Real estate investing is one of the best ways to make money and build wealth, no one can deny that. There are many benefits of buying and owning investment properties and earning passive rental income. However, although owning a rental property is a relatively safe investment, not every property investor can achieve guaranteed success in this competitive market.
Just like any other type of investing, there are a few risks associated with real estate investing which the property investor (whether an experienced or a new investor) should be aware of and know how to avoid in order to find the best rental property and succeed in the business.
So, without further ado, here are 10 major risks of real estate investing and how to avoid them:
Real Estate Investing Risk #1: Unpredictability of the Real Estate Market
The real estate market has been growing quite well in the past few years; however, there is no guarantee that this positive trend will continue. The real estate market is known for its ups and downs with the ever-changing economic conditions. In real estate investing, the economy plays a major role in the value of an investment property. Therefore, there is no guarantee that you’ll be making a profit when you decide to sell an investment property.
For example, if you buy investment properties during a time when demand is high for real estate investing, you might be at the risk of selling them for lower than the initial purchase price (even if this property generated profit through rental income) because its value has gone down as the housing market changes. This might cost you more money than what you’ve earned while renting out the property.
For this reason, when entering the real estate investing business, real estate investors should always be aware of this dynamic, understand and stay up-to-date with the market economy and how it functions, and prepare ahead of time to be able to forecast any real estate market downturns. This will help them determine whether or not buying an investment property at a certain time is a good investment decision.
Related: What Are the Expected Real Estate Trends in the US Housing Market for 2018?
Real Estate Investing Risk #2: Bad Locations
In real estate investing, location is everything! Expert real estate investors agree that when you’re buying any type of investment properties, the location should always be the top factor to take into consideration. How can location be a risk in real estate investing? There are several ways in which investing in a bad location will lead to a failed real estate investment.
First, location determines the supply and demand. You might think a certain location is a good choice for real estate investing due to lower prices. However, these locations can sometimes have too many investment properties available and yet not have a growing population or a good job market. Thus, investing in these locations will cause real estate investors great risks.
Moreover, the property investor should avoid locations that have a relatively higher crime rate. On the one hand, these areas have lower prices and high occupancy rate because people tend to rent instead of buy homes. Meanwhile, when investing in high crime areas, the property investor might face the risk of getting vandalized or robbed, which would lead to unexpected expenses and high repairs costs, not to mention the complications of legal matters as a result of these acts.
Furthermore, in real estate investing, location determines appreciation. Low appreciation means negative return on investment when the property investor decides to sell an investment property. Thus, never buy investment properties based on price alone!
The best way to avoid this risk is for real estate investors to be careful when choosing the location for real estate investing. While it might be tempting to purchase a cheap investment property, in most cases the risk is not worth it.
Click here to start searching for the best locations to invest in!
Real Estate Investing Risk #3: Negative Cash Flow
In real estate investing, the cash flow of investment properties is the amount of profit that the property investor earns after paying off all expenses, taxes, and mortgage payments. The next risk associated with real estate investing is the possibility of generating a negative cash flow instead of a positive one. This means that expenses, taxes, and mortgage payments are all higher than the rental income, which results in losing money.
The risk of negative cash flow occurs when the property investor buys investment properties without conducting a real estate market analysis first. Thus, the best way to avoid this risk is by accurately calculating your income and expenses (how much the rental income will be and how much you need to spend on the property) before buying an investment property, and ensure that the rental property is located in a prime location that yields positive cash flow to guarantee a high return on investment.
It is very important to be as thorough as possible because, in real estate investing, even the smallest expenses might add up in the long run. Use Mashvisor’s rental property calculator to easily compute cash flow and rental income of the rental property based on monthly expenses.
Real Estate Investing Risk #4: Vacancy Risks
Buying an investment property does not automatically guarantee 100% occupancy and quick profits. In real estate investing, there is the possibility of high vacancy, which is a major risk to real estate investors’ rental income as it can yield negative cash flow. Moreover, since tenants are the source of rental income in real estate investing, vacancy is a huge risk for real estate investors who rely on rental income to pay off their mortgage, insurance, property taxes, and other expenses.
To avoid the risk of high vacancy, real estate investors should purchase investment properties in a good location with high demand. These locations are typically safe neighborhoods with nearby amenities such as transportation, shopping malls, and schools. Mashvisor allows you to check out vacancy rates for investment properties in different neighborhoods around the US!
