New Funding Resources 
To be a real estate investor is to be an optimist. It’s to believe that your next deal is just around the corner. It’s not to give up when going gets tough. It’s to persevere and to have faith. But it’s also about embracing a set of entirely different traits, such as being analytical, cool-minded, and, yes, skeptical. Sometimes, it isn’t easy to harmonize them all, but finding the right balance is essential. Without that balance, we risk being either a naïve novice ready to fall into a trap or a perpetual nay-sayer with no ability to recognize an opportunity.
This is why I want to start this article about the red flags in real estate investing by encouraging you to find that balance. None of the flags we are about to discuss mean that you should walk away from the transaction. On the contrary, they might be why you are about to purchase the deal of a lifetime. The red flags are nothing more than potential issues that may or may not arise. If they do, you may solve them without negatively impacting your bottom line, or they might throw a wrench in your plans and blow a hole in your budget. It is important that you are aware of them and proceed with both caution and optimism.
Here are some common red flags that any rational investor must investigate before proceeding further.
The seller is another investor who cannot finish the renovation.
The whole point of a short-term real estate investment is to identify and purchase a property that presents a good profit potential. If you find such a property but now also discover that it is another investor who is selling it, it should give you pause. Why this investor is choosing to sell without first attempting to realize the profits themselves is a logical question.
First, how do you know that the seller is an investor himself? The most obvious answer is that the property title is held in the name of an LLC or another business entity. The second tell-tale sign is that the property was clearly in some stage of renovation before the owner decided to stop it and put it on the market. A listing agent would likely give you an innocent explanation for the situation: The owners had a better investment opportunity to pursue, or they ran out of cash, or they got sick. That might be the case. Or not. The concern is that this investor has discovered something that ultimately makes this investment unappealing, and now they are trying to conceal it.
How to mitigate: Approach the properties sold by another investor with extra caution. Mind you, by another investor, I mean an individual or an entity who actually assumed the title to the property, not a real estate wholesaler who just assigned the contact. Hire an inspector or bring a contractor you trust to inspect the property. Share your concerns and make sure there are no hidden issues that might increase the rehab budget.
Ask pointed questions about any title defects. Your title company will eventually discover them, but it’s always better to nip those issues in the bud. Are there any encumbrances, encroachments, or easements that might affect the value of your property? Last but not least, do research to find out whether the area where the property is located is undergoing any changes (major road development, fracking plans (if it’s a rural area)) that might have a negative impact in the long term.
The property is held in a trust.
When a property is owned by a trust, the legal title to the property is held by the trust rather than by an individual. In a trust arrangement, the property is managed and controlled by a trustee, who holds the property for the benefit of the trust beneficiaries. Holding property in a trust can offer flexibility, control, and potential tax benefits, but it also involves specific legal requirements and considerations. Purchasing a property held by a trust can introduce some unique considerations and possible concerns.
How to mitigate: Be prepared that your title company might take longer to process the file and that you will pay additional fees for the title or estate planning attorney to conduct a detailed review of the trust documents. You and your attorneys want to ensure that the transaction is legitimate, that the trustee has the legal authority to sell the property, and that the trust itself complies with the state laws governing it.
The value of the property is hard to evaluate
In life, we praise uniqueness. In real estate investing, it’s a different matter. What is unique is different; what is different is hard to estimate in terms of value. When the value is hard to calculate, it increases your risk as a real estate investor. When your risk is high, it becomes challenging to secure financing. It might take longer to sell the property. Last but not least, you might have to sell it for less than you hoped for.
What makes a property’s value hard to evaluate? The absence of good comps. When an appraiser estimates the value of the property, he or she relies on comps – other properties of the same style, size, vintage, and condition sold in the immediate neighborhood. If he cannot find such comps, an appraiser expands the search further from the property or uses other sales in the neighborhood that might differ from the subject. The further the appraiser must go to find comps or more adjustments he has to make to account for differences between the subject properties and the comps, the less accurate the value will be.
As a hard money lender in the DMV area, the most common challenges in evaluating the property value we encounter are: (1) the subject property has extensive acreage of unspecified value, (2) it’s rural or agricultural property with comps too remote to provide accurate assessment; (3) it’s a non-residential property (commercial, mixed-use, or multi-unit with few recent sales nearby; (4) the style of the property is unusual for the location (geodome, hexagon – they might be striking but don’t have a broad appeal).
How to mitigate: When the after-repair value price range is wider than usual, do not count on the best-case scenario. Ensure your number analysis shows a profit, even if you sell at a price on the lower side of your range. Once your renovated property hits the market, watch it carefully. Adjust your price quickly and decisively if your listing is not generating enough excitement and offers. To help you with calculations, you can use our maximum purchase price calculator, our nifty tool that enables you to calculate the highest price you want to pay for the property based on your minimum profit requirements.
