mortgage payments, investment properties come with expenses like maintenance, property management, repairs, insurance, utilities, legal fees, and other capital expenditures that can quickly add up.
Those costs can weigh even more heavily during periods of vacancy, which also come with their tenant turnover costs.
If you’re investing in property, you need to stress-test your numbers by working out your estimates assuming higher operating costs and making sure that you have the reserves necessary to handle any repairs and emergencies in the future.
Be conservative with your assumptions and make sure that you have the money at the ready to keep the property afloat so that you don’t have to go digging into your personal funds.
Overestimating Your Rental Income
Being too optimistic about your rental income is another mistake well worth avoiding. Market rents will fluctuate over time; even if you’re raising the rents, you might not be able to raise them in keeping with inflation, which can mean real-terms rent stagnation or even a decrease.
Furthermore, you shouldn’t assume year-round occupancy in a property where you have yet to secure a long-term tenant with demonstrated reliability.
Overestimating rent can make your investment look better on paper than in reality, but in the end, that’s only going to hurt you. Always assume a vacancy rate of some degree and analyze the real rents of comparative properties when the data is available. You want to make sure that your investment can still perform under less-than-ideal conditions.
Ignoring Cash Flow
A lot of investors use appreciation as the basis of their plan for profit, but this can leave them in a vulnerable position, especially if they’re not paying as much heed to cash flow as they ought to.
While appreciation is typically determined by factors outside of your control, such as market cycles and interest rates, you have a lot more control over your cash flow.
Ignoring it can see you running out of cash before you’re able to see the returns that you need on your investment. Improve your cash flow by focusing on minimizing vacancies or managing your costs to be better able to weather downturns. If you’re able to net positive cash flow, you can even maximize your potential profits by reinventing or paying down debt.
Financing Too Much Or Unwisely
Most investors are going to need some assistance with financing to afford an investment property. However, doing it wrong can put you in a risky situation.
Taking on too much debt puts you at greater risk, and makes interest rate rises and rental income decreases much more compromising. Similarly, if you rely on unstable or unproven lenders, you can end up with unfavorable loan terms or even delayed funding that can push your plans back and put your whole purchase plan at risk.
Exploring your financing options and knowing when to use solutions such as hard money loans for specific property investments can help ensure that you’re only borrowing as much as you need and from those who won’t leave you in the lurch.
Not Having A Clear Tax Plan
Real estate is one of the most complex assets to account for in terms of your taxes, so you need to consider your tax implications well before closing a sale.
Keep in mind factors like capital gains tax, VAT implications, transfer taxes, and ongoing income tax, and how they should be evaluated throughout your investment’s lifecycle. Even the structure of ownership, whether you own property as an individual, or part of a partnership or corporation, can affect the taxes you can expect to pay.
Consulting a tax professional early ensures that you know the short-term and long-term implications and how they might affect the overall profitability of the property.
Not Making Use Of Depreciation
While appreciation might be the goal with some properties, depreciation is a fact of life with others. However, the loss of value in your asset isn’t always something to lament; it can be an opportunity to make use of as well.
Depreciation can be used, for instance, to increase your tax deductions, and if you’re willing to accelerate depreciation with techniques such as cost segregation, you could also improve your deductions, reducing your taxable income and improving your cash flow at the beginning of the tax year.
If you’re not making use of depreciation, especially where it’s inevitable, you could be leaving serious tax savings on the table.
Not Having An Exit Strategy
Every property investment, even those whose profit plans are based on rental incomes, should have an end in mind, right from the beginning.
If you don’t have a clear exit strategy, then you can find yourself forced to sell at an unfavorable time or miss your chance to get the best returns for your money.
Whether the plan is to sell the property, refinance, carry out a tax-deferred exchange, or even pass the property to your heirs, you have a plan for the road to that point, ensuring that you’re putting the right tax plans in place or making the connections to pave the way for a smoother sale.
You don’t have to lock yourself into one path, as some degree of flexibility can be important, but you should at least start preparing for the option that makes the most sense to you.
There are further potential financial pitfalls to manage in the lifespan of a property, but with the above tips, you can be much more mindful of the risks in general, making you better prepared to deal with those risks as they arise.
