Ten-X CMO Rick Sharga Identifies the Top Five Red Flags in Rental Property Investing
By Kerry Curry, Contributing Writer, B2R Finance
Imagine purchasing a single-family property to use as a rental only to discover that the homeowners association’s tough restrictions will prohibit using it as an investment property. Or, what if you thought that you bought a foreclosure at auction, but in reality, you purchased a worthless second mortgage and now the bank that holds the first mortgage is foreclosing on you?
These are real-life scenarios that we hope won’t happen to you. We went to Rick Sharga, executive vice president of Ten-X (formerly Auction.com) to get some expert advice about red flags to watch for when investing in rental property.
Here’s Sharga’s list of red flags (in no particular order):
- Time on market.
“If a property has been on the market a long time, it begs the question, Why? Is there some problem that isn’t readily apparent? Is it in need of extensive repairs? Is there something fundamentally wrong with the construction of the property? If the price hasn’t moved, it’s probably an indication that you should be able to buy it at a lower price,” Sharga says. “As a buy-to-hold investor, you want to make sure you are not buying above market price.”
At market value is fine, though, as buy-to-hold investors generally seek most of their returns on cash flows as opposed to price appreciation.
- Long-time vacancy.
“The longer a property sits vacant the more likely it is to have deteriorated, or even been vandalized. In today’s foreclosure climate, depending on where you are buying a property, there are cases where a property has been vacant for a year or more before the foreclosure is finalized, let alone how long it’s been vacant afterward,” Sharga says. “The two biggest mistakes investors make when buying these kinds of properties is they either overvalue the property from a purchase price standpoint or they underestimate the repair costs.”
- Lack of data.
If the property is already an investment property, an investor should have access to cap rates, maintenance costs, taxes, tenant status and other data to evaluate the deal. If you can’t readily get this information, that raises a red flag. “It suggests that someone is trying to hide something from you,” Sharga says. “I would stay away from a property like that.” To be sure, investors in today’s market are looking for stabilized assets that have tenants in place. “If it were me, I’d want to know who the tenants are. What’s their track record? What are their credit scores? What are the maintenance costs and what is the maintenance history? If you are buying a property with a water heater that is 15 years old, that is useful to know. If the water heater was replaced within the last year, then it probably will be good for awhile.” The more data you can get, the more comfortable you can become with your buying decision, he says.
- The neighborhood.
Is it improving or deteriorating? “You can look at a neighborhood that looks a little rundown but what you don’t know is that new families have come in and are investing in fixing their homes up,” Sharga says. “Or you might look at one that looks fine, but the unemployment rates have climbed recently, and people have stopped investing in the upkeep of their properties.” Sharga suggests talking to local real estate agents, a title company or an appraiser along with the chamber of commerce to get a good handle on the local economy and the housing market. Are plants opening or closing? Are people moving in or out of the neighborhood? What are prices doing in that particular neighborhood? “If you are getting what looks like a really good buy on a property, it could actually be an indication that prices in that neighborhood are going down, and it might not be a good place to buy,” Sharga says.
This category has numerous red flags. If you are buying at a courthouse auction, you may have to evict a tenant or the owner and your ability to do so may be affected by city, state or federal regulations, and may involve redemption rights that allow the foreclosed borrower to buy the property back from you for whatever you paid for it within a certain period of time, Sharga says. Additionally, bidders at sheriff’s auctions cannot inspect the interior of a foreclosure, so they are buying them based only on what they can see from the outside. If that’s not enough, there could be multiple liens on the property, including a first and second mortgage, tax liens and mechanical liens. The title could be cloudy, and the entity selling the property may not even have the right to do so. Investors would do well to spend some money upfront and buy a preliminary title report and consult with a real estate attorney.
To be sure, thousands of investors have found success and are earning substantial profits buying and renting out single-family properties in the United States. But mistakes can be made, so pay attention to these red flags and learn how to avoid them. Combine that knowledge with a thorough due diligence on each prospective property, and you may end up a success story, rather than a cautionary tale.
B2R Finance offers rental investors innovative lending products to help unlock equity from existing portfolios and provide the cash needed to build rental portfolios nationwide. For more information about how B2R can help you obtain rental property financing, just call 800-227-8107 or visit http://www.b2rfinance.com/apply-now and follow us on Twitter @B2RFinance.
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