*** Real Estate Investing: Beware of Red Flags

“On this April Fool’s day, vow never to become the fool.” - Gary Eldred, PhD

Although I love real estate and believe it offers most people their best opportunity to become wealthy, no one should assume that every great-sounding offer actually represents a great deal. In fact, investors are well-advised to recognize and beware of numerous red flags that signal danger - or at least warn would-be buyers to slow down and examine cautiously before they proceed.

One such red flag that I continuously spot as I travel around the world looking at property offers involves “rent guarantees.” Although in the high-dollar commercial property field, rent guarantees sometimes make sense, the red flag rent guarantees are those offered by builders of new residential apartment projects - especially projects sold off-plan (preconstruction) to out-area-buyers. I’ve recently seen such offers in the U.K., Eastern Europe, the Middle East, and in much of Asia. (Timeshares, fractional ownership, and hotel room sales also have been making similar offers.)

Ads for such projects might promise something like, “8% rental guarantee for 3 years.” Why do I view that as a red flag? Because as with all “too good to be true” come-ons, it intends to dull your critical inquiries. Such a promise should cause you to question whether the market rent levels will actually support the project - and what is likely to happen to rents into the future. The promise implies (quite wrongly) that you need not worry about the true rental market.

Further, many naïve buyers fail to inquire whether the promised rental return yield refers to gross or net returns. (They are almost always gross--i.e., before operating expenses and amortization.) Moreover, the buyers fail to ask who is actually making the “guarantee” and what their financial capacity to honor such a commitment is. And in many instances, the “investment” units are rented out furnished, which could mean large out-of-pocket costs for furniture replacement in the not-too-distant future.

Although this “rent guarantee” example refers to just one specific type of hyped promotion, apply the general principle to all come-ons, promises, and “too good to be true” offers such as:

• “These properties are bound to appreciate at least 10% to 20% a year - just as they have in the past.”
• “You set the terms, I’ll set the price.”
• “Nothing down - below-market financing.”
• “Priced well below appraised value.”
• “No need to worry - you can always refinance.”

Beware: Due diligence must rule all purchases. Remember that more than a few builders, sellers, and sales agents want to highlight (even exaggerate) your potential gains and keep the potential risks well-hidden in the fine print and footnotes of your written contracts.

As many cities throughout the United States now experience the down part of the real estate cycle, I am receiving many e-mails from investors (using the term quite loosely) who now find themselves in the red. In every instance, these investors failed to adequately research and forecast the underlying supply/demand fundamentals of the markets where they were buying, and /or failed to understand the pitfalls of the financing terms they were agreeing to.

So, on this April Fool’s day, vow never to become the fool. No matter how appealing the sales promotion and promises, no matter how much a market is booming, no matter how certain the deal seems in terms of risk and reward - before you act, rely on multiple metrics of valuation, multiple data points, and multiple sources of information. Even with property, long-term wealth-building invites and encourages education and work.

Gary W. Eldred, PhD, has been involved in hundreds of real estate transactions as buyer, seller and consultant. He is author of many best-selling books on real estate. Dr. Eldred created The Real Estate Investor Training Program for Trump University.