How to Avoid “Money Pit” Real Estate Investments

Money pit - bad real estate investment concept

There’s a scary phrase in the real estate world—”money pit.” It can happen to regular home buyers who bite off more than they can chew. And, it often happens to real estate investors who go into an investment unprepared. The money pit curse generally happens when renovations and repairs end up costing way more than expected. You end up pouring in more than you can afford. Eventually, you are on the losing end of a bad investment.

So, how do you avoid falling into a money pit as a real estate investor? Here are a few things you will want to consider before you buy your next investment property.

Start With a Budget and a Plan

You should have a general investment plan and overall budget in mind before you start searching for investment properties. Know how much you can truly afford and how much you are willing to put into the property. Consider both the purchase price and renovation costs. Let’s say you have a maximum budget of $500,000. You are looking at buying a run-down property for $350,000. However, it needs a lot of work and may cost around $100,000 to renovate before it is ready to rent out or resell. That gives you about $50,000 of wiggle room, which may not be enough. If you find yourself in a money pit situation, you are not far from losing money when all is said and done.

Run Better Property Analytics

To help avoid a money pit, you will want to run very detailed property analytics. You need to study the market where the house is located to determine realistic rent prices or resale values once the property is renovated. You need to understand the real estate market, in general, as it can always have some natural ups and downs. Then, you need to thoroughly examine the property itself to figure out estimated renovation costs. No two properties are ever the same, so you have to perform detailed analytics on any house you are considering buying.

Property-Specific Budgeting

Once you have run the property analytics, you can then set a property-specific budget and investment plan. Don’t buy a house before doing this important step. Knowing how much the renovation will cost and what you can fetch for the property when all is said will help you determine how much you are willing and able to spend on the purchase price. If the asking price and projected renovation costs add up to more than you think you can get for the property in the end, then it’s not a good investment.

Wiggle Room

We always recommend being extra conservative on all your price estimates. Give yourself a lot of wiggle room because real estate investments and property renovations rarely go exactly as planned. Creating price ranges will help significantly. First, you will project a realistic resale price range (or rental prices, if you are planning to rent out the property). Let’s say your $350,000 property will probably be able to sell for $500,000-$550,000 after it is renovated. Assume it will sell for the lowest value. Let’s also say you estimate your renovation expenses to be $100,000. Add another $50,000 on that budget just to be safe. Unexpected issues are likely to come up during the remodeling process. There may be construction delays or other problems that set you back. Build in this cushion and you will be thankful later.

So, in this particular scenario you are buying the house for $350,000 and putting in up to $150,000 for the renovations. However, it may only sell for $500,000. This is a break-even situation and is obviously not going to be worth your time. Your best-case outcome would be only $100,000 in renovations and a maximum $550,000 selling price, which would net you $100,000 profit. However, you can’t go into the investment expecting the best-case result. Do your estimates based on the worst-case scenario and you can protect yourself against losing investments. Make sure your plan and budget have ample wiggle room to ensure a profitable outcome even if everything goes wrong. If everything goes right, then your profit just gets larger. Either way, you are avoiding a money pit and you are making a smarter investment.

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