So, you’ve found what appears to be a great rental investment property. It looks like it offers:
- grand value
- in a great location, and
- it meets the 1% rule. It’s a grab investment, right? Not necessarily.
Before you go full speed ahead, you should do your homework and due diligence appropriately. Keep digging. When you find a property that hits all the numbers, it can be tempting to not think twice; after all, you’re not the only investor out there. The history of failed investments in Kenya is littered with cases where buyers ignored warning signs and “followed their gut” right into bankruptcy or endless court cases.
What are the most common warning signs that could signal a perilous investment? Some of the most frequently-seen red flags include.
- The Property Tax and Rates Trap
You’ve found a great deal on a house in an affordable neighbourhood that’s about to take off. Maybe the County Government’s designated a nearby commercial area an “opportunity zone,” or a new public transportation station or railway line is going in, or maybe a mall etc. Congratulations! — your investment is about to skyrocket in value.
But that can come with an unexpected downside: a parallel spike in property taxes. Property tax increases lag behind a neighbourhood’s development, so they can sneak up on an inexperienced investor. How much can they go up? One investor saw a 150% increase overnight.
Property tax and rates spikes can be ruinous for landlords. If you base your rent on your old, lower tax rate, you could find yourself looking at a year when the rental income from your property just barely covers your expenses, or even falls short. And once you do adjust the rent to take the new tax rate into account, you might find that it’s harder to attract tenants at the new, higher price point. It’s a loss.
How do you avoid the property tax and rates trap? A little research could save you a lot of pain later. Check the historical property taxes for the area and look into tax and rates. Smart investors run a comparative market analysis (CMA) on prospective investment properties to check price accuracy, and you can do essentially the same kind of research on the tax and rates side of things.
- Big Repairs
You’ve found a property that’s perfect in every way; the location, the condition, the price. The only problem is, well, that there’s one big problem. Maybe it’s the roof, the septic system, or the foundation. But to make it more tempting, the seller is offering a discount. Should you take a chance on tumbledown investment?
Probably not. That one big problem can easily snowball into an even bigger problem, and seller discounts often don’t cover the eventual cost, especially once you include the time and effort you put into renovations.
Two of the most serious red flags are foundation and roof problems. These are urgent, necessary repairs; the longer you delay, the more serious damage will be done to the property. And they aren’t cheap.
The upshot? Unless the seller is offering a six-figure discount, it’s probably not a good deal.
- A Questionable Neighbourhood
There’s a fine line between an up-and-coming neighbourhood and a down-and-out one, and being able to tell the difference is a skill every investor needs to master.
We all know what a great neighbourhood looks like; the rate of homeownership is high, the lawns are manicured, inroads in shape, and the homes are very well-maintained. Ironically, these neighbourhoods don’t typically offer great investment value; the homes are already pricey, so high that any rent that would cover the mortgage or loan cover is nearly prohibitive.
The best neighbourhood for investment is a middle-class. One yet to ascend to apex level. In areas like this, homes are reasonably priced, demand for rentals is high, and the community is stable. Investors need to hunt for these areas that offer high values or returns in future.
But high value and potential come at a cost. These can be high maintenance, hands-on properties, which require a lot of your time, or the services of a professional property manager. Once you take that into account, along with the occasional non-paying tenant, the deal looks a lot less attractive.
- Buying at the Peak
One easy way to peek into the future is to look at the stock market, since stocks represent future earnings expectations and are much faster and more responsive than the real estate market. If the stock market looks good, the real estate market can reasonably expect a year or two of clear sailing. Hence an opportune time to buy having done your homework properly.
Another way to anticipate (and avoid) the peak of the market is to look at vacancy and construction rates. At the beginning of a boom cycle, there’s little to no new construction, and vacancy rates are headed down due to tight supply. This is a classic seller’s market, and the peak is a long way off in this phase. In the next phase, construction picks up, and vacancies continue to decline as pent-up demand is met. This, too, is a relatively safe time to get into the real estate market.
But when vacancies go up while new construction is still high, the peak is likely near. Investors should be cautious about buying in this period.
A knowledgeable buyer’s agent in buying and selling investment property can help you navigate these pitfalls with ease, so consider consulting with one before you fall in love with a property and make commitments.