Seven steps not to skip when buying an investment property
By: Tom Brady
As demand in the hottest markets pushes housing prices higher, worries about a bubble are rising. But the bigger concern, according to some experts, is the level of risk buyers are willing to tolerate to land a deal.
“One thing not being talked about is the shift in risk from seller to buyers,” said David Zanaty, chief real estate officer for Mynd Property Management. “There has been a qualitative change in the controls in place.”
Those changes include buyers who are willing to waive home inspections, forgo title insurance, or accept a seller’s insistence that a property be sold “as is.”
“As is” could provoke a case of “buyer’s remorse.”
Dylan Jones and his wife were relocating from California, bought a 1,100-square-foot home in Essex, Conn., at the end of September despite a heated seller’s market there and some qualms about the commitment.
He knew the home needed work, he told The New York Times, including a new septic tank and furnace, and framing work. But it bothered him more than he thought it would.
“The peak of my buyer’s remorse was when the structural engineer came in and told us we would have to redo the basement to make sure it is structurally sound,” Mr. Jones, a physician’s assistant, told The Times. (A different engineer recommended more modest repairs.)
Most industry observers do not anticipate a meltdown reminiscent of the housing crash of 2008 because of tighter qualification standards for lenders in the mortgage market. But the frothiness in the market — median existing-home sales price rose to $313,000 in February, 15.8% higher from a year ago, according to the National Association of Realtors — has a lot of observers wondering how long it can last.
But investors in the single-family home market can protect themselves if they avoid getting caught up in the frenzy and remember to do their due diligence on an investment property.
Seven steps not to ignore when buying a home
A home purchase, whether it be a rental home or for a residence, is the largest outlay of cash for most people, so not taking the steps to protect the investment exposes a buyer to risks that can be financially ruinous. For investors in the single-family real estate market, unseen problems with a home can turn a profit-making venture into a harsh lesson in the realities of capitalism.
- Hire a home Inspector and attend the inspection in person
- Order up an appraisal, even if paying cash
- Pay for a title search on a property
- Forgetting to take into account closing costs (and taxes and insurance)
- Not assessing the neighborhood where the home is located
- Not setting aside funds for emergency repairs
- Skipping the final walk-through
What does a home inspector look for?
Many homes that have curb appeal can harbor problems that only a qualified home inspector can uncover. And some of these problems can require repairs that can run from the thousands to the tens of thousands of dollars. A buyer tempted to skip a home inspection should keep in mind that the types of problems uncovered during scrutiny of an investment property can be the difference between a profitable venture and a money pit.
In the overheated housing market in cities across the country, waiving contingencies is one way a buyer can stand out from the crowd at an open house. And some buyers are offering to forgo the inspection, which can lead to costly mistakes.
Among the problems a home inspector can uncover are these:
- Water Damage If an inspection of a home’s basement reveals standing water, that could signal that the foundation has been affected. Or it could indicate that there is a roof leak or a plumbing issue. Mold often accompanies water damage, and it should be ameliorated as quickly as possible. Water damage should be assessed by a professional, as repairs for these problems can run into the thousands.
- Issues with a House’s Structural Integrity Signs of structural problems include cracks in basement walls, uneven doorways, leaning stairs, uneven floors or floors that seem to “bounce,” gaps between walls and floors, a cracked or leaning chimney, nails popping out of walls or gaps around windows. If there are any of these signs, a structural engineer should be consulted.
- Damage to the Roof A roof generally lasts for up to 25 years, but it should be inspected annually. Signs of problems include loose or missing tiles, discoloration, cracks or rust on flashing, moisture or mold in the attic, and soft spots and unevenness.
- Problems with a Home’s Electrical System Electrical fires in the home account for an estimated 51,000 fires each year, about 500 deaths, more than 1,400 injuries, and $1.3 billion in property damage. Signs of electrical issues include exposed wires, aluminum wiring, double tapping of circuit breakers, improperly modified panels, knob and tube wiring, no GFCI outlets, Federal Pacific breaker panels. Rewiring a home can cost $3,000-$30,000, so a buyer should not overlook these issues, and an electrician should be consulted.