The property is not on public water and/or sewer.
The further you go from Washington, DC, the higher the chances that the property will not be on public water or sewer. Of course, there are exceptions to that rule. For example, many homes in close suburbs such as Great Falls don’t have access to these public utilities. If you discover that your potential investment property does not have such access, don’t panic. All it means is that it relies on its own septic tank and well. The issue you need to be aware of is that the property’s tank and well might be approaching their lifespan and have problems. This is especially common for distressed homes that might not have been well-cared for by their owners. If a septic tank or well needs to be repaired or replaced, that might cost you a pretty penny.
The cost to replace a septic tank can vary widely depending on several factors, including the size of the tank, the accessibility of the site, the type of soil, and the local labor and material costs. On average, you can expect to pay $7,000 or more for a septic tank replacement.
The prices can be even higher with a well. The cost to replace a well for a residential property can vary depending on several factors, including the depth of the well, the type of well (drilled, dug, or driven), the local geology, and the accessibility of the site. On average, however, you can expect to pay $15,000 or more for a good replacement in Maryland, Washington, DC, or Virginia.
How to mitigate: Since a faulty well or septic can increase the costs of your rehab by tens of thousands of dollars, make sure that your contract has an inspection contingency. If such contingency is not possible, try to arrange at least a couple of days during which you can wiggle out of the contract if the potential costs of repairs erode your profit margins too much. Make sure you hire a professional who is thorough, fast, and reliable to do the inspection before you fully commit to buying that property.
The property has a swimming pool.
To a novice investor, a pool might appear to be a fantastic luxury add-on that increases the property value and marketability. Unfortunately, it’s rarely the case. First, it might limit the pool – no pun intended – of potential buyers, many of whom would not be interested in the time and expense of pool maintenance. Families with young children might steer away because of the safety concerns. Most importantly, as an investor buying a distressed property, you should be ready that the pool will be in much worse shape than the house itself. In such a case, you would need to decide whether to invest in renovating a pool or invest in draining and filling it in. One way or another, you would need to spend major cash dealing with it.
How to mitigate: In the DMV area, a pool generally does not add much to your after-repair price, but it does increase your renovation expenses. So, when evaluating a real estate investment opportunity, treat it as an obligation rather than an opportunity. Bring a pool repair expert to inspect the pool before purchasing a property. This way, you can adjust your purchase price accordingly. Also, please refer to our detailed article about swimming pools in investment properties.
The property is in violation of zoning regulations.
Our borrowers don’t run into zoning issues too often, but when they do, these issues are potential deal-breakers. Understanding the local zoning laws is crucial. Zoning laws dictate how a property can be used (residential, commercial, industrial, etc.), its density, building height, setbacks, and other factors. Violating these regulations can result in fines or the inability to renovate and use the property as intended. Of course, zoning is rarely a concern if you are buying a property in an established neighborhood and your renovation plan is limited to cosmetic repairs. However, if you plan to expand the property footprint or add a floor, you should be aware of zoning regulations.
A year ago, we had an investor trying to secure a hard money loan to purchase a property in Darnestown, MD. On paper, it was an incredible deal. The property was heavily distressed but retained its good bones. Even with a substantial renovation budget, our potential borrower was slated to make good money. Or so it appeared until I happened to drive by the property. The issue was clear: The house was situated so close to Route 28 that it would feel like you’re working in a drive-by restaurant if you lived in it. Clearly, the zoning laws would require it to be moved back during the renovation process. Even if it was possible, it would increase the budget substantially. With that added expense, one might wonder whether it will make sense to bulldoze the old house down and treat the whole transaction as a brand-new construction.
How to mitigate: Several common issues might affect your real estate investment. Among the most common are setbacks and lot coverage requirements. Zoning laws often stipulate the minimum distance a building must be from the property line (setbacks) and the maximum percentage of a lot that buildings can cover (lot coverage). As a real estate investor looking to expand the property, you must carefully study these regulations.
One way to deal with a non-compliant property is to seek a zoning variance. A variance is a request to deviate from the specific requirements of the local zoning ordinance. When a property owner or developer wants to use their property in a way that doesn’t comply with these regulations, they can apply for a variance. Variances are typically granted by a zoning board of appeals or a similar body. Bear in mind that obtaining a variance can be challenging and may involve public hearings and approvals.
The red flags are like red traffic lights on a busy street. You don’t necessarily have to change your course. But you must stop and wait until the green light. Stop and pause if you are a real estate investor purchasing a property with any of the issues above. Investigate the problem and contact experts to determine the next course of action. Feel free to contact New Funding Resources at 240-436-2340. We are here to help increase your profitability and minimize your risks.
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