Costly Mistakes to Avoid When Buying Investment Homes in California

California is a popular market for residential real estate investors. The Golden State has a strong economy, a high population growth rate with frequent property turnover, and a diverse range of markets.

This makes California a great place to buy investment homes, whether it’s part of a “fix-and-flip” business model or for long-term rental income.

Part 1: Why California Is a Popular Market for Investors

California earned its nickname as the “Golden State” during the days of westward expansion, partly driven by wealth-seeking prospectors in search of gold.

Today, California offers a “golden” opportunity for real estate investors who want to earn a strong return. It’s a good real estate market in which to buy an investment home, and for several reasons:

• Strong economy. California has one of the strongest economies in the world. This means there is strong demand for housing in the state, which can lead to higher rents and property values.
• Population growth. California has experienced steady population growth over the past 70 years. This long-term growth creates a constant demand for housing in the state, which can be beneficial for investors.
• Diversity of markets. California has a diverse range of real estate markets, from urban centers to rural areas. This increases the chance for investors to find properties that fit their investment goals and risk tolerance.
• Strong rental market. The rental market in California is strong, with a low vacancy rate and high rents. Because of this, investors can generate a steady stream of income from their rental properties.
• Potential for appreciation. Home prices in the Golden State tend to rise steadily over time, despite occasional dips during recessions or anomalies. Investors could potentially enjoy steady appreciation over time.

Part 2: Investment Home Buying Mistakes to Avoid

Despite the great opportunities for investment in California, there are some common mistakes and pitfalls to watch out for along the way. Here are nine of them.

1. Neglecting thorough research

Before investing in California real estate, research the local market extensively. Analyze property values in the area you’re interested in, study rental rates to understand potential income, and examine vacancy rates to gauge demand. Look into neighborhood trends, such as upcoming developments or infrastructure projects, which can impact property values and rental demand.

2. Overestimating rental income

Overestimating the rental income for an investment home can lead to disappointing returns and financial setbacks. You can avoid this common problem by thoroughly researching rental rates for similar properties in the area. Consider factors such as property size, location, amenities, and market demand. It’s important to be realistic about rental income to ensure positive cash flow and a healthy return on investment.

3. Ignoring the total cost of ownership

When evaluating an investment property, consider all costs associated with ownership. Calculate property taxes, insurance premiums, maintenance expenses, and potential homeowner association fees. Failure to account for these costs could cause financial burden and limit the profitability of your investment.

4. Underestimating renovation costs

If you plan to renovate or make improvements to the property, be diligent in estimating the costs involved. Obtain multiple quotes from contractors, factor in material costs, and consider any unforeseen expenses that may arise during renovation. Underestimating renovation costs can quickly eat into your potential profits.

5. Disregarding location

California’s real estate markets vary widely, so you’ll want to carefully consider the location of your investment property. Research the neighborhood’s desirability; proximity to amenities like schools, shopping centers, and transportation; and access to employment centers. For example, California investment properties located near universities or major employment hubs tend to attract a steady stream of potential tenants.

6. Skipping property inspections

When buying an investment home, it’s always wise to conduct a comprehensive property inspection before finalizing the purchase. Hire a qualified home inspector who can identify any underlying issues or necessary repairs. Inspections can reveal problems such as structural damage, plumbing or electrical issues, or the presence of pests. Skipping inspections, on the other hand, could lead to unforeseen expenses or even legal issues.

7. Underestimating the time and effort required

Managing an investment property takes time and effort, so be prepared for the responsibilities involved. This includes finding and screening tenants, addressing maintenance requests, and managing finances related to the property.

8. Relying solely on appreciation

While property appreciation is desirable, you probably don’t want to make it the only component of your investment strategy. Long-term home price appreciation can be uncertain, even in California’s strongest real estate markets. So you’ll need to consider cash flow from rental income (or profits from resale) when evaluating the viability of your investment.

9. Not seeking professional advice

Real estate transactions can be complex and costly. So it’s always wise to seek professional advice. Consult with an experienced real estate agent who knows the market where you’re planning to buy. You might also need to work with a real estate attorney to review contracts and ensure legal compliance. Financial advisors can help you assess the feasibility of your investments and build a sound strategy around them.

Part 3: Types of Loans Commonly Used by Investors

While real estate investors in California have many financing options to choose from, most of them use one of the five types of loans mentioned below. Popular options include hard money and private money loans, along with the debt service coverage ratio (DSCR) loans. So let’s talk about what they are and how they work.

1. Conventional mortgage loans

Some real estate investors use traditional or conventional mortgage loans to finance their investment properties. But there are certain pros and cons to consider when choosing this option.

On the upside, conventional mortgage loans typically offer the lowest interest rates among all financing options. This means investors can save money over the life of the loan. Additionally, conventional mortgages offer longer repayment terms, which allows you to spread the payments over a longer period to reduce their size.

On the downside, conventional mortgage loans tend to require more documentation and take longer to process. The qualification criteria can also be stricter, when compared to some of the other financing options below. Because of this, some real estate investors in California avoid conventional mortgage financing.

2. Hard money loans

Hard money loans are a type of short-term loan often used for fix-and-flip properties. They typically have higher interest rates and fees than conventional loans, but they can be a good option for investors who need quick access to cash for purchasing properties.

Hard money loans are called “hard” because they are typically secured by a hard asset, such as real estate. They’re often issued by private lenders or investors, rather than traditional banks or financial institutions. The qualification process and loan amount will depend on the value of the collateral property, rather than the creditworthiness of the individual borrower.

3. Private money loans

Private money loans are made by individuals or groups of investors, rather than banks or other traditional lenders. They can be a good option for investors who have difficulty qualifying for a conventional loan, or who need a loan for a property that is not considered to be a good investment by traditional lenders.

Private money loans typically have higher interest rates and shorter terms than traditional loans (a common theme among alternative financing options). This is because private money lenders are taking on more risk, as they are not backed by the government or a financial institution.

4. Home equity loans

Home equity loans are secured by the equity in your primary residence. They can be used to finance a variety of expenses, including the purchase of an investment property. Borrowers can often obtain up to 85% of their home equity (which is the value of the property minus the amount owed on the mortgage).

Home equity loans typically have lower interest rates than credit cards and personal loans, but they can have high closing costs. They can be a good option for investors who have a lot of equity in their primary residence and need to borrow a large amount of money.

5. Debt service coverage ratio (DSCR) loans

Debt service coverage ratio (DSCR) loans are a type of commercial real estate loan that is based on the cash flow generated by the property. To qualify for this type of financing, the borrower must be able to demonstrate that the net operating income (NOI) of the property will cover the loan payments, with a margin of safety.

California real estate investors use DSCR loans because they provide a way to finance income-generating properties. They tend to require a lot less documentation when compared to a conventional mortgage, and typically offer a much faster closing timeline as well.

Ready to Explore Your Financing Options?

The truth is, there is no single type of loan that works best for all real estate investors in California. Investment property purchases can involve a lot of different variables. So you have to choose the right type of loan for your particular financing goals and income situation.

Bridgepoint Funding works with real estate investors and borrowers all across the state of California. As a mortgage broker with a diverse group of partners, we can offer most of the financing options explained in this article.