Even if you are not brand new, it is sometimes helpful to get a very general view of things in order to deepen and understand them better.
Before you even talk about the risks, there is one thing you should be very clear about when it comes to rental properties: the numbers. When I first got interested in real estate, I didn’t know how to quantify a potential rental property, and since then I’ve learned that most people really don’t have a clue about it.
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The truth is that most properties are not a good investment in rental property.
I usually hear that properties that are not financially viable as rental properties are in the 80% or so range. Why is this? Because the numbers don’t work.
What do I mean by “the numbers don’t work?” This means that your actual expenses (which are usually higher than what people assume) will exceed the income from the property and therefore you will lose money. Losing money is not the point of investing. Make money is.
All of the risks associated with rental properties are directly related to the numbers. I can point out the risks of rental property to you, and you will understand them well enough. But when you really know more about the numbers and what it takes to actually get returns from them, the risks will make all the more sense.
All seven of these risks have one thing in common: they all cost you (the owner) money. Do you see the logic there? If the whole point of owning a rental home is to make money, then all the risks of owning a rental home would be associated with losing money, right? Say yes.”
If you wish, you can alternatively formulate the question “What are the risks associated with owning a rental apartment?”. like: “What are the possibilities of losing money with a rented apartment?” Choose your poison. Again, a seemingly pointless distinction for the more advanced investor, but at the beginning of learning all of these things, certain distinctions are not that pointless.
In no particular order, here are the top seven risks of owning rental property (aka the seven most likely ways of losing money on a rental property).
1. Job offer
Unfortunately, vacancy is a bigger financial problem than most buyers realize. Be aware that the tenant can break a contract unexpectedly and move out at any time. In the case of vacancies, you will deal with:
- Loss of rental income that you absolutely have to take into account if you are currently paying a mortgage on the rental property
- Sales-related repairs
- Payment to an agent who manages your property (usually the equivalent of a month’s rent)
While vacancy costs are a risk, there are some things you can do to avoid them.
- Buy in a growing market, not a saturated one. You don’t want a market with an oversupply of rental properties from which a potential tenant can choose.
- Find out about vacancy rates in the general market and submarkets so that you have an advance idea of what to expect.
- Don’t buy investment property in a neighborhood that usually only attracts owners, which means it will be difficult to find tenants for the property.
2. Damage, repairs and maintenance
The cost of fixing things can be across the board – and sometimes it can cost more than recognition. Minor repairs could cost less than $ 100 while larger repairs could cost tens of thousands of dollars, with all possible costs in between. These fixes could include theft or damage caused by tenants, as well as wear and tear or maintenance at the CapEx level. Here are some of the more serious issues to be aware of.
- water heater
- Structural problems
- Internal wiring
- Something you didn’t know when you bought the rental property
There are several ways a landlord can minimize the risk of high costs from repairing a rental home.
- Never buy a property without getting a full, professional property inspection done.
- Always estimate the costs in these calculations and be financially prepared for minor repairs as well as CapEx maintenance and the like.
- Have a prospective tenant fill out an application that includes a look at their rental history and bank statements to ensure they are good quality tenants. This isn’t always foolproof, but it does reduce the chances of getting burned financially.
3. Lower rents
The risk of rent reductions arises in cases in which the economic framework conditions of the market change in such a way that you can no longer generate as high rental income as you used to be. When general rents go down, you need to go down in rent too to stay competitive. This means you may have an income level that doesn’t necessarily support the property’s spending level.
The advice for landlords who want to avoid market volatility is to buy in a solid growth market – not just a stable one (and certainly not a declining one), but a solid growth trend.
4. Decreased real estate value
If the neighborhood where you bought your rental property suffers multiple foreclosures or short sales, the value of the entire neighborhood depreciates. This is important if you intend to buy, sell or refinance your investment property. You never want to be in the situation where the market for your rental housing collapses to the point where you cannot collect high enough rents (or rents) to cover your expenses and you as a landlord are flooded.
There is an easy way to avoid the risk of potentially falling property values: buy in a growth market. When a market grows, values should rise. When a market is down, values are likely to go down.
Plus, you don’t want to buy at the top of the market (when real estate is the most expensive). Take a look at the history of the other properties in the neighborhood and remember to avoid buying property for rent in a neighborhood full of foreclosures.
5. Market Unpredictability
It is important to consider the role of the market economy in the future value of investment properties. When buying investment property at peak times, it is important to remember that if the market moves away from the top, its value at the time of sale may have dropped dramatically. Even if you generate significant rental income, the depreciation of the property can result in more expenses than you have received from your tenants.
The best way to avoid this negative equity problem is to do a thorough research of the market economy and gain a deep understanding of the market economy. Once you have the knowledge to forecast the long-term results of a rental property investment, you can determine if it is the right time and type of property for you to invest in.
This can also be conveyed by adding many types of investments to your portfolio such as apartments, shopping malls, REIT funds, and office buildings.
6. Bad location
Location, location, location! If you’ve never heard this phrase before, the real estate business is not for you. Choosing a good location is one of the very first things real estate investors need to consider. While some lower priced locations may seem like a bargain, keep in mind that neighborhoods with high crime rates have lower property purchase prices. This means that you run the risk of your rental property being destroyed or robbed, which you would have to pay to repair it.
While choosing a poor location may seem like one of the biggest risks when buying and holding real estate, some investors still choose to take the risk because the purchase price is so low. This can be a good idea if you have the additional capital and the neighborhood is showing signs of future property development. If things go in the right direction, the neighborhood’s location can be worth the risk of investing in the long run.
7. Negative cash flow
After you’ve paid your mortgage payments, expenses, and taxes on your rents, the remaining profit is defined as your cash flow. When your income from rent collected from your tenants is less than your expenses, you have a big problem – negative cash flow. Of course, you want positive cash flow for your investment property because you’ve invested primarily to make a profit.
The best way to avoid negative cash flow is to thoroughly calculate all of your expected and unexpected expenses before buying the property. This includes the calculation of possible repair and maintenance costs, management costs and vacancy rates. Even the smallest expenses add up in the long run, so these financial estimates are essential to the pre-purchase process.
Buying rental property – also known as a buy-and-hold strategy – helps investors secure both stable cash flow and equity. In this method, real estate investors buy properties and rent them out over the long term while the value increases. BiggerPockets Buy and Hold Strategy Guide shows you how to analyze rental markets, budget for your investment, choose the best property, and finance your purchase.
Are you ready to invest in rental property? Start With Buy And Hold: An Investor’s Guide To Buying Rental Property.
Real estate investors know that there are risks associated with every single method of buying property. If it weren’t for that, more people would.
You can never completely eliminate risk, and things can happen even when the highest level of risk mitigation has been achieved. So you always know what you’re getting yourself into. Instead of completely coping with analytical paralysis, spend some time studying the risk factors associated with each investment opportunity.
Ultimately, investing in real estate should be fun. Be smart but have fun with it. They know what they’re saying – no reward is risk-free. Now that you know how to identify and avoid seven of the biggest risks of buying and holding real estate, have fun making your first investments.