The Only 5 Rules You Need to Know About Investing in Real Estate

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The numbers are impressive: The median existing home price for homes across the United States stood at $232,500 in April, according to the National Association of Realtors. That's up 6.3% from the same month one year earlier, and marks the 50th consecutive month in which median housing prices have increased from one year to the next.

This steady rate of appreciation might inspire you to invest in residential real estate. After all, the performance of the housing market during the last four years has been far steadier than that of the stock market. But be careful: Sure, investing in real estate can be profitable — but it can also be risky. Investors who don't do their homework before sinking their dollars into homes could lose a bundle of money.

Here are five rules you must know before investing in real estate.

1. Don't Let Your Emotions Betray You

Jamal Asskoumi, owner of the online real estate agency CastleSmart, says that too many inexperienced investors make the mistake of falling in love with a property for the way it looks. They then invest in it without running the numbers to make sure that the home has real potential to increase in value enough to make it a sound investment.

Falling in love with a property can also cause investors to spend too much on it upfront, making it nearly impossible for them to make a profit after their purchase.

"Unlike stocks that are numbers on a screen, property must be liked and appreciated before it can be invested in, and this is the downfall of many investors," Asskoumi said. "When visiting a property, investors sometimes become attached and feel as though they have to have it, regardless of the price. They end up paying more than what is necessary and lose on the investment."

2. Have Enough Money to Cover Both Known and Unknown Losses

Investing in real estate isn't cheap. You are buying a home, after all. But the real trouble spot for investors are the unexpected costs: If you rent out your investment, you never know what damage your tenants might cause. Fixing that damage could cost thousands of dollars.

You also have to be prepared for possible losses. Housing values can go down as well as up. You need the financial cushion to handle these fluctuations, said Rocky Lalvani, a financial coach and founder of the Richer Soul financial blog.

You also need the money to cover possible monthly losses until your property does appreciate enough in value for you to sell it and earn a big profit. Maybe your mortgage on the property you bought is $2,000 a month but you can only rent the home for $1,800 a month. You'll essentially be losing $200 a month while you wait for your investment to appreciate.

"Be prepared for losses; it's a cost of business," Lalvani said. "Real estate may lose money in the short term while your asset is building over the long term."

3. Don't Rent to Just Anyone

Finding good tenants is one of the biggest challenges in investing in real estate. The wrong tenants could damage your property, stop paying their monthly rent, and force you to evict them, a process that is long and costly.

That's why it's so important to do your research before renting out your home. Run the credit of potential tenants to determine if they've struggled to pay their bills before. Run criminal background checks, too, on potential tenants.

Above all, never simply buy into the promises that potential tenants make to you.

"Tenants will literally lie about anything and everything," said Eric Bowlin, a real estate investor and founder of the real estate investing blog EricBowlin.com. "Assume everyone has no job, no income, and a long eviction record, until otherwise proven."

4. Invest in the Right Neighborhood

You want to invest in an area in which homes are most likely to increase in value. Unfortunately, there is no guarantee that any home, even if located in a desirable neighborhood, will be worth more 10 years from now than it is today.

But investing in the right neighborhood can at least increase the odds.

Study what homes are selling for in any neighborhood in which you want to invest. Study, too, the average monthly rents that homes and apartments in a neighborhood fetch.

A neighborhood that is dotted with new restaurants and shops might be a good investment. So might be one that is gaining the reputation as being an up-and-coming area. Be careful, though: It's easy to spend too much upfront in these hotter neighborhoods.

Paul Ullman, founder and chief investment officer of Asset Based Lending in Hoboken, New Jersey, says that the key is to look at the strength of nearby schools and to target areas that have positive job growth. It helps, too, to know the neighborhood in which you are going to invest.

"Ideally, invest close to home, at least initially," Ullman said.

5. Know Your Limits

Before investing in real estate, be honest about what you can and can't do. If you're not particularly handy, you might not be able to repair that leaking dishwasher on your own, for instance, and might need a plumber to resolve the problem. That will add to the costs of your real estate investment.

You might also want to avoid 2:00 a.m. calls from tenants complaining that the heat in their apartment isn't working. To avoid these calls, you can hire a professional property management company to take over the daily operations of your real estate investment. Hiring such a company, though, costs money, and will eat into your profits.

"I always tell people who are interested in getting into investment real estate to consider how comfortable they are with doing any kind of repairs or construction to a house or rental property," said Todd Barton with the Atlanta office of Renters Warehouse. "You'll have to budget in the costs of contractors or professional property managers. Be honest with yourself upfront so that you don't get into a situation where you are overwhelmed with projects and mounting debts."

Have you taken the plunge and invested in real estate? What other rules should new investors stick to?