By Ken Davidson
Success in the real estate business looks completely different for every individual. There are literally thousands of paths you can take to get to the same destination and nobody takes the same path twice. Regardless, there are a few common factors that differentiate the real estate projects that succeed from the ones that fail.
More often than not, the root cause of failure in real estate comes back to various incarnations of poor due diligence. Sure, you might think you have planned for every potential scenario, but there are many distracting pit stops on the road to success in real estate – if you aren’t careful, you might run out of gas before you get there.
Otherwise highly intelligent people can find themselves in a serious situation by making one of these nine mistakes that cause real estate ventures to fail.
You should be excited about the projects you’re working on, but jumping into a project where you haven’t done your due diligence is something I like to call “rose-coloured glasses syndrome.” Your reasons for investing in real estate need more justification than good feelings and a desire to get in the business.
2. Choosing the wrong partners
People spend years dating their spouse before they propose and get married, yet they will become business partners in a real estate transaction very quickly simply because one guy has money and the other has a project…and they don’t even know each other!
You need to get to know your partner before you go into a real estate venture with them. If you don’t, the odds are that it’s not going to end the way you thought it would. Can you really afford to risk having a negative outcome over something that is preventable? Even if you can, that’s not sound logic for running a business.
3. Interest rates skyrocket (and you aren’t prepared)
If you don’t take this into consideration before acquiring, you could be in trouble if or when it happens.
4. Poor risk assessment
There is risk associated with every real estate venture and if those risks are not taken into consideration when you acquire, things can go sideways before you know it. Truthfully, there is an element of luck here, there’s no question about it. There are always things in real estate ventures that are somewhat out of your control so you have to be looking for those potential liabilities when doing your due diligence.
Let’s say you own a very nice condo unit and your next-door unit sells to a new landlord who allows it to turn into a drug house. That’s a good example of something that’s totally out of your control, but it’s up to you to weigh your decision based upon the risks that are in your control.
5. No exit strategies planned
You bought a piece of real estate thinking you need it for a long-term hold. All of a sudden your circumstances change and you need to break the contract or get out of a deal. Then what?
You should have several exit strategies to choose from so that if circumstances do change, you can look at using one of them. Many people buy real estate with one goal and one intended outcome in mind without considering other possibilities. Take a step back and consider your exit strategies ahead of time.
6. Your partner’s circumstances change
Your partner’s circumstances may radically change and this could put you in a compromising position that threatens your ability to recover. There’s a certain element here that’s out of your hands, but part of selecting the right partner is evaluating potential outcomes in the event something does go sideways. Are you ready for those possibilities?
7. Unexpected expenses
This is another for the ‘due diligence’ category. Depending on the project, I’ll always put in buffers to have room for variances in expenses. How much those buffers are will depend on your risk tolerance and comfort level with the situation at hand.
8. Analysis Paralysis
Over-analyzing can kill any real estate deal. Remember that you can analyze anything and find a reason why it won’t work. Where there’s a will, there’s a way. Take it from an accountant: You can’t always trust the numbers.
9. Revenue is lower than expected
When you’re doing due diligence, you have to build your cash-flow models so there is an understanding of flexibility and variability because NOTHING is going to be as you originally estimated coming into the project.
I’ve seen business proposals for real estate projects where the person assumes they are going to be 100 per cent full, 100 per cent of the time in a residential apartment complex. That’s not even possible.
I don’t care how good the market is. You will have turnover and when that happens, you will have vacancies. Although it doesn’t make sense to plan your financials around being 100 per cent occupied all the time, too often I see people planning for this very optimistic scenario and that’s dangerous. Although the intention is noble, the reality will quickly reveal how misguided this approach is.
Be honest and realistic. Those rose-coloured glasses might brighten the future you think you’re seeing for your real estate project, but the real image will inevitably come into focus. It’s you and your advisor’s job to do your own independent due diligence, plan for the unexpected, and consider all possibilities before you close the deal on a real estate project that may end up being more trouble than it’s worth.
Ken Davidson is a business growth strategist, real estate investor and chartered accountant in Kelowna, B.C. He writes a weekly blog for entrepreneurs and investors at BusinessGrowthStrategies.ca.
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