The allure of real estate with the possibility of positive cash flow is an intoxicating one to invest into. Some investors look to purchase fixer-uppers and invest the money into repairing them and then selling for profit. Others look to go into rental properties and over time build up multiple units. REIT’s (Real Estate Investment Trusts) are also growing in popularity for those who wish to invest in real estate on a small scale without spending a lot out-of-pocket. There are inherent risks of real estate investing and we’ll look at five of them below. These five risks will cover those looking to invest in rental properties and general real estate (non-REIT).
Since this is a generalized risk, this takes quite a bit of information from across the board. There are so many markets to consider when investing in real estate. You have to take the general economy into consideration, is there a recession going on? How is the job market looking in the area that you’re looking to buy in? Interest rates also become a factor as an indicator of general economic health. It may seem that some of these trends are vastly different, but they are all interconnected when it comes to real estate investment.
Whether you have just one house or a multiple-unit building, you have to consider the legal risks involved. What if someone slips and falls outside on your property because your property manager couldn’t get the sidewalks salted after a snow and ice storm? What if you had an angry tenant looking to drum up charges (whether legitimate or not) against you when he vacates the unit? Some investors have umbrella insurance to help mitigate the legal expenditures and others who have larger holdings look at the possibility of housing their entire real estate business inside an LLC.
Partially tied in with the “angry tenants” scenario above, it would be a blessing to have perfect tenants who kept the property in mint condition, but in the real world it’s just not realistic. Deposits (even first and last month’s rent) sometimes won’t cover the damage caused by unruly tenants. Background checks to vet potential renters may curb this issue somewhat but it won’t eliminate it completely.
In terms of investments, Stocks are great for liquidity’s sake as you can sell them rather quickly on the stock market during the trading day. Real Estate is about as un-liquid as they come for investments. Selling real estate takes time and effort and can be quite difficult to do, especially in a down market.
The typical route of rental property unit investing is to take out a loan for it, assuming that the borrower’s credit is good enough. After a few months of positive cash flow, the borrower looks to add a second unit to his portfolio and takes out another loan. Repeat this process a few times over the course of a few years and you end up with a lot of leverage. Having a few of these units under-perform (vacancies, repairs to the building, etc.) can take its toll on the rest of your portfolio. Not to mention that you’ll always be under the specter of having the bank call in the note at any time, requiring you to make full payment of the loan. Banks don’t have to wait until you’ve missed a few payments for this to happen, legally they can call in a note at any time.
Tags: Real Estate Business Tax
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