Note: This is a guest article by Tali Wee of Zillow
All investments carry some form of risk and real estate properties are no exception. First-time real estate investors exploring the most lucrative opportunities must complete their due diligence before purchasing. Investors don’t stumble upon highly-profitable, passive opportunities. However, with plenty of homework, they can find properties in quality condition, located in popular markets where long-term profitability is possible.
Here are three investment properties where investors risk steep losses.
1. Vacant Land
First-time investors might know a friend or relative who invested in land years ago and sold it for impressive profits to a developer, or lucked out when that rural location became a coveted neighborhood. Although major profits are possible through vacant land investments, those cases are typically long-term ventures. In most cases, significant land value appreciation takes years.
While owners wait for increased property values, they pay annual property taxes without earning income from the undeveloped land. Taxes on vacant land are cheaper than developed properties, but the fees still increase the cost of the investment. Zero income generation, and guaranteed losses of annual taxes make vacant land an investment to avoid. Alternative investments offer shorter-term return potential such as stocks, bonds and positive cash flow rental properties.
2. Development Properties
Just as vacant land lacks positive cash flow, so do development properties. Without income generation, investors must pay significant costs beyond the initial purchase prices of the properties. Investors shell out exorbitant fees for entitlement and development authorization. The process typically requires approval from federal, state and local governing bodies to meet development regulations including land use, permitting, zoning and infrastructure codes.
This authorization process sometimes takes several months before the added cost of the construction begins – all without positive cash flow. Development properties are risky investments because they require long-term commitments for positive returns, and investors face expensive costs with challenging loopholes. Development properties are better opportunities for affluent, experienced investors.
3. Prize Vacation Homes
Another high-risk but attractive investment is the prize vacation home. Whether on a beach, near a national attraction or in an exotic, luxurious locale, sought-after vacation homes are often unstable ventures. Principally, the prices of these properties are bloated and therefore the costs of their mortgages are also enormous. With large mortgages comes high property taxes and pricey insurance.
Beyond this initial hurdle, vacation rental cash flow is fundamentally unpredictable because availability is often inconsistent. In the location of the property, how many weeks of each year are considered vacation season? How many of those weeks can the owner book annually? These answers might vary per year based on something as random as the weather forecast. Expensive vacation property owners also face major availability challenges when the economy struggles because travel is a luxury.
Provided mortgages are affordable and owners fully book their properties throughout vacation season, the costs of operation are enormous. Typically, vacation property operations cost 60 to 75 percent of the total property revenue, before the cost of the mortgage. Owners pay for utilities, amenities, general upkeep, cleaning services, emergency maintenance for vacationers, transaction processes and check-in/out services for guests. Therefore, prize vacation rentals leave narrow profit margins causing them to be high-risk investments.
Real estate investments are a gamble, and any property without proven, positive cash flow or at least the long-term commitment for potential appreciation is generally an unreliable, high-risk investment.
photo by: pfsurgeon