Real estate is my favorite asset class to build wealth. I own two properties in San Francisco, one property in Lake Tahoe, and one property in Honolulu.
I used to own another property in San Francisco but sold it because I got a great price and reinvested the proceeds in real estate crowdfunding for passive income.
My properties have been a boon to my net worth. But I also temporarily lost money during the financial crisis with my Lake Tahoe property because I wasn't thorough with my inspection. We're talking a 50% decline from peak to trough.
I've learned my lesson and want to share with you what to look for besides doing pro forma mathematical cost / return calculations.
I see property every weekend because I find visiting open houses to be a great hobby. Here are some red flags to be aware of before buying any property.
Biggest Red Flags To Be Aware Of Before Buying Property
I look for certain tell-tale signs that someone is trying to cover up minor issues, because if they are doing that, they’re probably covering up major issues as well. Here are some key areas I look out for.
* Inside versus outside condition. If the condition of either the inside or outside of a property is neglected, rest assured that it was all neglected and someone just spruced up one or the other. If the interior looks good with a fresh coat of paint and new carpet, but the exterior is crumbling, beware or hidden damage on the inside.
* Ownership history with rapid turnover. Check your county records and look at historical sales. Some houses are lemons and will change hands time after time. Maybe it's a problem with the condition of the property, but maybe there is a nasty neighbor that drives people away, or maybe you don’t realize that the property is 1/4 mile away from a rail line that will rattle you out of your bed 4 times every night.
* Look in wet areas for water damage that has been freshly painted over. This can be a sign of mold that has been concealed instead of correctly remediated. Look carefully at the underside of drawers and sinks in the kitchen and look for wallboard damage around toilets and tubs. Mold hides in dark, sealed places that are hard to inspect. Since mold can be dangerous to your health, don’t take chances here. A big culprit is right under the window sills. If you see soft sheetrock or warped sheetrock, you know there are leaks. And if the soft/warped sheetrock has been painted over, then you know the seller is trying to pull a fast one on you.
* Look for recent repair work on the HVAC. If there is any, make sure you get copies of the repair work so you know what the issue is and if it was actually resolved.
* Look for patched cracks coming from doorways and around staircases. Minor settling cracks are to be expected, but gaps over 1/4 inch that have been filled or cracks that run laterally across a wall can be signs of big foundation issues.
* Beware of deodorants or strong room fresheners. If they are trying to mask the smell of something, you need to figure out what it is. Be especially cautious if the usage is strong in an unfinished basement or crawlspace.
* Beware when music is playing in each room. The agent/seller is trying to mask the noisiness outside. I know, because this is exactly what I did when I had potential buyers come over. I turned on the central fan to create some white noise and played some music in the master bedroom.
* Areas the seller won’t let you see. If a seller won’t allow access to the crawlspace or a room in the property until you are under contract, they probably have something to hide.
* Be very wary of sellers that want to provide incentives to waive inspection objection rights. There is no reason to waive those rights unless there is something big to hide. Always have an inspection contingency because it is your leverage to get out of a deal or negotiate your price lower.
* Be aware of highly uneven floors. Settling is normal and there will never be perfectly uneven floors. However, it's good to note which rooms have the most uneven floors in case you want to fix them or search for structural issues. Always bring a marble to an open house and place the marble around different areas of the floor of each room. The older the house, the more important you do the marble test to see how uneven the floors are. Sometimes a house will aggressively settle, creating a hump in the middle. Deflections are costly to fix. And if there are very uneven floors, foundation work might be needed.
* No permits for work done. You should always ask to see the property's “3R report.” The 3R report is like the report card for your property. If the seller says they added a new deck, the new deck should be in the 3R report. If it's not, then there is a chance the deck was not built up to code, and may therefore be unsafe. There are some things that really don't need a permit, such as redoing a roof, remodeling a bathroom, or changing windows. You can easily tell whether the work has been done right or wrong. But for major structural and electrical work, a permit is very much preferred.
* Buyers with no other offers. If an amazing house has been sitting a while, and you are surprised it hasn't gotten an offer, you should find out why. People have inspected the house before, so there must be something wrong. Maybe it's just overpriced. But if it's not overpriced, you've got to find out the issue.
Be Super Vigilant With Your Inspection
Each time you visit the property you want to buy, put your inspectors hat on. Test the electricity and water. Inspect the foundation. Look at the electrical box and see if it is properly labeled. Bring a marble and a needle to inspect the floors and sheetrock. Don't forget to bring a notepad too. A good disclosure package will highlight all the problems of the property. But it's up to you to verify the problems are what they say they are, and not worse.
The reason why I sold my property is because it needed a new roof as there had been multiple leaks that were driving me crazy. Several windows in the back were leaking too.
I had a 20 year old HVAC unit that needed changing. And the kitchen and bathrooms were all remodeled back in 1995. I did not want to spend $200,000 updating the house because it was a rental. So I figured I'd sell it to a nice family who wanted to offer me $1,000,000 more than I tried to sell it for in 2012.
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About the Author: Sam began investing his own money ever since he opened an online brokerage account in 1995. Sam loved investing so much that he decided to make a career out of investing by spending the next 13 years after college working at two of the leading financial service firms in the world. During this time, Sam received his MBA from UC Berkeley with a focus on finance and real estate.
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