Related: 7 Tips to Avoid a High Rental Vacancy Rate
Real Estate Investing Risk #5: Bad Tenants
Obviously, getting tenants is a necessity for making money in real estate investing. However, getting just any tenant won’t guarantee profitability. The risk of having a bad tenant and getting stuck with him/her could be even worse than the risk of not having a tenant at all.
True, not having tenants means not gaining any rental income. However, bad tenants might refuse to pay the rent for several months in a row, or even destroy the property too much, meaning you will risk dealing with evictions – which are pretty costly and time-consuming.
To avoid the risk of having bad tenants, go through the process of selecting good quality tenants carefully. Conduct a thorough tenant screening process, check their credit score, and ask them for contact information of their previous landlord.
Real Estate Investing Risk #6: Hidden Structural Problems
In real estate investing, a property investor might end up buying an investment property with serious hidden structural problems, which increases the chances of facing unexpected repairs and maintenance costs.
To avoid this risk, get a good evaluation of the state of an investment property and a home appraisal before you even buy the rental property. Property appraisers are professionals who will be able to discover any hidden damages or problems that need fixing; in addition, they will tell you exactly how much your potential investment property is worth.
Real Estate Investing Risk #7: Lack of Liquidity
Liquidity is the ability to access the money you have within an investment. One risk of real estate investing is that investment properties are illiquid, meaning you can’t easily convert them into cash. Selling a property is neither a quick nor a simple process, and selling quickly or under pressure will most likely result in taking a loss on your investment.
This lack of liquidity forces real estate investors to hold their investments for longer than other types of investments, which is risky for those who might need access to cash quickly if necessary.
Real Estate Investing Risk #8: Foreclosure
When real estate investors are unable to commit to their mortgage payments on time for a few consecutive months, this can put their rental property at the risk of foreclosure – losing your property to the bank. Foreclosures are risky as they hurt your chances of getting bank loan approvals in the future.
The best way to avoid the risk of forecloses is to make sure you first conduct a real estate market analysis and investment property analysis before you put a 20% down payment on your real estate investment, have an emergency fund, and try to pay off your mortgage payments quickly if you can.
Related: The Pros and Cons of Buying a Foreclosure
Real Estate Investing Risk #9: Depreciation
In real estate investing, depreciation is the opposite of appreciation. In general, real estate properties are expected to increase in value over the years (appreciation). However, not all properties are guaranteed to grow in value. Therefore, a major risk of real estate investing is investing in a rental property whose value drops in the future, meaning the property investor will end up losing money.
Once again, the best way to avoid the risk of depreciation is to be very careful in your research and real estate market analysis and study the economic growth of the real estate market to find a location with strong positive real estate appreciation.
Real Estate Investing Risk #10: Legal Airbnb Issues
Short-term Airbnb rentals can be a very profitable rental strategy in real estate investing. However, many local authorities have been issuing legislation to limit Airbnb rentals, under pressure from local hotels. Thus, as a property investor, you might end up in lots of trouble if you rent out your investment property as Airbnb in a place where this is illegal. This risk is actually the easiest to avoid. Just read all relevant local – state and city – laws that govern Airbnb rentals to ensure that they’re legal in your housing market.
Related: Your Real Estate Investment Guide to Airbnb Rental Properties: Where Is Airbnb Legal?
Click here to search for the best Airbnb rentals in the US real estate market to invest in!
Conclusion
Owning investment properties is a relatively safe investment. Nevertheless, real estate investors can never 100% guarantee a profitable investment. The above mentioned challenges are the most common risks associated with real estate investing which should always be taken into consideration before buying a rental property.
Smart and successful real estate investors conduct a thorough real estate market analysis in addition to a rental property analysis to avoid these risks. This includes studying the market economy, property inspection, computing expected expenses, and so forth. This gives them the ability to know when, where, and for how much to buy and sell, which ultimately helps them hedge against major losses.
Of course, this doesn’t happen overnight. This is the result of years spent in real estate investing and learning from past mistakes. Thus, if you’re on your way to becoming a real estate investor, don’t be discouraged and head over to Mashvisor to start learning!
Mashvisor made the process of real estate investing easier. Our platform provides actual and future real estate investors with the necessary tools to find the best rental properties (both traditional and Airbnb rentals). Not only that, but you also obtain analytics related to the expected rental income of an investment property and its estimated occupancy rate. Basically, Mashvisor allows you to make the best real estate investment decisions that lower the risks of buying investment properties.