Foreclosures and bank REOs are pulling a new wave of novice investors into the market, some of whom "are just plain clueless, to put it bluntly," says Robert Cain, a long-time rental market and real estate management specialist based near Tucson, Arizona.

"They see the price and they way, wow! I can buy that house and turn it into a rental," says Cain, who lectures around the country and online about investing intelligently.

"But they don't understand the local market, they don't understand landlording, and don't even necessarily visit the property," Cain said in an interview last week with Realty Times.

For example, a property manager in Tennessee called Cain for advice recently. The manager had a simple question: "Should I fire my client?" who lives in California and purchased rental real estate 3,000 miles away in Tennessee -- sight unseen because the low price made it sound like a steal.

But the property had a long list of defects requiring costly repairs, and it was slow to rent - causing the absentee owner-investor to blame the property manager for the cash drain.

"We see it constantly," said Cain. "New investors think it's easy. They buy on emotion, on low pricing, rather than buying with a disciplined plan.

What are some of the key rules for freshman class investors? Here are a few of Cains' that have served him well since the early 1980s:

Number one: Due diligence is never optional. You've got to understand the local market - and that includes not just where prices are headed, but specific market demand for rental real estate in this price segment, and even the local government's plans for the area where you're thinking of buying.

Number two: Buy with a written plan - that's right, just like the large professional investors use, with an entry strategy and an exit strategy. How long are you going to hold onto the property, how much will it earn you during your period of holding?

And what's the endgame - a sale to another investor? Conversion to condos? Tear it down and build something that's closer to the underlying real estate's highest and best use?

"Write it all down," says Cain. That way you can analyze it better.

Number three: Calculate the actual costs of the property in advance - not just the bargain basement price, but how much you'll need to fix it and feed it - the management costs, rental commissions, vacancy costs, taxes, to name just a few.

"If you don't know these things up front," says Cain, "you are flying blind. And there are no good surprises in real estate."

Published: October 23, 2009

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Kenneth R. Harney writes an award-winning, nationally-syndicated column on housing and real estate from Washington, D.C. He is also managing director of the National Real Estate Development Center, a professional education company. He is a past member of the Federal Reserve Board's Consumer Advisory Council, a committee that by federal statute reviews all Fed actions on home mortgage, consumer credit and banking industry regulation. He served as a member of the U.S. Department of Housing and Urban Development's Working Group on Computerized Loan Origination (CLO) systems, and is a member of the Editorial Board of the Fannie Mae Foundation's journal, Housing Policy Debate. He is the author of two books on mortgage finance and real estate.