5 Under the Radar Deal Underwriting Mistakes New Investors Make
As a Realtor specializing in working investors I come across a lot of new investors. It feels like yesterday that I was also brand new to investing and was struggling with figuring out how to analyze deals. Bigger Pockets has a great calculator that helps to capture the basic expenses (https://staging.biggerpockets.com/buy-and-hold-calculator), but where it fails is some of the deal underwriting items that can add up or that can save you some headache.
I’ve collected some items below that I missed at first and that I commonly see people miss when they are new to buy and hold real estate investing. I wouldn't even call these the "TOP 5" mistakes people make, because there costlier mistakes you can make. These are just 5 items to add to your due diligence research before buying a property that can fly under the radar.
- 1. Hidden Costs:
- There are a lot of things that are specific to certain companies or certain deals. For instance some municipalities in my area charge a $250 per year “Storm water Fee”. It applies to some municipalities, but not all, and there are over 100 municipalities in or around my city. Then you have tenant registration fees and occupancy inspection fees. Some areas charge $50 per new tenant to “inspect” the unit and then you usually have some small things to fix since the code was last updated. When it comes to these expenses you should ALWAYS call the local government office to see what fees they charge for rental owners and also what they charge outside of the basic utilities (trash, storm water, etc.).
- BONUS: Property management hidden costs. Check your agreements to see what is being charged outside of the monthly percentage based fee and the leasing fee. Sometimes you’ll find up-charges for maintenance, eviction costs, renewal costs, etc. Your bill will usually be higher than the basic monthly percentage.
- 2. Occupancy/Zoning:
- At least in my market there are A LOT of illegal duplexes, triplexes, and quads. These would be 2-4 unit buildings operating in single family zones. Some of these buildings are permitted because they have adequate occupancy permits, but you should always contact the local government to confirm.
- BONUS: This can also work in your favor if you find a property that is under-using it’s permitted zoning. A single family home in a 2 family zone can be a great investment opportunity if you are willing to put in the work to separate the property into a duplex.
- 3. Over OR Under estimating repairs and capex.
- What percentage of rents do you use to calculate repairs or capex?
- 7 percent?
- 10 percent?
- In my opinion the percentage based estimating of repairs is for napkin analysis. It’s not an accurate way to do things.
- You should always have a minimum. It doesn’t matter how much you are collecting in rent. The cost to replace a roof is going to cost similarly no matter if you are renting the house for $600 or $6000. After I establish my minimum I then adjust from there. My hold period is typically longer than 25 years so I base how much I save for expenses based on what items I could expect to replace over a 25 year period. So I calculate what it costs to replace flooring a couple times, paint 4 times, roof once, furnace/AC once, kitchen once, appliances twice, etc., etc. This all goes into a spreadsheet so for every deal I can break down the monthly cost if I have to replace ALL of this. Then I have the amount that I need to withhold for the building. In addition to that amount I build up a reserve account of $4,000 from the cash flow that I keep for regular repairs. As that depletes I just keep filling it back up. That way I’m not in a bind for regular repairs and I have a nice capex budget saved up for the big repairs.
- BONUS: I usually put my capex fund into a 2% savings account so that it is at least generating SOME return. Once it hits a set amount based on the size of the building I’ve also started investing the excess in index funds to make sure that all this savings isn’t just sitting there doing nothing and so that the budget is increasing to keep up with inflation in costs over time.
- 4. Tenant Background Checks:
- Most criminal and civil judgments are public information. When underwriting a tenant occupied property I always look up each tenant’s background to see if the prior landlord was actually screening tenants. It doesn’t catch everything because backgrounds can be cleared, but I also do a social media search on all tenants including Facebook, Instagram, LinkedIn, etc.
- It gives me an idea of who is in the building and if I should expect a smooth transition or a building where multiple evictions are likely. Additionally you can call the police department to see if they have any known issues with the building. Knowing some local police officers can help immensely with this.
- 5. Outstanding Code Violations:
- Where I am there is a “right to know” search that you can do to look up outstanding code violations. This is always something that you should do. Never a pleasant day to buy a building and then get hit with remedying open code violations.
- Well there you have it. Not an exhaustive list of due diligence items, but 5 that I do now that I never did at the beginning. If you have any questions I'm happy to help!