11 Mistakes to Avoid When Buying an Investment Property in Philly

Buying an investment property in Philly can be a rewarding and enriching experience. A good investment property can provide passive income and appreciation over time while your tenants pay down your mortgage. 

Of course, anything that is potentially lucrative can also be risky. Tenants might stop paying their rent while your lender expects its payments every month. The roof might need to be replaced, which could wipe out some of your cash flow for that year. Insurance costs or other expenses go up over time, and the list goes on.

There are lots of potential pitfalls if you are not prepared. For that reason, we’ve compiled a list of the top 11 mistakes you can avoid when buying an investment property in Philly.

Mistake #1: Not having a game plan (or strategy)

Like any other property purchase, your budget will inform your search location and criteria. However, when buying an investment property in Philly you need to know what type of investment you are looking for. To be successful, you can’t just want to be a real estate investor, you need to have a strategy!

Turn-key rental property

Are you interested in homes that need little to no work? If so, new construction is your best bet as these properties tend to have some abatement in place for property taxes, which keeps the overall annual expenses down (for a period of time). 

New construction homes are less likely to require major investments, though of course, that is not always the case! Things can and do go wrong in new development too. That said, you are also paying a premium upfront price for the new home so your yield might be slightly lower out of the gate relative to other types of investment property types.

Rehab for better rents

Alternatively, maybe you are handy or have a friend or contractor who can help with some renovations and you’re most interested in a fixer-upper to be able to increase rents? If so, every time you fix a bathroom or redo a kitchen or refinish the floors, you’re adding value to the property in some capacity. Of course you are investing your time and effort, also known as "sweat equity." And while that’s great, there are many risks. What are things to look for?

Mistake #2: Failing to budget appropriately

One of the most common mistakes, and easiest to avoid, is underestimating the overall carrying costs of an investment property or renovation budget. It’s easy to look at a kitchen and come up with a guess of how much it will cost to renovate, but unless you do home remodeling for a living, there are countless considerations that are easy to overlook or not even realize.

Like most systems, many things in a home are interconnected and codependent. For example if you just plan to add new cabinets, countertops and appliances, you will be better served putting new floors down at the same time. You don’t want old, tired flooring (or outdated tiling) underneath a nice, brand new kitchen. 

You will likely need to redo most of the plumbing as well. Will you add copper piping or use the new PEX systems? Will you put a garbage disposal in the sink? How deep will the sinks be? What level of granite will you use on the countertops -- the price ranges are wide. 

So take time, plan it all out and make sure you account for everything. Like anything, the more you know, the better off you’ll be. Do your research. Further, a licensed contractor can assist with this and make sure you avoid the pitfall of underestimating.

Mistake #3: Structuring your investment the wrong way

You certainly have a budget in mind for your targeted purchase price. You’ll also need additional funds for closing costs, renovation projects, or future carrying costs. 

Buying an Investment Property in Philly: All-Cash Example

• $500,000 - Purchase price
• $20,000 - Closing costs
• $150,000 - Renovation budget (optional)
• $22,500 -  Renovation contingency (recommended)

If you plan to pay cash to acquire the property, which is always great if you have it, you’ll need a total of about $550,000 in cash to complete the purchase (and more than $700,000 if you plan to do a major renovation, assuming the renovation costs are paid in cash too).

Buying an Investment Property in Philly: Financing Example

• $500,000 - Purchase price
• $125,000 - Down payment (equity)
• $375,000 - Mortgage (debt)
• $20,000 - Closing costs
• $150,000 - Renovation budget (optional)
• $22,500 - Renovation contingency (recommended)

In this example with financing, you’ll need a total of about $145,000 in cash upfront to complete the purchase (and more than $300,000 if you plan to do a major renovation, assuming the renovation costs are paid in cash too).

Even with financing, you still need a lot of cash but not as much as funding the entire deal out of pocket.

Mistake #4: Underestimating carrying costs

In the scenario with financing, it’s important to set extra capital aside for servicing the mortgage. Since you are taking out a mortgage to finance the acquisition, you’ll need to make your payments every month regardless if you are renovating or renting the property, so keep that in mind. 

Other expenses in both scenarios are property taxes, utilities (electric, gas, water), and insurance, all of which you’ll need to pay continuously during the rehab. Make sure to check with your insurance carriers for proper coverage as homeowners insurance doesn’t always cover construction or builders risk.

Largest Carrying Costs - Investment Property in Philly

• Mortgage payments
• Property taxes
• Homeowners insurance
• Repairs / maintenance
• Utilities

Mistake #5: Randomly choosing a contractor

The contractor you work with (sometimes called a GC) will make or break your Philly renovation project. Maybe a family member is a contractor. That’s great if you’re lucky enough to have one in your family, but for those who do not, you’ll need to find one. 

