There are many people who have become millionaires through real estate investing. However, there are a number of risks in real estate investing, which make it a tricky business. Such risks have made many investors lose a lot of money along the way. At the same time, these risks are what makes it so rewarding.
There are many types of risks in real estate investing and the first step in managing these risks is being able to identify them. Then you can learn how to avoid or minimize them. Keep in mind that taking proper steps to mitigate such risks may cost a little upfront but it will pay off in the long run.
Here are 5 common risks in real estate investing and how to limit them:
1. Risk of Bad Tenants
Having bad tenants is one of the main risks in real estate investing. For a rental property to make money, you will need tenants. However, not all tenants will guarantee profitability. Some tenants are risky because they may default on the rent payment for several months or cause major damage to the rental property. Some tenants can even steal from you or cause other bigger problems. Moreover, dealing with tenant evictions can be quite time-consuming and costly. It is sometimes even better to avoid renting out your investment property rather than being stuck with a bad tenant.
Although it is hard to entirely eradicate the risk of bad tenants, you can limit it by having a good tenant screening process. Make sure you carefully screen your tenants before allowing them into your rental property to ensure that they are responsible tenants. You can check their credit score and even contact their previous landlords. Furthermore, you should always collect a security deposit and have strong documentation to back you up in case of a disagreement. Documentation will be used as evidence if you go to court.
Related: 8 Things That Make a Good Tenant
2. High Vacancy Rate
A high vacancy rate is also another example of the common risks in real estate investing. Simply because you have an investment property, that does not guarantee that you will have tenants.
The rental income that comes from tenants is typically used to cover property expenses as well as provide a profit. So without it, your rental properties will be costing money instead of earning money if they are not occupied. This can spell doom for your real estate investment, especially if you are relying on the rental income to pay off the mortgage, property taxes, insurance, and other expenses.
To avoid vacancy risk, choose a location that has a high occupancy rate and rental property with high demand. You can use Mashvisor’s real estate investment tools to check out the occupancy rates of neighborhoods and investment properties in various cities in the US.
3. Hidden Structural Problems
Hidden structural problems are also among the common risks in real estate investing to be aware of. It is possible for a property investor to end up buying an investment property that has hidden structural problems. These hidden structural problems may sometimes be serious and bring unexpected costs in repairs and maintenance. One hidden structural problem can turn a lucrative project into a money pit. It is always better to walk away from this kind of investment property than to get into a bad deal.
To avoid these kinds of risks in real estate investing, you need to conduct a proper evaluation of the state of the investment property before buying it. With most buildings, it can be difficult to gauge the necessary repairs just by looking yourself. So hire an expert in property inspection who can discover any hidden problems that need to be fixed for you.
4. Risk of Negative Cash Flow
In real estate investing, there is a risk of failing to make any profit. Even worse, real estate investing can lead to major financial losses. This occurs when the rental income is lower than mortgage payments, taxes, and expenses. The investment property, therefore, generates negative cash flow. If an investment property cannot yield sufficient monthly income to cover its operating expenses, then it is not a viable investment.
Real estate investors should know how to find and analyze a good real estate investment. To find properties with positive cash flow, you must perform thorough real estate market analysis and investment property analysis. Calculate your rental income and expenses before purchasing an investment property. You can use Mashvisor’s rental property calculator to compute rental income and cash flow of rental properties depending on the monthly expenses.
Related: Real Estate Investing 101: How to Find Positive Cash Flow Properties in the US Housing Market
5. The Unpredictability of the Real Estate Market
The unpredictability of the real estate market is also one of the main risks in real estate investing. Even though the real estate market has had positive growth in the past few years, there is no guarantee that this trend will continue. All real estate markets have ups and downs depending on economic conditions. The economy has a huge influence on the value of an investment property. If the economy of the city or neighborhood goes downhill, the investor may lose money as the rental depreciates. There is no guarantee that you will sell an investment property at a profit when you decide to sell.
You can limit this risk by diversifying your portfolio with income properties in multiple locations. Real estate investors should also understand the economy and be able to forecast any downturns. This way, they will be able to determine the best time to buy an investment property. Studying housing market trends, like whether it’s a buyer’s market or seller’s market will also help you make the best decisions and limit risks when buying an investment property.
Related: 8 Tips to Mitigate the Common Risks of Becoming a Real Estate Investor
Bottom Line
Making money in real estate and building wealth would be easy if there were no risks. However, investing in property is a risky business. Only those that are not afraid to face the risks in real estate investing and know how to deal with them are usually successful.
Ensure you take the time to learn the risks in real estate investing and how to manage them. Whether you are experienced or you’re a beginner real estate investor, it’s always wise to be prepared. With proper education and a smart strategy, you will be a successful real estate investor.
Mashvisor provides real estate investors with the essential tools to make the best real estate investments with a good return on investment and limited risks. To start looking for and analyzing the best investment properties in your city and neighborhood of choice, click here.