Real estate can be a good investment if you get a good location at a good price. But in many ways, real estate is a very different type of investment compared to stocks and bonds. Here are some tips to avoid the common traps that real estate investors fall into:

1. Using too much leverage. Many people like real estate investing because they can make high returns with small amounts of capital. This strategy requires you to take out a large loan with a small downpayment. Some investing strategies even call on you to use any untapped home equity in your first home to make a downpayment on a second home and so on. When all goes well, such high-leverage investments are like a money printing machine. But when things go wrong, for example when property prices drop or when interest rates rise, the money printing machine goes into reverse. Margins calls and rising monthly payments can quickly sink you into debt. There is nothing inherently wrong with these high leverage strategies. Some of the world's richest property moguls made their riches through these means. Some are extremely lucky individuals, while others are insightful investors who forsaw local property market trends. What's important is to go in with your eyes open.

2. Overestimating your rental yield. Many investors overestimate the amount of rent they will collect from their tenants. While it's relatively easy to figure out the going rate for rentals in your neighborhood, it's a mistake to multiply this monthly rental figure by twelve and imagine that's going to be your rental yield for the year. Don't forget that it may take you a month or two to find a tenant, during which you'll receive no rent. And if you have a series of short term tenants that stay for a year or so, then you might have rent-free period between tenants as you scramble to find your next tenant. You'll also want to be careful when pricing your rental. Holding out for an extra month or two just for the extra $100 might a penny wise pound foolish. The one or two month's lost rental income could be far more than the $100 you recover in a higher monthly rent.

3. Underestimating your costs. There are many costs when maintaining a house, especially if you are renting it out. You'll have to budget for repairs if your tenants damage the house. Don't forget the costs of regular painting, plumbing and electrical maintenance, and any property taxes.

4. Getting tied to mental anchors. Property owners are particularly prone to a mental phenomenon known as anchoring. In essence, anchoring is when a certain price takes on a life on its own, which the investor becomes attached to. For example, a house owner may become fixated on the idea that his/her house is worth a million dollars. When this happens, he/she becomes extremely unwilling to part with the house for anything less, even if it means struggling to make loan payments that he/she may not be able to afford. This effect also happens when landlords set the rent for their houses. They may come to believe that it is better to leave the house empty than to rent it out at a discount to some price they have fixed in their mind. The anchoring phenomena can be very detrimental to real estate investors because of the non-liquid nature of their investment and the large amount of leverage they use.

5. Ignoring the difference between Residential and Commerical property. Some people invest exclusively in residential homes, while others buy commercial real estate like shops and office units. Both types of real estate have very different investment characteristics, which some first time investors fail to realize. In general, residential properties can almost always be sold or rented out, it is only question fo whether you want to accept the market's price. This is true even of houses in run down neighborhoods. It is rarely the case that a residential house cannot be sold at any price. Some commercial properties on the other hand, may be hard to get rid off even if you were willing to sell it for a dollar. Shop fronts for example, are only valuable if there is foot traffic nearby. If the lay of the town has changed and the area around a shop front has turned into a dangerous no-go zone, then it is entirely possible that the property is worthless. The only eligible buyers you'd have left are big developers who can redevelop and reinvigorate the entire area.

6. Foreign real estate. If you are planning to buy real estate in other countries, be sure to do lots of research before going in. Foreign property ownership laws may be very different from what you are used to. Some countries have land that is sold on a state lease, meaning that after a certain number of years the land is taken back by the government. Some countries also have special laws that apply to foreign property owners, which can restrict your ability to re-sell your house. You;ll also want to do some legwork to check up the area you're planning to invest in. For example. was the land formerly a swamp and thereprone prone to ground seepage? Is the area considered an unpopular area for locals? These things are hard to assess if you just make a short "tourist" trip to the area. It requires intimate local knowledge, or the willingness to do a good amount of research.

Copyright © 2008: Wei L. Wang