Businesses are hard to establish and much harder to maintain. Requiring a consistent struggle, clear vision and a coherent strategy, it is only then possible for businesses to flourish. These words hold especially true for the Real Estate Investment Business, which is mistakenly believed to be a means of acquiring ‘easy money’ through a one off investment. No, this is simply not the case in reality! The risks in real estate investment abound in number. A strategic real estate investor knows what those are and what he must do to tackle them before they approach and hinder his chances of growth and profitability.
Let us take you through 7 major risks in real estate investment, that you MUST beware of.
TYPES OF RISKS IN REAL ESTATE INVESTMENT
Financial Risks
You invest in real estate in hopes of reaping financial benefits. But what if instead of increasing your financial resource base, you end up depleting it? This means that your real estate investment has posed an active financial risk to your assets. The sources of financial risks to your investment can be varied.
However, we will be discussing 2 dominant ones, namely negative cashflow and high vacancy rates.
● Negative Cashflow
Negative Cashflow happens when the rate of return from real estate is lesser than the rate of initial investment. There may be several causes of a negative cashflow. These may include;
- o Increased Financing Costs
o Increased Maintenance Costs
o Flawed Rental Strategy
o Charging Less Rents
Avoiding a negative cashflow involves deeply researching the real estate area you want to invest in. It would be a dire loss if you end up buying a property that needs more work to be done on it.
This means it will consume your finances rather than dispensing you some. Therefore, it is highly important to engage in a good market survey before you decide to make an investment.
● High Vacancy Rates
Simplistically speaking, vacancy rate is the total number of units in a rental property that remain uninhabited during a particular period of time. Vacancy rate is the opposite of occupancy rate. It is an important signifier of how well your property is performing on the real estate market front.
A high vacancy rate is deemed bad for your property. It shows that your property is not popular and is instead undesirable or is situated at an undesirable location. It also signals that your property may be a victim of some economic downturn in the region it is located.
To lower down the vacancy rate it is important that you invest in a property that is situated at a good location. Not only will this improve the occupancy rate but will also be financially beneficial for your real estate business.
Political Risks
Another type of risks that can prove to be disadvantageous to your real estate investment business are the political risks. Political risks are basically the adverse consequences that may emanate from political circumstances, scenarios or events. Since they are unexpected in nature, they increase the uncertainty associated with investments thereby adding as a potent risk.
o Risks may be in the form of a change of terms by which the sovereign government allows or disallows businesses and investments
o It may bring in new taxes or exchange controls or put barriers to capital flows
o It may also engage in outright expropriation
While you may not be able to do anything to avert political risks, however, it is really important to brainstorm beforehand the consequences of a political move that may imposed a certain degree of risk onto your investment. It is always better to be prepared than to be sorry.
Legal Risks
Another significant risk to real estate investments comes in the form of legal risks. Each locality or area usually has a governable law that dictates the design and features of a property to be constructed /already constructed in that area. For instance, let’s suppose that the local laws of your area clearly specify the minimum size of the bedroom or bathroom of a house.
If you digress from this ruling, you will invite legal prosecution. And if you do not personally deviate, and instead have given over your house for rent to a certain party, any legally violative actions of theirs will be projected on you. You will be expected to be answerable for the tenants behaviour despite not having to do anything with any acts of theirs.
To counter such a scenario, its highly advisable to rent your property to good tenants, people who you trust would not land you in trouble with any legally violative act of theirs. Also conduct regular property surveys and inspections so that the tenants are mindful of their actions and their responsibility on the maintenance of the rented property.
