It is true that real estate investing can bring some serious returns in the medium and long run. Investing in real estate is often perceived as less risky than investing in stocks because you are very unlikely to just lose everything in real estate. However, people sometimes get the wrong impression that buying a rental property with the extra cash they have and a loan from the bank will definitely guarantee them quick returns with virtually no risk. If you yourself are considering buying a rental property and becoming a landlord, don’t be confused. Real estate investing is not risk-free.
In this article, we summarize some of the most popular and important risks that come with a rental property.
1. Buying Worse Than Expected Rental Property
Definitely, buying the right property in the right location is one of the most important factors that will determine how profitable your investment in real estate is. When you are choosing a rental property, remember that this is a business and a part-time job. You are not buying the home of your dreams to live there with your beloved ones. You are buying a property that will make money for you. In order to make some good profit, it is important not to overspend on this property before you even get your first tenant. Don’t get tricked by some unneeded extras while missing on major defects. Make sure you don’t buy a rental property that is more damaged than it first looks just because you are blinded by a beautiful fireplace or an amazing view from the window.
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To avoid the risk of buying a rental property that is in a worse shape than you initially thought, get an inspection. Bringing an inspector to the property you are considering will take a few hours of your time, but this professional will discover any hidden damages or problems that you will need to fix before renting out the property.
2. Not Being Able to Get Tenants
Buying a rental property does not automatically guarantee you 100% occupancy and quick profits. Once you’ve purchased a good property and prepared it for renting, you might get stuck finding tenants. This problem is especially risky if you’ve taken a loan from the bank to purchase the property expecting that the monthly rent will cover the mortgage payments. If you cannot find an appropriate tenant, you will have to cover the mortgage, insurance, property taxes, and other expenses from your other sources of income such as salary, savings, and other investments. Having said that, though, don’t make the mistake of allowing just any tenant to move into your rental property because you are so desperate to get some positive cash flow. The next point discusses the risks associated with having a bad tenant.
To minimize the risk of being unable to find a good tenant, you should do your homework well before purchasing an actual rental property. Make sure you choose a property that is in high demand. Choose a location with high occupancy rates. You can always consult Mashvisor to check out vacancy rates for properties in various neighborhoods around the US.
3. Having Bad Tenants
Obviously, getting tenants is a prerequisite for making money from your rental property. However, getting just any tenant does not guarantee you profitability. The risk of having a bad tenant and getting stuck with him/her could be even worse than the risk of not having a tenant at all. True, not having tenants means 0 rental income. However, if you get bad tenants, you run the risk of your rent not being paid on time while utility costs being accumulated. Additionally, depending on how bad your tenants are, your rental property might get more damaged that normal use supposes. If your tenant is a really bad one, refuses to pay the rent for several months in a row, and destroys the property too much, you might even risk dealing with an eviction. You will have to go to the local court, file a notice, schedule a court date, show up on that date, empty the property, and repair it. Actually, evictions are very costly (could reach a few thousand dollars) and time-consuming (up to a few months) procedures. Thus, it is crucial that you do everything possible to choose good tenants.
To try to avoid the risk of having bad tenants, go through the process of selecting tenants carefully. Put for yourself some unwritten rules about what kind of tenants you would feel most comfortable in dealing with. Meanwhile, make sure you don’t discriminate against potential tenants on the basis of age, gender, religion, social status, etc. When you choose possible tenants, ask for recommendations from previous landlords and/or employers. Write a very specific lease agreement. If you are unable to find good tenants, it might be a better idea to lower a bit the rent that you are asking for for your rental property than getting just any tenant to start receiving rental income. Another important thing – make sure you get the landlord insurance. It is higher than the insurance you pay for the property you live in, but the risks associated with a rental property are also higher. You want to make sure you have this insurance if you will have to deal with any serious damage caused by bad tenants.
Related: 8 Steps to Becoming a Landlord
Another option is to hire a professional property manager – either an individual or a company which will deal with your tenants directly. You will have to pay the property manager a fee, but this will save you a lot of troubles in communicating and following up with the tenants.
4. Higher Than Expected Expenses
Let’s face it. The cost related to being a landlord does not finish with the purchase of the actual rental property. Just like any other property, rental properties require constant expenses. You have the mortgage payment, taxes (higher than for your primary home), insurance (higher than for your home), and maintenance (potentially higher than in your home because of the risks associated with tenants). Ideally, the rental income will cover all these costs, and there will be plenty left to guarantee you a positive cash flow – that’s the goal, at least.
To avoid the risk of having to pay money for your rental property instead of making money from it, do your homework carefully before becoming a landlord. Do the math. Make the proper calculations before buying a rental property to know how much it will cost you and how much it will bring to you. Make sure you will get positive cash flow.
5. Real Estate Market Failure
The real estate market has been growing quite well in the past few years, but there is no guarantee that this positive trend will continue. One risk with investing in real estate is the concentration of assets. For most people, owning a rental property is a serious concentration of assets because purchasing this property will require a major portion of their net worth, potentially even all of it. Since as a landlord, your investment will not be diversified, if let’s say the neighborhood, the city, or even the national economy goes downhill, you risk losing lots and lots of money in depreciation.
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An option to avoid the risks of assets concentration and to diversify your investment is to pull your money with some other investors and launch a residential investment company. This is a small business for buying, renting out, and selling rental properties. It is very similar to what you would do as an individual investor but will give you the possibility of distributing your money as shares in several properties in different neighborhoods, cities, states, and why not even countries. In this way, you can minimize the risks associated with local economic and real estate market conditions.
While you should be careful when making the decision to enter real estate investing, please don’t allow these risks to prevent you from buying a rental property and becoming a successful landlord. Just make sure to consider the risks in advance and build a strategy for how to avoid them.