- Plumbing-Related Issues Redoing a home’s plumbing can cost tens of thousands of dollars, and small leaks and rusting pipes can be signs of bigger problems. Polybutylene piping, polyethylene piping, galvanized pipes, hidden leaks, an aging hot water heater, rust or sediment buildup all require attention before move-in day.
- Insect and Pest Infestations Termites, carpenter ants and some beetles are the culprits here. It’s estimated that termites damage some 600,000 homes a year and Americans spend $5 billion in repairs and control efforts. Rodents can also be a sign of underlying problems with a house. Both problems need to be addressed.
- Trouble with a Home’s HVAC System An HVAC system should be inspected at least twice a year, and a well-maintained HVAC will last longer and save money over time. Replacement can cost $4,000-$7,000 so ignoring it can mean the difference between a profitable investment and a money loser.
Contingencies that can protect a buyer
Another way a buyer can protect himself from signing on to a bad deal is to present an offer contract with contingencies that allow a buyer or seller to call off a sale without a penalty.
Offer contracts can include a contingency that states if any major issues are identified at the home inspection, such as a foundation that is unstable or severe termite damage, then the buyer does not have to move forward.
But an investor who agrees to purchase the property “as is,” might find themselves stuck with an exorbitant repair bill. A buyer who has agreed in the contract to purchase a home “as is” can ask the seller to cover or contribute to repair costs, but the seller is not required to do so.
If a seller refuses to contribute to repairs, and there is no “as is” clause in the contract, the buyer may cancel the sale. But if a buyer agrees to purchase “as is,” backing out could mean that he will forfeit money that is in escrow to the seller — anywhere from 1 percent to 10 percent of the home’s sale price.
Online tools help propel housing frenzy
Another factor driving the frenzy is the availability of online tools that have made it easier than ever for investors to purchase a property unseen. At the same time, Covid protocols have made it more difficult to visit homes in person. Remote shoppers can get a fuller picture of a home than ever before just sitting in front of their computers: virtual house tours, 3-D renderings of home interiors, crime statistics that are searchable online, built-in home price comparisons on sites like Zillow and Streeteasy, online rankings of schools served by a neighborhood, and Google Street View all allow.
Redfin reported that 63 percent of buyers who used it in November and December made an offer on a home they had not seen in person, a 500 percent increase since February 2020, the month before the Covid-19 pandemic hit.
With homes in the hottest markets attracting above-asking bids (sometimes in cash), buyers are feeling more pressure than ever to give in to sellers who demand contingencies be waived. And sometimes these buyers never have a chance to visit a property in person, even for a final walk-through.
John Burns Real Estate Consulting, a national firm, reported in its April 2021 land survey that those purchasing buildable lots are also taking more risk than usual, including:
- Very short due diligence periods, putting buyers into riskier positions
- Bidding over asking price and with no financing contingencies (by builders who need financing) that often leads to negotiation
- Entitlement risk, which means many of these lots won’t be ready for development in the next 6–12 months
- Development risk, because finished lots just aren’t available
- Bigger nonrefundable deposits
Burns consulting said among the reasons builders are willing to take on more risk is that they expect the housing market to stay strong. Some 48 percent of survey respondents assume the pace of sales will quicken, and 61 percent believe there will be even higher appreciation than there is currently. Sixteen percent believe appreciation will be “much higher.”
So if all this makes one worry about a housing market headed for an unpleasant resolution, though maybe not as severe as the 2008 crash, it’s time to remember that old nugget: caveat emptor (Latin for buyer beware, more or less).
David Zanaty, of Mynd, says some investors who make questionable decisions may be bailed out when the homes they buy appreciate in value.
“The market is forcing them to make imprudent decisions,” Zanaty said, of some overanxious investors. “If you want to mitigate risk and still be competitive in the marketplace, Mynd can help you do that.”
Thank you for getting in touch!
In the meantime, learn more about ways to start with a smaller downpayment here.