The Worst Kinds of Real Estate Investments
Real estate investing can be a great way of making a lot of money, usually in the long run. However, real estate investments can also turn into a way of losing lots and lots of money.
It all depends on the type of investment property, the knowledge and strategy of the real estate investor, and the market conditions. While as an investor you cannot control the market conditions (though you can perform a careful real estate market analysis) before purchasing your income property, you can and should definitely strive to constantly increase your knowledge of real estate investing and work hard to choose the best strategy for each particular market and each particular property. Another thing which you have control over and should be careful with is the type of real estate investments which you buy.
As a real estate investor, you are exposed to a wide range of choices: single-family homes vs. multi-family properties or condos; city vs. countryside properties; traditional vs. Airbnb renting; etc. Whereas all these kinds of real estate investments can make you gain or lose money, there are certain types of investments which have been proven over the years as the worst kinds of real estate investments. Following is a list of the investment properties which you should simply avoid as an investor, if you want to make money.
1. Real estate investments that don’t generate rental income
Yes, you hear right. There are various types of investments in real estate which simply do NOT make any rental income. Examples include second homes and lands which you don’t rent out to tenants. You are asking yourself: Why would a real estate investor even think about such an investment? Well, usually the reason would be that he/she expects high appreciation in the future. However, while real estate appreciation is a great thing and you should always aim for real estate investments which promise high appreciation in order to make money in the long run, you should NEVER EVER go for a property just for appreciation. First of all, it’s risky because you have no guarantee that the value of your property will actually go up. Second, when calculating the final profit, you should factor in the money you could have made if investing the same amount in stocks or just putting it in the bank. So, any successful real estate investor should avoid no-rental-income properties.
Related: Is It OK to Invest in Real Estate Just for Appreciation?
2. Negative cash flow real estate investments
While real estate investments that don’t generate rental income should be avoided, such which have negative cash flow are strictly forbidden. You should always remember that real estate investing is about positive cash flow from day 1. Don’t ever make the mistake of going for an investment property that is likely to generate negative cash flow in the short run, but you expect things to change in the medium or long run. Having negative cash flow simply means losing money — rather than making money — from your rental property. Once again, appreciation is not a good enough excuse to go for such an investment. Negative cash flow properties could include beach properties, vacation rentals, and others. When deciding whether to buy a certain income property or not, make sure to use Mashvisor’s investment property calculator which will help you calculate the cash flow and all other important numbers.
Related: What Are the Best Cash Flow Investments?
3. Overly luxurious real estate investments
Directly related to the previous point is buying investment properties that are just too luxurious. You should keep in mind that people who rent — i.e., tenants — are generally not too well-off individuals. Otherwise, they would have bought their own home instead of living in someone’s income property and paying for it every month. Thus, they simply can’t afford to rent a property that will cost a few thousand dollars each month. So, if you go for a very luxurious and expensive rental property, you may end up not being able to find tenants or having to rent it out for a much lower rent than what it is worth. In either case, you will have a negative cash flow property. Moreover, expensive properties to buy are expensive to maintain as well, which will put further upward pressure on your costs and push your profitability down.
4. Real estate investments that you cannot afford
Sometimes there are these amazing real estate investments that would make wonderful, positive cash flow investment properties. Except for the fact that you simply CANNOT afford them. For example, rental properties in San Francisco tend to generate great cap rates and CoC returns, but the prices are so high that few real estate investors can afford them. That is to say, don’t go for an investment without budgeting carefully by including all costs associated with it and calculating exactly how much you can afford to invest. If you end up losing a great property to the bank because you cannot pay your mortgage payments, then that’s one of the worst real estate investments you could possibly make.
5. Airbnb real estate investments in locations with bad Airbnb legislation
Airbnb renting has experienced some significant growth in recent years due to the profitability which it offers. In response, many states and/or cities have started issuing prohibitive legislation under pressure from local hotel lobbies. So, although in general Airbnb real estate investments can generate great rental income, you should always check carefully the local laws related to Airbnb prior to buying a property that you plan to use for Airbnb. Otherwise, you run the risk of making one of the worst real estate investments.
6. Tenant-in-common real estate investments
Tenant-in-common (TIC) real estate investments are arrangements under which a property is co-owned by two or more individuals through separate, undivided interest. While partnerships can be a great way of diversifying a real estate investment portfolio and of affording a property which you might not be able to buy on your own, experts generally agree that TIC investments should be avoided. TIC investments were particularly popular about a decade ago, but investors rarely made any money out of them because of the high costs and fees associated with setting and managing the required agreements.
Related: What You Need to Know about Real Estate Partnerships
7. Timeshares and intervals
Another type of bad real estate investments according to many experts includes timeshares and intervals. Timeshares are ownership models in which many individuals own allotments of usage in the same property. Let’s say, in the case of a vacation home in Florida, you could be allowed to use it for the first 2 weeks of June, while other co-owners would use it for the rest of the year. Of course, you can then decide to rent out your timeshares to tenants as a form of real estate investment. Interval funds, on the other hand, are closed-end funds whose shares do not trade on the secondary market. The main problem with both timeshares and intervals is that they are very hard to sell and usually sell for only a fraction of the original price. Moreover, they do not generally produce rental income. So, real estate investors are advised to avoid these investments.
8. Real estate developments
Real estate development refers to a complicated process comprised of anything related to purchasing land, building on it, designing, constructing new uses, manipulating, renovating, and releasing properties. Property development is very expensive and extremely risky. It is not a good kind of real estate investment for the average investor. Developments are usually best left for very wealthy and very experienced investors who can take such a risk.
Diversity comprised of virtually unlimited options is what makes real estate investments so great. It is possible to find something applicable and profitable for any type of investor, regardless how big or small, how new or experienced. However, within this wide diversity, there are certain kinds of real estate investments that are just not good — because they don’t generate rental income, lead to negative cash flow, are too expensive, or are extremely risky. Above is a list of the 8 real estate investments that you should avoid.
Originally published at www.mashvisor.com on April 26, 2017.
