About 80% of new real estate investors will eventually lose money on their investments. This is because they fail to account for one or more expenses associated with owning and operating properties. To minimize losses, it is necessary to understand how you can lose money in this type of investment. Being informed and taking precautions can reduce your chances of experiencing a financial setback.
Here are a few of the most common ways real estate investors lose money.
1. Failing to account for repairs and maintenance
Over time, all properties will need repairs and maintenance. These costs can add up, eating into your profits. When budgeting your investment, consider investing in an annual repair and maintenance allowance. You can use this allowance to cover unexpected repairs and routine maintenance tasks.
A good rule of thumb is to set aside 1% of a property’s value each year for repairs and maintenance. So, if you own a $200,000 property, you should budget $2,000 annually for repairs and maintenance. Although this may seem like a lot, it’s important to remember that even minor repairs can cost hundreds of dollars.
2. Not insuring against risk
Investing in real estate is a risky venture. Many things could go wrong, such as fire, theft, or damage from severe weather. To protect your investment, it’s important to insure your property against these risks. The insurance cost will vary depending on the value of your property and the location. You can expect to pay around 0.5% of the property value yearly in insurance premiums.
When insuring your property, ensure you purchase enough coverage to replace it if it is destroyed. It’s also a good idea to purchase liability insurance to protect yourself against lawsuits. It’s important to note that most homeowners’ insurance policies will not cover rental properties. You will need to purchase a separate policy for your investment.
3. Not securing your personal finances
Investing in real estate can be a costly venture. If you take out a loan to finance your investment, you will be responsible for making monthly payments. If you fail to make these payments, you could lose your property. Before taking out a loan, be sure you can afford the monthly payments. Having some extra cash aside to cover unexpected expenses is also a good idea.
Some investors also work with a professional wealth management financial services company to help them secure their personal finances. This company can provide investment advice and help you plan your finances. You can also use their services to get a loan for your investment. Consult with a financial advisor to see if this is the right move for you.
4. Not diversifying your investments
Investing all your money in one property is a risky proposition. If something happens to that property, you could lose all your investment. To reduce this risk, it’s essential to diversify your investments. This means investing in different property types, such as residential, commercial, or industrial.
You can also invest in different geographical areas. This will help to protect your investment if one place experiences a downturn. Look for areas that are growing and have the potential for future growth. Diversifying your investments will help to ensure you don’t put all your eggs in one basket. You can also use this strategy to balance your risk and potential return.
5. Not understanding the tax implications
Investing in real estate comes with several tax implications. These can include capital gains tax, property tax, and income tax. It’s important to understand these taxes before investing. This way, you can budget for them and avoid any surprises.
You may be able to reduce your tax bill by taking advantage of tax deductions. These deductions can include the interest you pay on your mortgage, the cost of repairs and maintenance, and property taxes. Consult with a tax advisor to see what deductions you may be eligible for.
6. Not having an exit strategy
Finally, every kind of investment carries risk. Real estate is no different. Before investing, you need to have a plan for how you will exit the investment. This is known as an exit strategy.
An exit strategy is simply a plan for how you will sell your property and take your profits. Without an exit strategy, you could be stuck with a property you can’t sell. There are many exit strategies to choose from. You must select the one that makes the most sense for your situation.
The most common exit strategy is to sell the property when it has increased in value. You can also choose to refinance the property and take out a loan against the equity. This will give you cash in hand so that you can reinvest in other properties.
Investing in real estate can be a great way to build wealth. However, it’s important to avoid these common mistakes. Doing so can increase your chances of success and avoid costly mistakes. Always do your research and consult with a financial advisor before making any investment.