How To Detect Red Flags in Real Estate Investments
Real estate investing can be a fantastic way to make money, as well as a catastrophic way to lose it if you don’t know the red flags in real estate. The last thing any buyer or renter wants is their dream home to become a fixer-upper, but sometimes problems with a given location do not reveal themselves right away. A potential investor’s decisions go far beyond the property itself: other concerns include the property’s history, how it is being marketed and maintained, and the surroundings of the property.
If you are considering investing in a property with an aim for renting it to others, what are some of the warning signs you should know to avoid? Here is a brief list of property red flags so you can do your due diligence before you become a rental property investor.
These red flags in real estate can be organized into three silos: the presentation and marketing of the property, the property itself, and the environment surrounding the property. Paying attention to these three factors can mean the difference between productive investment and a financial disaster.
Table of Contents
Red Flags On How The Property Is Presented
Often, an investor can tell a lot by how a property is being marketed or presented; even some of the things that a seller has omitted can be a good indicator of whether or not to invest. Let’s look at some things we can find in the property’s overall presentation.
Property is being sold “As-Is.”
Although “as-is” properties still need to meet minimum state and federal disclosure requirements, mainly for health risks such as carbon monoxide or lead pipes, there are still plenty of severe property issues that fall outside of those disclosure requirements, meaning sellers do not have to tell you about them. Whatever issues exist, even those you were not aware of when signing the dotted line, will be yours to fix and repair.
Although not inherently a recipe for disaster – the repairs required might turn out to be minimal, for instance, or the high rental costs for tenants might offset any expenses incurred – buying ‘as is’ means you have no safety net in case of a disaster.
The property is selling slowly
The time it takes to sell varies greatly on location, price, and circumstance. Nearly identical brownstone walk-up homes in Brooklyn can sell at very different speeds depending on their actual location, for example.
Generally speaking, if nobody wants to buy it, it is hard to imagine anyone will want to rent it. If you are looking to invest in a place sitting unsold in a fast-moving market – such as a recently gentrified neighborhood – this is a potential red flag in real estate you should pay close attention to. Unless you have a firm idea of why the property is slow to sell, assume the market knows something you do not.
Stay away from the duds unless you intend to renovate extensively.
No photos of the property’s interior
One major real estate red flag is when there are only a few photos of the property’s interior, even if the seller compensates with beautiful professional exterior photographs. Even if the space itself has no problems, a lack of interior pictures can suggest the property is not in good condition and unfit to be photographed.
Potential renters will better respond to clean, well-lit photographs of the interior of any habitable space, and the more detail is included, the better.
This is a useful thing to watch out for, and one that many investors miss: whether or not a property has been recently “flipped” or purchased, renovated, and resold rapidly at a value. While a flipped property is not necessarily something to avoid entirely, it is crucial to be cautious.
The quick turnaround time of these locations means that some work may have been done shoddily or unprofessionally, potentially cutting corners. Any potential investor should collect as much documentation as they can on the house’s renovations and pay extra attention that the less apparent infrastructures – such as insulation or plumbing – were correctly installed and meeting federal and local codes of safety.
Properties For sale by owner
An alternative to using a real estate agent is to deal with the property owner directly. Locations that are for sale by the owner, or FSBO, will be more expensive to purchase, with fewer guarantees that the property is up to code. It is recommended that any potential investor going this route should consult with a real estate lawyer before entering into negotiations for an FSBO investment.
High property management turnover
This is something of a particular case, but it is worth looking at. A high turnover of property managers, or individuals tasked with day-to-day duties operating a piece of real estate, indicates issues that cannot be easily surmounted. Property management companies typically make money with volume, keeping the apartments full and low maintenance costs.
Although many rental locations employ property managers, more than one or two over several years may hint at more profound issues with the property itself. This could be anything from recurring maintenance problems to issues with setting rent prices. But it often is a red flag indicating that the property is challenging to manage.
Red Flags With The Property Itself
Now that we have identified some potential trouble spots regarding how a property is marketed and presented, let’s look at things to watch out for involving the property itself.
Problems with electrical systems are some of the easiest warning signs for any buyer (or renter) to detect. Many properties, especially older ones, have had their electrical wiring degrade over time and use. The potential investor does not necessarily need an electrician upon first inspection; simple checks like turning light switches on and off, checking for flickering lights, or examining outlets and fuse boxes can give a base idea of the conditions of the grid.
Poor drainage and/or grading
Flooding and drainage are a constant concern for new homeowners and renters, especially those who live in a flood zone. Almost all water-related issues have direct correlations with inadequate drainage and other factors such as the house’s grading. Investors must carefully note a property’s plumbing records and any recent or upcoming repairs done to the house’s pipes, drains, and foundation.
