Owning and operating income property is a proven method for creating wealth. Despite what you might see on late night t.v., real estate is not really a means for getting rich quick and first time investors can easily get in over their heads if they buy the wrong property.
Here are 5 red flags to watch out for when you're looking to buy an investment property.
1. Deferred maintenance
Deferred maintenance means only one thing, neglect. Typically, the current owner either cannot afford to keep up the property or they choose not to. The good news is, it's very easy to spot when you know what you're looking for. A professional building inspector is highly recommended if you buy a property that needs repairs. Before you buy someone else's problems, you need to identify what they are and what it's going to cost you to fix them. Capital expenditures are a big drag on cash flow and profits.
2. Shoddy repairs
If there's one thing that's worse than deferred maintenance, it's shoddy repairs. Again, you're dealing with an owner who either can't afford to do things the right way or just prefers cutting corners. Poor repairs can be a future budget buster for a new owner, especially when dealing with plumbing, electric, and anything structural.
Many times, poor repairs can also mean building code violations. If you can identify poor cosmetic repairs in the open, odds are that what you can't see behind the walls is even worse. Use good judgment and get a professional building inspection done before you buy.
3. Illegal use of living spaces
A quick way to increase rental income is to build out additional living spaces. Adding in-law apartments in the basement or attic is a widely used practice in Chicago but many times it is done without permits and thus the finished space is not legal for occupancy. If a City of Chicago building inspector finds illegal units on site, the owner can get fined and will likely be ordered to demo the units and return them to the original condition.
As a buyer, you need to know exactly how many units are certified by the city so you are not unknowingly taking on unwanted risk by purchasing a property with illegal units. Note, many investors buy buildings with illegal or in-law units. The property is simply priced accordingly.
4. Problematic tenants
Seasoned investors have probably dealt with plenty of problematic tenants. As a new investor, it's sometimes better to steer clear if you identify problematic tenants. You can identify pay issues by requesting payment history for the tenants. When you're touring the property, if a tenant won't give you access to the unit, that could be an issue. Interestingly enough, tenants who tell you about everything that is wrong with the building and the current ownership or management are usually the ones you need to watch out for.
5. High rents
High rents aren't typically a red flag but as an investor you should consider that real estate markets are cyclical. As such, when you underwrite the property you'll want to confirm that the income can support your expenses and mortgage at "X" level, maybe 5, 10 or 15% lower than the current rental rates. If the rent roll can cover in a worst case scenario, you should be in good shape.
Contact Brent Hall to discuss buying and selling multifamily property in Chicago.