What Are the Risks of Investing in Real Estate?

Daniel Penzing
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Risk #1: Choosing the Wrong Location

The beauty of investing in real estate is that there is always a potential buy. That’s also the danger. You cannot simply choose a new location and expect it to be a profitable investment. Before investing your money, do your homework.

Does the location already have a handful of rental properties?

If there’s already a rental market, developers will follow. If possible, you should rent out a property in the new location for 6-12 months. You won’t see the full benefits of the rental income right away, but you will definitely see the value in having already established a rental market for other investors. Be sure to invest in a location where you not only have a rental market, but where there is still demand to create a rent market.

Is the new area growing steadily?

If there is a distinct lack of rental properties in a steady growing area, then renting could be a lucrative investment. If you are able to rent out your property within a few weeks after its completion, there is a good chance you’ll do fine in the rental market.

Is the new area a popular place to live?

Even if the area is steadily growing, if the location you have purchased your home is not a place many people want to live in they may not rent the property.

Things to Research

Investing in real estate depends primarily on how much you are willing to learn. If you do not have the time to research properties and do your homework, this may be a risky investment for you. There are many real estate investors that are still successful even in difficult economies.

The key to learning more about investing in real estate is to gather information. Here are some things to look into while you do your research:

  • How does the real estate market work in your state? Is the housing market price going up? Is the market for rentals going up?
  • What is the occupancy rate for rental properties near you?
  • What is the average rent for different sized properties and the market value of small businesses around you?
  • What are the property taxes for you and your investors?
  • What is the unemployment rate in your area?
  • What is the average salary for the state?
  • How much of the population in your area benefits from housing subsidies?
  • What is the crime rate in your area?
  • Is your local school district stable?
  • What are the demographics in your area and how do they compare to other cities and states?

Why Location Matters

No matter what you buy, location is going to be an important consideration. This is even more true if you’re investing in real estate. Sure, a beautiful lakefront property can go for a premium price in a remote corner of the world, but if there’s no surrounding infrastructure and no way for it to be developed, what’s the point of buying it?

Many real estate investors like to focus on purchasing distressed properties and flipping them for a profit or renovating them to sell at a higher market value. But the key to this approach (or any approach) is that you have to know exactly what you’re getting into.

For example, let’s say you’ve found a property that’s situated along a beach that’s the unofficial gathering location for half the community. Because of the area’s popularity, there’s a greater chance the property will appreciate faster than other types of real estate in the area.

Risk #2: Paying Too Much (Or Not Getting What You Think You Paid For)

You’re always at risk of paying more than necessary. Home prices always seem to go up, but that doesn’t necessarily mean the purchase was right for you. One of the best ways to avoid paying too much is to make sure you’ve done your research and understood all the pros and cons properly.

On the flip side, it’s also possible to pay too little. For example, if you rent out a property, there’s a good chance you’re not getting the maximum profit you could be getting. The market value of some properties may decrease over time, so you may be leaving money on the table with a rental.

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Risk #3: Bad Tenants

If you are not very good at the same time at screening potential tenants, there is a risk that you will get a problem tenant. Problems range from your tenant not paying rent to marijuana growing or shootings taking place on the property. Let us take a look at some of the risks that you may deal with when you have a bad tenant. Let us take a look at some of the risks that you may deal with when you have a bad tenant.

Security

When you have a problem tenant, you will end up having a problem with the security of your property. There will be a need for constant vigilance by you as a landlord over your property. There will even be a requirement that you remain close to your property at all times.

It is not just unsafe for you to walk around your property at all times, it is also dangerous for you. Robbery, theft, vandalism and even violence can be expected if you are not careful in choosing and keeping tenants.

Unwanted Guests

When you have problem tenants, you are likely to have strangers walking around your property. This will involve a lot of time in ensuring that the problems that they are causing do not escalate.

Risk #4: Vacancy

Real estate investors often focus on the rewards associated with the business, including the quicker repayment and the lower interest. The risks they often overlook, however, can lead to losing money quickly and compromising the longer-term outcome of the investment.

The risk of vacancy is often not a concern for real estate investors. This is because market trends suggest that it is less likely for you to become vacant in a certain location or region. If your location is in demand, then you should sell your properties either directly or through an agent; alternatively, you can sit back and enjoy that it remains completed and generates a steady income flow. However, what if you have risky areas, and/or you experienced a bad location in the region? Then the chances of making a profit are unlikely, some investors have tried to guess how long it takes for the property to sell, based on industry data and other factors, the most common guesses are 6 months, 9 months, or 12 months. Although you are guaranteed a great return on investment in this period, you have to keep in mind the risks of losing your investment. Suppose, between 6 to 12 months, no one is interested in the property, and it stays vacant.

Risk #5: Negative Cash Flow

Real estate investing definitely has its risks, and one that should keep you up at night is cash flow. Cash flow is basically how much money you make or lose on a property each month. The benefit of real estate investing, of course, is that you can hold onto an asset for a long time and receive income from it in the meantime.

However, this can backfire as well because if you pay more in expenses than the property brings in each month, that’s called negative cash flow. It doesn’t matter how great the ROI on your property is if you only have several negative months to go before you break even.

The main culprit for negative cash flow is a high-interest mortgage – if you pay too much in interest each month, it will deplete your cash flow quite quickly. You can protect yourself from negative cash flow by knowing, going into the investment, how much you can afford to pay in terms of both principal and interest.

Also, keep in mind that just because you made positive cash flow one month, that doesn’t mean that you’ll do the same next month. When you invest in real estate, the market changes. Things happen, and those things will always have an effect on cash flow.

Risk #6: Real Estate Market Unpredictability

You can track real estate markets like other aspects of the economy, but it’s not always reliable. Some markets swing quickly while others change slowly, and if you’re relying on market trends to get the best return, it can be frustrating.

The other risk is that real estate has decreasing returns and the faster you want to invest, the smaller your return. This is because investors buy property in areas that have the best returns, and those areas with the best returns will cost more and will give a smaller return. So, the faster you want to invest in, say, New York or San Francisco if it’s slower, the less the return, and the slower you get in, the more the return.

Other risks with real estate investing are location, financing, government regulations, and local demographic trends. You need to consider all these things before you choose to invest in a particular market. But on the whole, real estate is a solid investment with a strong return that can be less risky than other forms of investing.

Risk #7: Becoming Over-Leveraged

Real estate investors should not go into a deal with the goal of financial suicide. While it’s easy to fall in love with a property and become infatuated by the problems, the notion of losing all that money needs to be present in your mind. Many real estate investors go into the business because they choose not to take out a loan to buy a home or because they are tired of working for someone else. Many overlook the fact they are creating a business and a business has risks. When an investor becomes over-leveraged, they usually lose their job, their home, and their life. Many investors fail quickly out of the gate because they are not prepared for the risks associated with real estate investing.

Conclusion

If you’ve ever had any doubts about the profitability of real estate investing, or wanted some of your questions answered about it, you have hopefully gotten the answers you were looking for. You’ve also been exposed to the fact that it’s not that easy to get into unless you’ve already got a million dollars or more to invest, which is a big reason why so many people are afraid to get into it. Well, there are a lot of experts out there who say it’s the best investment ever, and that’s certainly true if you’re smart about things.