Strategy for avoiding costly financial mistakes when buying properties

A strategy for avoiding costly financial mistakes is to invest in your own education. In particular, learn how to conduct due diligence.

Easy to make mistakes

Wannabe real estate investors can muck up a real estate deal beyond all recognition. At the same time, they can wreak financial havoc.

When this happens, it can take a very long time for them to recover from the effects of this financial whammy.

Let’s take an example.

At the peak of the mining boom in Australia, a fully renovated four-bedroom house in Moranbah sold for $820,000. In November 2015, that house went for $170,000. (Australian Financial Review, 2016)

Conduct the appropriate due diligence

Here’s what we can learn from this example.

Changing rental yields

When a mine is in the development phase, there will be a peak number of people employed. These numbers will fall away as the mine becomes fully operational. Property vacancies dramatically increase due to mine closures or staff cutbacks.

Corporate leases

The period for corporate leases is long. Two to three-year leases are normal. There is often a high turnover of people in the property. This causes excessive wear and tear. There is no individual responsibility.

Buying at the wrong end of a cycle

Property markets have cycles.

Within a cycle, a growth phase can be more prolonged than other property markets. In between growth spurts you get a plateau where market stabilise for a period.

The timing of buying a property and the phase of the mine lifecycle are two very important variables to get right. Not many investors know how to do it right.

Single industry town

The impact of a ‘one mine town’ can be devastating to the local community. This is common around Australia. The total dependence on one industry without diversification can be disastrous.

Not enough infrastructure spending

Infrastructure spending can be a growth driver for towns.

However, the bottleneck is in the delays to make new land available for development. Forward planning can be caught out. Reaction to a sudden increase can be very slow.

The life span of a mine

The lifespan of a mine is determined by the size and quality of its resource deposits. We need to be concerned with questions such as the long term mineral price forecast, the long term demand forecast and what is in the pipeline.

Unfortunately, individuals who do not do their due diligence as part of their property strategy will be caught out.

In 2012, then 24-year-old Kate Moloney and her 23-year-old husband, Matt, were crowned Investors of the Year in Your Investment Property magazine. They bought 16 properties in mining towns such as Queensland’s Moranbah, pocketing $570,000 a year in rental income. Today, if the Moloneys sold all their properties, they would still owe $3.5 million to the banks. (Domain, 2016)

House prices don’t always go up

When you invest in the wrong location (especially single industry towns), your investment can significantly reduce in value when the economy turns.

I attended an annual property investing conference and the speaker asked the audience, “How many of you are making losses on your real estate investments due to poor or insufficient due diligence?” A quarter of the room of about 1,200 people raised their hands.

That was a revelation for me.

The strategy is lacking for many people

After talking to many wannabes in real estate investing, I found that their knowledge about investing in real estate is superficial, at best. They lack in-depth nuts-and-bolts knowledge required to put a real estate deal together from start to finish.

Here’s a list of some real estate education topics that should be considered by anyone wanting to buy properties:

General principles and strategies
Financing
Deal analysis
Finding and negotiating deals
Property management
Legal and contracts

Worse still, the majority did not have a personalised real estate investment strategy.

I attribute the high failure rate to the fact that real estate investing doesn’t have any of the so-called barriers to entry that many other businesses have. It seems easy and anyone can invest in real estate if you have the money. My friend did it, why can’t I? Perhaps it is about trying to keep up with the Joneses.

Anyone can invest in real estate at any time, without the slightest clue as to how to find, analyse and manage a profitable real estate investment deal. I was once that person.

Many reasons for failures

Most people usually fail to make it as investors. The reasons for failure include:

Inability to stay focused on a single objective and real estate investment strategy.
Failure to perform adequate due diligence.
Incompatibility with their personal financial mindset.
Lack of capital and creditworthiness.
Pay above market value for the property.
Lack of basic real estate investment knowledge.
Lack of persistence and patience.
Failure to act in a timely manner
No defined exit strategy.
Unrealistic expectations.
Bad advice from unreliable sources or so-called ‘experts’.
Lack of planning and project management.
Lack of mental toughness for the long haul.
Inability to manage time.

When-to share investments

Then there are those who say that real estate investing is bad. You can make more money on the stock exchange buying equities or shares. The entry barriers are much lower for buying equities and anyone can do it.

Shares, commodities, and futures tend to be ‘when-to’ investments.

Share prices are volatile, fluctuating up and down. Then up and down again. Sure, you can get your money out quickly. You also run a bigger risk of making a loss.

As a ‘when-to’ investment, you have to know when to buy and when to sell.

The problem is that timing is crucial with these investments. If you buy low and sell high, you do well. However, if you get your timing wrong, your money can be wiped out!

Most ‘when-to’ investment vehicles produce only a handful of large winners. There are many losers.

How-to real estate investments

I’d rather put my money into a ‘how-to’ investment. These investments are located in major capital cities. They generally increase steadily in value over the long period. It doesn’t have the wild variations in price.

That’s me. You may be different.

Yet it is still powerful enough to generate wealth-producing rates of return through the benefits of leverage.

While timing is still important for ‘how-to’ investments, it’s nowhere near as important as how and where you buy the property and how you add value.

Unfortunately, ‘how-to’ investments are rarely liquid.

Ultimately, it comes down to the return of your capital and your risk profile.

If nothing else, just educate yourself in the various property strategies for avoiding costly financial mistakes when buying properties.