Risks Associated with Real Estate and How to Avoid them

Investing is the process of investing money into an item to gain profitable returns.

Essentially, when you invest, you are putting your hard-earned money on the line under the notion that you will create a larger future wealth off the initial investment. There is no such thing as a risk-free investment. Investing can be risky, regardless of what you are investing in.

While investing is never 100 percent risk-free, there are types of investments that bare smaller stakes. Real estate is one of these. Real estate comes with its own set of risks. However, with a little foreknowledge and some creativity, avoiding these risks can be easier than playing the stock market.

Risk #1: Debt

Investing in real estate is a much heftier investment upfront than say placing $500 on the stock market. However, there are financing options that can help you get started. These options come with risk and must be weighed against all other options.

The real estate market can be fickle, experiencing ups and downs just like the stock market. If you finance a property at one price, the home may end up being worth less on resale if the market takes a downward turn unexpectedly. One of the worst things that can happen to an investor is finding themselves saddled with a property that cannot be rented or sold due to their expenses being greater than the current market.

Solution

When considering financing real estate, make sure to take on only the best deals—evaluate the area and determine if the market value in that specific neighborhood has been holding strong over the years. Check current and future development plans in the area and analyze how strong the job market is in the community. Consult with an industry professional—whether your real estate agent or an investment specialist—regarding the value of the property and the current market trends before making any purchase.

Risk #2: Tenants

It is impossible to discuss real estate investment risks without covering the subject of tenants. Regardless of how great of an investment your property is, without the right tenants—you are likely to be looking a money pit. Tenant selection is one of the biggest risks you can take with a property, especially if you are new to the rental industry.

Solution

Consider hiring a third party, such as a property management company, to handle your tenant selection. Having an experienced professional review your potential candidates is a safer route, as they are more adept at spotting red flags. These companies also understand how to run the appropriate checks on each tenant—background, credit, and references. It is the property management’s job to mitigate some of the risk involved by placing a highly qualified tenant in your property, that will perform long term.

Risk #3: Vacancy

When renting a property to tenants for cash flow, you always need to consider the possibility of vacancy. Vacancy can happen to any landlord—at any point in time. Vacancy can be an expensive issue, especially if you have financed the property. Whether you have tenants in place or not, bills still have to be paid.

Solution

While you can never really be free of the risk of vacancy, you can take steps to reduce the complications caused by the issue. Assuming you will have a 30% vacancy period at any given time will give you a buffer if the situation does arise. Keep a small nest egg of cash set aside to cover expenses for the down periods whether or not you feel you have reliable tenants.

Hiring a property management company that only collects their fees while the property is occupied is another great trick in minimizing vacancy. If the vacancy affects their pocket as much as yours, you are more likely to see your property filled with high quality tenants than if you were working alone.

Risk #4: Property Issues

Even if a property looks good on paper, don’t assume it is a good deal. The numbers may be great and the photographs may be amazing, but don’t be fooled by that river rock wall in the shower or that new shiny range in the kitchen. Sometimes there are major issues that can’t be seen through photographs and you may end up purchasing a property that is going to cost you more than you can imagine down the road.

Solution

To avoid getting caught by the shiny frivolities an agent may be pitching to you, always hire a third-party home inspector to give the property a thorough check. The inspectors know what to look for and can point out serious concerns that you may not see at first look.

Risk #5: Natural Disasters

When investing in something solid, like a rental property, you always have to take into account that Mother Nature may have other plans. Floods, earthquakes, tornados, hurricanes, and other severe weather can wreak havoc on your rental property and cut into your cash flow if seriously damaged.

Solution

Nobody can plan for a natural disaster, right? Wrong. When researching areas to purchase your investment property, try to avoid areas known for reoccurring severe weather. Keeping adequate insurance on the property will also help to avoid any major losses if something does occur.

Real estate investment can be a profitable venture for investors of any caliber, unlike many other forms of investment. There will always be risk involved when investing money, but with a little due diligence, an investor can safely capitalize on the rental property market with minimal risk.