Any appearance of pooled water on the surrounding grounds may indicate a sewage leak. Evidence of standing water in the basements such as rings or moldy areas is a huge red flag to investors, buyers, and renters alike.
Regardless of the property’s location, pests are always a concern. Certain pests, such as termites, can wreck a property’s structure and cost thousands of dollars in damage; other pests, such as mice, can decimate a whole pantry full of food with just a few nights’ worth of gnawing. Any indicators that pests are present, such as traps, can be real estate red flags that the location has a tough time dealing with invaders.
Mold is dangerous as it can cause severe illness in young children and can grow undetected under carpets or behind wallpaper. Linked to leaking pipes and poor drainage, mold issues are a big warning sign when looking for a home purchase link to leaking pipes and poor drainage. Mold problems are uncommon, but if your potential investment appears to have even minor mold issues, you should consider whether it hints at deeper infestation.
Although mold removal is feasible, it is frequently expensive as it requires deep cleaning and extensive disinfection. Generally speaking, mold can be found in attics and basements, where moisture collects.
Most HVAC – heating, ventilation, and air conditioning – systems will last anywhere from fifteen to twenty-five years. Still, this estimate is highly variable depending on the system and other influencing factors. As a property’s HVAC system degrades over time, issues with heating or cooling a given property may arise.
Potential investors might have to repair or replace a location’s air conditioning, ventilation, and heating systems, possibly all in the very same year. They will need to be repaired to remain up to code and to ensure the property’s renters are comfortable.
Foundation and/or structural problems
The most difficult repairs are problems with the foundation. Any structural engineer will tell you that a building without proper foundations is a recipe for disaster and can end up costing millions. Any property inspection must include looking at the foundation and underlying superstructure, including blueprints if possible.
Sometimes, the basement of a property on the market is unfinished, and any cracks or bulges in the foundation may be easy to detect. Minor cracks may only signify the natural settling of the building. Still, giant cracks, or bulges in the concrete, might indicate uneven load on the foundation, which will only degrade over time. Additionally, indicators such as sagging or leaning door frames can point to a poorly-structured property with serious potential for damage.
Red Flags Surrounding The Property
Potential investors must also examine other factors outside of the actual physical property itself: they must also consider the property’s setting. Here are a few things to remember when looking at the environment surrounding their potential investment.
Although the property may be in top condition and reasonably priced, the actual setting of the property itself should also be considered when looking to invest. Often, surrounding neighborhoods may make these places tricky to sell or rent. If your property is located in an area with high crime rates, or poorly-rated public schools, the more difficult it will be to turn a profit through rental.
Most of the current upscale neighborhoods of Brooklyn, for example, needed years of investment and renewal before it became an attractive place to live and grow in. Unless an investor is willing to stick it out, long-term rental properties in these areas are not a great investment opportunity.
Many country regions are being depopulated; other areas are experiencing unprecedented growth. Investors should make sure they understand the demographic shifts of their area before investing. Paying attention to the ebb and flow of populations as it pertains to their investment is highly recommended. It can serve as a bellwether to how easily the location can be rented out and at what price. As a general rule, areas with declining populations are to be avoided, while areas with population surges and investment increases are worth looking at.
A note on profitability
Let’s say you’ve gone through all of the other steps, and everything looks good. Finally, you’ve found your property!
Upon closer home inspection, however, you realize that you will need to charge more than the market value for a few years to get some profit out of this investment property. In short: you cannot afford this house because the numbers simply do not add up.
Unless you intend to use the rental property as something of a bond, i.e., waiting until “maturity” (sale) to get a profit, monthly rent checks are a part of the equation. If you are looking at taking a loss until you sell the house years into the future, you should not buy the property.
By paying attention to the physical aspects of a potential real estate investment and its history, marketing, and surrounding environment, anybody can be forewarned and forearmed with the information they need to make a wise and profitable choice for the home buying process. You don’t need to be a real estate agent to know a good investment when you see one. When it comes time to sign on the dotted line, we hope you will utilize these helpful tips to make the right decision!
Now you know about all the red flags in real estate, check out our blog about Single-Family Vs. Multi-Family Investing to find out which is suitable for you.
About The Author
Please note that Point Acquisitions is not a tax expert or tax advisor. The information on our blogs and pages is for general informational purposes only and should not be relied upon as legal, tax, or accounting advice. Any information provided does not constitute professional advice or create an attorney-client or any other professional relationship. We recommend that you consult with your tax advisor or seek professional advice before making any decisions based on the information provided on our blogs and pages. Point Acquisitions is not responsible for any actions taken based on the information provided on our blogs and pages.
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