Overpaying for Real Estate Eats Profits: Paying the Right Price is Essential but Complicated for the Investor

Driven by visions of easy money, many people leap into buying investment properties with great enthusiasm but little preparation and foresight. Real estate investing is a business, and as in any business, there are problems and challenges. Nonetheless, many of these obstacles can be anticipated and avoided. Overpaying for property is one of the most common but avoidable errors committed by novice investors.

Local Patterns Trump National Trends

Despite the screaming headlines about mortgage meltdowns and plummeting real estate prices, many experts stress that buyers must focus on what is happening in their local markets. Supply and demand and, consequently, pricing and sales patterns can vary widely from state to state and even neighborhood to neighborhood. To be well-informed and well-positioned to choose wisely, investors must keep tabs on this type of data by questioning real estate agents, reading local newspapers, exploring target areas, and speaking with residents there.

Patience Pays Profits on Income-Producing Property

Purchasers of property have long heard the maxim that profits are made when a property is bought, not when it is sold. This means that, when selling property, those who paid more than necessary for it will not make as much money as they could have if they had negotiated a lower purchase price.

Real estate agents have noted that buyers have no sense of urgency in stalled markets. Instead, savvy buyers are patient enough to wait for sellers to further slash their asking prices, says Mike, a realtor Dallas.

Market Timing vs. Lost Net Operating Income

Nevertheless, just as it is difficult to time the stock market, it is difficult to time the real estate market with any precision. Although prices in a target area may drop further in the months ahead, an investor loses rental income while sitting on the sidelines. In such a case, the investor should determine – with reference to his or her real estate investment plan – whether it makes sense to continue waiting or to buy now even if the higher price will mean higher operating expenses, such as mortgage payments.

For example, if the asking price for a duplex in an urban area has dropped $10,000 in one year and the inventory of unsold similar houses in the area remains large, the price of the duplex may drop another $10,000 or more in the coming months. But whether this occurs depends on the owner’s particular circumstances: the existing mortgage on the property may be too high to allow much of a price drop, the owner may have inherited the property and can be flexible as to its price, or the owner may be anxious to sell and move away.

If an investor believes that the property is in good shape and fits the needs of his or her investment plan because of the rental income the property produces, the desirable location, and the steady demand for rental housing, the investor should calculate how much net rental income would be lost while waiting for another price drop. If the monthly net operating income would be $700 after deducting estimated operating expenses from a monthly rent of $1,200, it would take 14 months to recoup the $10,000 that the price might drop in that time frame. The solution may be for the investor to buy the property now, collect rents, and hold on to the property a little longer than called for in the investment plan (which, after all, should be flexible enough to accommodate unforeseen opportunities and circumstances).

Losing Nerve and Chances

There are two other considerations for investors who sit on the sidelines. First, another buyer may snap up property that the investor has been eyeing. Second, waiting too long may erode the fragile resolve of the individual who is finally mentally ready to begin building a real estate investment portfolio.