Climate Risks
With climate change being an evident reality of the global world now, more than ever before, real estate investors need to be considerate of the challenges climate risks may pose to their business. It also needs to be understood that most of the climate risks are by-products of the geographical location of your property. Some factors which are an offshoot of the geographical locations include,
o Sea-level Changes
o Varying Weather Patterns
o Drought
o Higher or Lower Average Temperatures
As an investor you must have the requisite foresight to predict the amount of wear and tear and maintenance costs you will have to manage in case of being confronted with a climate risk. A climate catastrophe can lead to,
o Hurricane, Earthquakes, Tornadoes, Typhoons
o Irreversible damage to properties
o Unexpected repair costs
o Decrease in property value
o Increased insurance cost
o Decreased insurance availability
Here is what you can do to as a part of the evaluation process of a property before investment to steer clear of any potential climate risks
o Strategically evaluate the climate risks as a part of your investment plan
o Discuss potential risks with your insurance provider
o Consider aversion strategies to mitigate any climate risk when posed
o Analyse the local governments preparedness in dealing with a possible climate emergency
o See whether or not you can spare enough funds for any emergency repairs in case of a climate emergency risk
Tenant Risks
There are good tenants and then there are bad tenants. When we talk of tenant risk in real estate investment, we are particularly focusing on the behaviour and practices of bad tenants. Renting out your property to bad tenants is a huge risk you pose to your investment itself. Here’s what bad tenants usually do,
o They don’t pay the rent on time
o They don’t pay the rent at all, hence leading you to deal with costly evictions
o They damage the property and don’t take an active part in its maintenance
o They ignore tenant responsibilities
o They host extra occupants ( for instance if you have disallowed the keeping of pets, they do that)
o They perform illegal activities within the precincts of the property ( may end up making the property a prostitution den, or a drug dealing location)
To avoid the risks of bad tenants , it is important that before renting out your property you properly screen the tenants. This involves thoroughly tracing their criminal background and credit checks. If possible, also verify their behaviour from their previous neighbours or landlords to look out for potential red flags.
It is true that a proper screening will not only save you a lot of mental stress and physical hassle but will also be financially beneficial for you in the longer run.
Management Risks
As a real estate investor , it must be your priority as well as interest to self-manage your property. However, if you are not really good at management skills or you lack the time for effective and efficient management, it is always good to hire a property manager so that you delegate your services without having to bother about any mismanagement issues from arising. Hiring a property manager will save you the effort and time required to relay rents from the tenants timely. It will also help you to keep abreast with the state of your property and whether or not any improvements are desired in any capacity.
Hidden Structural Risks
Consider a situation where you end up buying a property for it’s amazing location and the estimated financial benefits it will bring on in the future. What you probably did not consider when buying the property was the amount of repair and maintenance required to make it fully functional. Since you underestimated the cost of maintenance, you risk losing your finances through this stream of investment. Be it structural repairs or remediation, some maintenance efforts can easily deduct thousands of dollars from your finances.
What you really need to do to avoid such a scenario is to always inspect the property you seek to invest in. It is wise to hire the services of a property inspector, or a mold inspector/ pest control specialist before you even decide to buy a property. Not only will they really inform you about the areas of house that may need maintenance and repair, but will also brief you about the cost estimates needed to sort these issues out.
Depreciation Risk
Real Estate Investments hold a tangible risk of depreciation. Going by general trends, real estate properties are ‘expected’ to increase in value over a specified period of time. However, depreciation causes them to lose their value in the future. With the value drop, you run the risk of severe losses as the owner of that property. Hence, to avoid such a scenario, a good rule of thumb is to always study and survey the economic trends of the real estate market you seek to invest in. Not only doing so will give you a good idea of what to expect but will also help you to plan out your investments wisely.
Foreclosure Risk
The risk for foreclosure is a dominant one. When real estate investors fail to commit to their mortgage payments for a consistent and consecutive period of time, rental properties risk foreclosure. Foreclosure is bad since it hurts your credit score and my hamper your chances of securing a bank loan in the future.
The best way to avoid foreclosure is to always have an emergency fund that allows you to pay off your mortgage payments whenever they are due.
Our engaging and informative sessions for real estate investors at The Real Estate Investment and Freedom Club, are something that you must engage in. We relay important information to future investors and entrepreneurs looking to invest in real estate, to help inform their property choices and decision making process. With us, you get the basic know how of what to do prior to investing in real estate. Get in touch with us now to register for our next informative session! You surely don’t wanna miss it!
