By Scott McGillivray
I recently had a question come through my website from a young guy who had purchased a home and got in a little over his head. Wait, scratch that — he got in way over his head.
He needed the income from a basement rental unit to pay his mortgage, but the house had so many problems it wasn’t even livable.
Not only did he need to renovate the rental unit in order to make it legal, he also had to renovate the entire home before he could even move in. He didn’t anticipate the number of problems when he purchased the home, and with his limited budget there was no way to make the numbers work.
As I read through his note, I felt bad for him, but the more I read the more I thought he should have relied on the advice of professionals.
All the real estate warning signs were there, but unfortunately, he either didn’t recognize them, or he chose to ignore them. What’s even scarier is that not only did the house fail a building inspection, but the inspector said he would never let a child of his live in the home — and still he bought it!
Let’s take a look at where he went wrong, and how a professional could have steered him in the right direction.
Review the listing
While none of the following are inherently wrong, they could provide an initial warning sign for interested investors to reach out to a professional for advice. With that being said, the only way to know for sure is to see the property — and have it inspected before you finalize a deal.
• “Attention renovators” — the house needs a total redo from top to bottom.
• “Fixer upper” — a cute way of saying it needs work.
• “Needs a little TLC” — needs a ton of your money.
• “Sold in ‘as-is’ condition” — the seller knows there are problems and isn’t interested in negotiating.
• “All the work has been done for you” — recently renovated and could be a flipped house. Pay close attention to the quality and workmanship as it might have been renovated in a hurry and with maximum profit in mind.
• Listing has no photos — the house probably doesn’t show well. I always maintain you should still look at houses that don’t have photos in the listings. Most people skip right over them so you can sometimes get a great deal (I have), but don’t expect it’s going to be in great shape.
None of this is to say you shouldn’t seriously consider purchasing one of these homes. If you’re smart about your finances and you budget properly, there’s a lot of opportunity. But what it does mean is major renovations could be required and you need to be prepared to spend a lot of money to get it where it needs to be.
Make a budget and check it twice
A REALTOR® can help you find a property within your budget. Plus, they can help connect you with a financial advisor, mortgage broker or other financial profession to ensure you have enough funds to buy and maintain a property.
Using a mortgage calculator is one of the easiest ways to estimate your monthly payments and expenses before you buy, including taxes, interest and utility fees. This should give you an idea of how much cash you should have on hand in a reserve fund in case you don’t have tenants right away. Your reserve fund should also have money for renovations and maintenance costs.
Your REALTOR® can help you look at comparable rental properties in the market to ensure the price you’re hoping to get in rent will cover your costs and be in line with the rest of the market.
The buyer from my story knew he needed the income from his rental unit to cover his mortgage, so he must have calculated the numbers or consulted professionals. A great first step, but he neglected to budget in the costly repairs that were uncovered during the inspection.
The cost of renovations
Our buyer was smart to consult a professional for a building inspection — but he failed to listen to the outcome.
Inspections are meant to uncover issues before a sale is finalized, if you make a conditional offer. When issues are uncovered, a buyer can go back to the seller to renegotiate the selling price or revoke their offer.
During an inspection (if possible) you should come equipped with questions like: are there signs of mould? Is the wiring up to code? Is the roof in good condition?
After the home inspection, our buyer should have consulted with a professional contractor, plumber and/or electrician to get a quote on the repairs to see if the costs would fit into their budget. Not all problems are deal breakers, but you still need to look at your bottom line.
Investors should also consult with municipal and provincial officials to ensure they understand what is required to make their rental unit “legal.” A real estate lawyer can also help you understand your responsibilities.
Buying a house can be a very emotional process. And when you have visions of rental income dancing in your head it can be easy to ignore the real estate warning signs. But you have to remember, when it comes to investing in real estate, you have to fall in love with the numbers before anything else.
One of the best things you can do is work with a REALTOR® who can guide you through the process. They know all the techniques and terms and can help you navigate the often-confusing world of real estate listings. Not to mention, REALTORS® have a list of trusted professionals they can share with you.
I’ve written about the four main risks to consider before purchasing an investment property in the past, and it’s important to reiterate them here: financial, property location, age of property and the real estate market.
These are all things you can discuss with your REALTOR® and/or the listing agent of the property you’re interested in.
Real estate agents are familiar with contract details and clauses that can be included, trends in the market, and so on. When you’re dealing in real estate you’re dealing with big money, and you should be using the best tools you have available. A REALTOR® should always be a part of your team.
Scott McGillivray is the host and executive producer of HGTV’s award-winning series “Income Property”, and has made making money in real estate a reality for hundreds of hardworking homeowners across North America. For more information about homeownership and investing, visit scottmcgillivray.com