Are you risk averse? Or do you enjoy taking risks in your life?
While I believe that real estate investing is the easiest form of investing to get started, it comes with some risks. Sometimes this causes people to stay away from real estate. But by knowing the risks ahead of time, you can avoid them – or at least be more prepared for them.
For example, one huge risk is the chance of being sued. But you can protect yourself against being sued by using an LLC umbrella policy (read more about that here).
There are many potential risks in the real estate business. I’ve included some of the biggest risks below. Begin thinking about how these risks have either 1) kept you from getting started or 2) made you stall as you’ve tried to grow your real estate investing business.
Remember, knowledge is power. Gain some knowledge about these potential risks and you’ll be prepared to avoid taking a big risk!
Here are some potential real estate investing risks:
1. Problem Tenants
Tenants may be the biggest risk in real estate investing. If your renters aren’t taking care of your properties or paying rent, you have a big problem.
I have created a long list of suggestions to help you avoid this risk. If you can’t do all of these things, at least complete many of them.
- Go visit where they currently live. To me, this is more important than calling their previous landlord. You actually see how they take care of their belongings and their property.
- Call two previous landlords. If you can’t get ahold of two, at least call one.
- Use a detailed rental application.
- Check all references thoroughly.
- Get a credit report and criminal history.
- Use a printed lease that complies with your state laws.
- Address delinquent rents immediately. You cannot compromise on people paying their rent. Yes, sometimes people go through difficult times and you want to find ways to help them. It just shouldn’t be out of the rents that you owe—especially if you’re paying mortgages with those rents. You can get into a dangerous area of creating a co-dependent relationship with your tenant if you aren’t careful here.
- Enforce policies immediately. If you don’t want to allow pets, then don’t allow pets. If you cover all of these issues in detail and they sign the agreement, then you’re able to enforce policies. Make sure you don’t build a weak reputation.
- Require a security deposit and first and last months’ rent.
- Complete a Statement of Condition and have the tenant sign. This is an addendum to the lease. Basically, I go through the property and inspect everything’s condition. I list out the condition, and list out possible damages the tenant could cause. Then I put an average cost for those repairs on the Statement of Condition. If a toilet costs me $75 to unclog, then I put that on there for the tenant to see. Many tenants will expect you to fix it, but I put it as what’s called rent due. If the tenant needs a repair, then you collect the money for that repair the the next month. If they do not pay it, then you can proceed with an eviction.
- Check the property once a month. Your managers should check your property once a month and provide you with an inspection report.
I’m a big advocate of refinancing property if it’s appreciated properly. In 12-36 months you can refinance, pull cash out, and then purchase another property. But, unfortunately, many investors miss the pre-payment penalty.
A Pre-Payment Penalty is when you refinance a property within 12-36 months and the lender charges you a very high rate. This pre-payment penalty is sometimes 2-3% of the loan amount that you have to pay out if you want to either sell or refinance the property.
In most cases, for a real estate investor, it is much wiser to pay a little higher rate and to completely avoid the pre-payment penalty. No one should pay higher than they should, but there are times when it makes good business sense. You lose your flexibility to refinance and cash out of your properties if you have a high pre-payment penalty.
It all boils down to this: do your research and know what you’re doing.
3. Long Term Costs of Owning Property
I loved holding real estate. I enjoyed setting up management companies and the like. But it wasn’t always easy.
Holding real estate takes money. There are going to be times when you have vacancies. You are going to have unexpected repairs and unpaid rent. These things just happen. It’s part of the real estate risk. You must handle your property prudently and make sure your managers are being thorough.
Here are some target percentages for you:
- Vacancies: 5% is your target. Ensure that your manager is being aggressive about filling your vacancies.
- Unexpected Repairs: 5% is your target. Remember to build predictable repairs into your Statement of Condition (mentioned above) so this doesn’t happen too often.
- Unpaid Rent: 0% is your target. Always, always be strong on this issue!
Despite these risks, I still advise anyone who is looking to make passive income to try out real estate investing. It’s fairly easy to understand and control compared to other investments.
For every bad tenant, there’s a wonderful tenant. So, when done properly, you can truly build wealth through real estate investing.
What risk are you most afraid of and why? Share with me in the comments!
P.S. Thinking about getting started in real estate investing? Already in the game but want to grow your business? Come to the 2017 Real Estate Workshop! Find out more here.