edited in 2021
Investing in real estate is not magic. Yes, investing in real estate tends be safer than other investment options because after all, you have real physical assets you can count on! While that’s the case, like any other investments out there, investing in real estate carries its own risks. Here, we’ll review the 5 common risks:
For a multifamily property, a good asset should always have 90-95% occupancy rate. Single-family property carries a higher risk of turnover because there is only one sole income that’s reliant on leasing the unit. Vacancies happen and in fact, can actually be used on the value add strategy as part of forcing appreciation. Vacancies become risky when you can’t rent out your units (especially after forced appreciation). There is a whole slew of reasons why tenants don’t stay and it can range from personal reasons (e.g: new job elsewhere), deferred maintenance, lack of amenities or the tenants themselves being simply priced out of market rents in the area.
While there isn’t a magic wand that can mitigate every risk here, things like deferred maintenance can and should be avoided. After all, how can you expect to have happy tenants when you aren’t delivering the right services they expect? Real estate investment is a business and your tenants are your customers.
Tenants being priced out of the market can happen. This is especially true if you purchase a lower class asset in a path of progress (or if it’s already in a higher class neighborhood). After all, the strategy here is to bring the asset up to par to market rents through renovations.
Well, there is no good way of putting this. Some tenants will respect your property as if it was their own and some will not. It might be self-explanatory, but to level-set, characteristics of bad tenants include: having a trend of not paying rents on time, intentionally destroying the unit, callously playing loud music in the middle of the night, etc.
To mitigate this, we can’t stress enough the importance of having a great property manager who’s on top of the local rental laws and regulations. A great property manager will screen the tenants for your property (while always being equitable & non-discriminatory – this is non-negotiable), do a proper walkthrough with the tenants to document the state of the unit, spot where the problems are to avoid deferred maintenance, go through the eviction process, and much more. Some real estate investors try to manage properties by themselves (some without any prior experience doing it) and this is the #1 reason that investors quit the game.
Real estate investing is a team sport. To succeed, you need all your team players to deliver. If one player fails, it can throw off your whole game and this is true in the case of your real estate strategy. Your team can include brokers, property managers, contractors, lawyers, even your own general partners and investors. So how do you make sure you have a good team?
Do your homework, leverage the network you trust and VET, VET, VET – always check what how they are doing with other assets and how they respond to you. Mutual respect and transparency are also key to this. Remember, you’re in a business. For example, if a property manager is hesitant to share their portfolio with you (probably because of deferred maintenance – you can check out properties around the area that they manage) or fails to give you an adequate business plan on how they plan to fill vacancies, those are major red flags and you should move on and screen the next one.
Climate hazards might happen unexpectedly. Of course, there are areas that are more prone to natural disasters (e.g: hurricanes on southeast coastal zones) and so the types of due diligence that have to go into such asset in areas with history of natural disasters happening become more involved.
The only way to somewhat mitigate this is to understand the areas that you’re investing in and make sure there are adequate insurance put in place.
At times of economic crash (remember 2008?), real estate investments and asset values (values are different than prices) are also at risk. While many investors have put in a big effort to research future market corrections, a more widespread unexpected issues (e.g: pandemic, war) would result in severe downswing in the market. This is a risk that’s harder to mitigate. However, history has shown that a multifamily type of real estate, specifically B and C class assets, proved to be resilient. One of the reasons for that is because people will always need a place to live. In cases of loan defaults on their house, people will look to (yep you guessed it!) apartments/multifamily properties that they can rent.
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