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8 Mistakes To Avoid When Building Your Real Estate Portfolio

Key Takeaways

  • Preparation, in the form of a business plan and a clear understanding of your local market, is the foundation of a good real estate portfolio. 
  • Avoiding risky deals, whether they be over-leveraged or in the wrong location, can often be one of the biggest keys to portfolio success.
  • Trying to go it alone, and do every single activity under the sun, is perhaps the biggest key to establishing your real estate portfolio.

What should you do when it comes to building your real estate portfolio? How do you make sure you avoid many of the mistakes that newbie investors make when building a real estate portfolio from scratch?

Building a real estate portfolio requires foresight and planning, in the form of a quality business plan, adequate insurance, and knowledge of local market conditions. It also requires keeping yourself out of vulnerable situations, such as choosing the wrong location for your properties or the right location, but the wrong leveraged position.

Here are eight mistakes to avoid when building your real estate portfolio and smooth over any speed bumps on your wealth-building quest.

Mistakes to Avoid When Building a Real Estate Portfolio

Lack of a Business Plan

To invest successfully in commercial real estate, you need a good business plan. A business plan will help you analyze your current situation, set property investment goals and, more importantly, create investment strategies to achieve those goals.

Your business plan should include an exit strategy to protect your portfolio if things fail to work as anticipated. Moreover, an exit strategy can help you sell your commercial property at the most opportune time, thereby maximizing profits.

Not Doing Your Due Diligence

You should perform due diligence before investing in commercial real estate in order to reduce your investment risk. Simply stated, due diligence involves taking the necessary precautions reviewing all relevant documents, performing calculations, walking the property and procuring insurance.

Put another way, you should do your homework for the property you intend to add to your real estate portfolio before you purchase the property. This will help you determine whether a property has issues or not.

Of course, you should not purchase a property with too many issues to avoid exposing your real estate portfolio to unnecessary risk. Similarly, if you add the wrong property to your portfolio, it will erode the value of your portfolio.

Not Getting Insurance

Insurance is one of the most important components of a real estate portfolio because it protects investors from the inherent risks of commercial real estate investing. Examples of such risks include liability lawsuits and property loss due to various factors, including natural disasters. Without adequate insurance, such risks can destroy easily destroy your portfolio.

The different types of insurance available to commercial real estate investors include loss of income insurance, liability insurance, flood insurance, builder’s risk insurance, general contractors insurance and workers compensation. Of course, you should maintain a healthy balance between insurance costs and portfolio income.

Failure to Understand Local Market Conditions

Since the dynamics of a real estate market vary from one area to another, you cannot adopt one-size-fits all approach to investing. For instance, a poor property may do well in a great market, whereas a great property may fail to do well in a bad market.

The secret is to understand local market dynamics. Fortunately, you can identify the right investment opportunities in a particular market by analyzing critical market aspects including employment trends, median income and population growth.

Overly-Ambitious Projections

Granted, real estate investing is a numbers game. However, when calculating the value of a property, you should use the actual operating figures for the gross revenue and the operating expenses, not overly-ambitious projections.

Moreover, you should value the commercial property based on current income, not projected income. In other words, you should be able to analyze your cash flow properly in order to determine whether the investment is worth the time and money or not. This is particularly important because every assumption you make will likely increase your investment risk.

Over-leveraging

While it is common for commercial real estate investors, especially fledgling investors, to finance their investments through debt, over leveraging can easily destroy a portfolio. This is because a large debt would attract a large amount of interest, which could be higher than the income generated (negative leverage).

In such a situation, you would likely struggle to repay the loan and your lender could potentially foreclose your property. In essence, if your break-even ratio is higher than 80%,  you are over-leveraged.

Wrong Location

Location matters when building a real estate portfolio because it determines property-tax levels, the type of commercial property you can build, the amount of rent you can charge your tenants, as well as demand for your property.

This means that, if you want to build a profitable portfolio, you have to choose the right location for your commercial properties. Some of the major factors for commercial real estate valuations include proximity to warehouses, markets, freeways, transport hubs and tax-exempt areas.

Working Alone

Building a real estate portfolio typically involves a lot of work, including finding the right property, organizing financing, finding tenants and renovating properties. Given the amount of work involved, you need all the help you can get.

One of the strategies you can use to achieve this goal is to build good relationships with industry professionals including closing attorneys, lenders, home inspectors and appraisers. Additionally, you should have a team of reliable contractors to handle your remodeling and maintenance needs. Your team of contractors should include painters, HVAC technicians, flooring installers, cleaners and gardeners, among others.

Is there something you wish somebody had told you about building your real estate portfolio? Let us know in the comments below.

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