Make sure to vet, vet, vet! Check references and put together a thorough budget with very specific descriptions of the scope of work and make sure you include it in the contract for your protection. 

Things can and will go wrong so it’s important to find someone who is reasonable that you can work with. There should be give and take on both sides and if there isn’t, then you might be in for a rocky road. 

Worse, a bad contractor can delay the process, which can cost you thousands of dollars in mistakes. Or worse yet, an unvetted contractor could take your money and disappear without finishing the job. There are plenty of horror stories out there so make sure you know who you’re dealing with. 

Come up with a reasonable payment plan with your contractor. It is true they will need money up front to order materials, hire some sub-contractors and get started. Don’t pay the whole fee up front though. You want some money due on completion to incentivize your contractor to finish the job.

Mistake #6: Poor planning on the timing of a renovation

Not only do you need to know the financial logistics of owning an investment property in Philly, but it’s important to put together a time schedule for critical tasks. Because time costs money. And, like with your budget contingency plan, make sure to add extra time to your schedule for all the same reasons. If you think the project will take four months, plan for six.

Every day you’re not renovating or not renting is a day your property is not positively cash flowing. And any hiccup in a part of the project can cascade down the critical path, meaning what seems like an insignificant delay for one minor thing can ripple down the line. Again, time is money.

Give yourself a cash buffer for delays

It’s always crucial to add a contingency of at least 10% to the rehab budget, and even closer to 15%. The contingency gives you a buffer in case pricing for materials goes up -- prices can and do fluctuate. The contingency also gives you room to make change during the construction, meaning that you will likely decide to upgrade things either more than you originally intended, or you will find new challenges that were not planned for from the outset. Either way, there will be new line items that require money that you did not account for in the initial cost estimations.

What happens if you underestimate time or money?

If you underestimate, you’ll need to get more capital for your renovations and that can be a big problem if you don’t have any funds available. You might have to borrow because a half finished kitchen or renovation project doesn’t do anyone any good. It needs to be finished so you can rent it out and begin to recoup some of your costs. 

Mistake #7: Doing too much with a renovation

It’s important to renovate a property consistent with the neighborhood and the potential rental stream that the typical tenant can afford in that market. In other words, don’t do a champagne renovation in a beer-priced rental market. 

Some things that you spend money on will not necessarily bring you higher rental income. Some things will of course, but adding Sub-Zero or other high end appliances to a kitchen you’re remodeling in most parts of the city won’t necessarily translate to higher rents. Spend your money wisely and plan, plan, plan.

Conversely, it can be problematic if you don't renovate enough and not achieve the potential for the property. Making the rehab too simple or using finishes that aren’t as nice as tenants desire may detract renters from placing offers. Again, research is key!

Mistake #8: Setting aside too little for wear and tear

Keep in mind that your renovated property will be someone’s home. However, most real estate investors will tell you that tenants don’t always take care of the place as well as an owner does. There will be wear and tear on the property (renovated or not), and this means you’ll have to keep a fund available for maintenance and updates.

Mistake #9: Not having the time to manage the property

Who will manage the property for you? Will you do it? What if you move out of town? Will you be too busy with your job or responsibilities to be able to fix a leaky sink when it occurs at an inopportune time -- things will invariably happen at inconvenient times! It’s part of being a landlord! 

Property managers are invaluable partners. They look out for your interests, help source tenants and execute leases and keep the cash flow coming. Like any valuable service, it costs money in the form of a percentage of gross rents. Make sure to budget for management because it’s another expense if you aren’t managing the property yourself.

Mistake #10: Being bad with paperwork

This seems simple, but it’s crucial: Make sure to pay property taxes every year. Keep your insurance policies current. Track your monthly rents and expenses regularly to simplify annual tax season. Finally, if you are doing renovations, make sure you get the necessary permits for any projects that require them. You don’t want to have to re-do work if you didn’t get the necessary permits or inspections, nor do you want fines or stop work orders from L&I.

Mistake #11: Forgetting to speak with your accountant

Finally, check with your accountant or tax professional on the best practices for tracking the income from your investment property. Understand the key items you need to know before you buy a property. Tax implications of investment properties are not the same as for primary residences.

Wrapping up

If everything goes well, your Philly investment property will be a low-impact source of passive income. After some years, if the property was purchased at the right time and in a sought after location, it could appreciate considerably too. 

On the flip side, if not everything is planned or executed properly, this "investment" could be an endless source of discord and strife -- a veritable money pit that never returns a satisfactory yield. Worse yet, it could cost you significantly if you need to sell at a loss just to get out of it and cut the losses.

Real estate is illiquid and risky. How well capitalized you are and how well you plan and execute will determine if your investment property is a winner or not.

Interested in buying investment property in Philly? Browse listings and see how much you could save with Prevu’s Smart Buyer commission rebate in Philadelphia.