There are many advantages to owning rental property and earning passive income to safeguard a long term financial security plan and secure for retirement. To build wealth in real estate, investors tap into real estate investment opportunities located in prime locations to yield positive cash flow returns. Although owning rental property is a relatively safe investment, it is nevertheless important to take into account potential risks involved in rental real estate to hedge against major losses down the line. Whether it is the traditional real estate investment or short term rentals like Airbnb, real estate investors must conduct proper due diligence and property research before buying and owning rental property. This entails property inspection, real estate comps, expected expenses for maintenance and upkeep, property taxes and property insurance, and so on and so forth. The ultimate goal in real estate investing is to yield major return on investment in a steady manner, while at the same time mitigating the downside risk associated with owning rental property.
Risks of owning rental property
1. Risk of vacancy
Incurring high vacancy is a major blow to landlords’ rental income potential and one which can yield negative cash flow returns and burn a hole in the landlord’s pocket. To avoid, or better yet, mitigate the risk of vacancy, buy rental property in good residential neighborhoods with nearby amenities such as transportation facilities, shopping malls, and schools. Safer neighborhoods reap higher rental income and higher tenant occupancy than run down neighborhoods with high crime rates. It might be more costly to buy rental property in good neighborhoods, but it is a much safer real estate investment with less risk of prolonged vacancy. The negative repercussions of high vacancy are expenses eating into your return on investment; if you cannot find the right tenant, you will have to pay your mortgage, property insurance, and property taxes out of your own pocket. Having an emergency fund cash reserve might be a good idea if this case arises.
2. Choosing the wrong tenants
In tandem with the previous point, choosing good quality tenants is a major factor to mitigate the risk of frequent vacancies throughout the year. Be very selective and conduct proper due diligence to find the right tenants for your rental property. Choosing the wrong tenant will hurt your real estate investment in big ways and might cost you more than you bargained for.
Tips for choosing the right tenants:
- Verify their income
- Run a credit check
- Run a criminal background check
- Ask for two references from previous landlords
- Always take a deposit
- Trust your gut
3. Negative cash flow
Underestimating the cost of maintenance and expenses related to your rental property is the antithesis of positive cash flow returns. Conducting proper real estate market analysis and investment property analysis is the crux of a successful real estate business and high ROI. Experiencing negative cash flow returns is the result of negligence and lack of proper due diligence. If you expect to buy a property on a whim without thoroughly taking into account mortgage payments, property taxes, utilities, vacancy, ongoing maintenance, and any other regular or ad hoc expenses, you will be paying out of your pocket and lose a lot of money on your real estate investment. You must calculate your net profits every month, taking into account all the incurred expenses and costs of managing the rental property. It is crucial you run the numbers before sealing the deal. With Mashvisor’s rental property calculator, real estate investors can easily calculate a rental property’s negative or positive cash flow returns based on the monthly expenses. In this way, you can rest assured of whether or not the rental property in question is a worthy real estate investment in the long run.
4. Buying at the wrong time
Buying rental property during booming times might put you at risk at selling way below what you originally paid for. The housing market is cyclical and is constantly fluctuating, hence there is never a guarantee of making a profit when you decide to sell down the road. Buying real estate when the housing market is up will cost you a lot of money, so make sure the expected future return on investment is worthy the investment in the first place. In a seller’s market, property buyers don’t have the upper hand and might end you paying too much for buying real estate.
5. Risk of burglary
The location you decide for owning rental property is a key determinant of your rental income, the quality of tenants, and the occupancy rate throughout the year. Owning rental property in lower income locations will put landlords at risk of burglary as well as high vacancy. There will be a high tenant turnover if the rental property is located in rundown neighborhoods with a high crime rate. Moreover, the rental income will not be as high as when having rental properties in good residential areas. Owning rental property in dodgy neighborhoods could burn a hole in your pocket followed with courts and legal procedures.
If landlords incur negative cash flow returns and are unable to commit to their mortgage payments, they can put their rental property at risk of foreclosure. There are many factors which may contribute to a loss in home equity and a cripple in credit history, which may hurt your chances of getting bank loan approvals in the future. To mitigate the risk of forecloses, make sure you analyze and run the numbers before you go ahead and put a 20% down payment on your real estate investment.
Owning rental property is a great business venture for many people, and there are many perks along the way, including financial independence. Real estate investing is a business, and it should be treated as such, which means landlords must actively manage and maintain the rental property as well their relationships with tenants. With all this said, you can most certainly mitigate the risks and maintain a good return on investment on your rental properties in the long term. Owning rental property is one of the best investment strategies reaping great return on investment for many years to come.
Head over to Mashvisor to kick start your real estate investing business today!