THE RISKS INVOLVED WITH REAL ESTATE

THE RISKS INVOLVED WITH REAL ESTATE

Posted on January 18, 2015 by REDDOG Advertising & Marketing Strategies
My Property Coach
Author - Antonio Sawlwin  - Santolo

All things to do with making money carry with them some degree of risk.

The same holds true with real estate investing.

Despite the promise of high rewards you should be aware that plenty of people loose substantial amounts investing in Real Estate, just as people lose money investing in the share market or on the currency markets.

Unfortunately there are occasions when peoples ambitions do not match with the reality of the risks involved and the potential losses can even be just as high as the potential rewards.

For this reason you need to take every possible precaution in order to insure that you minimise your exposure to risk and whenever possible are prepared, financially for a worst case scenario. You need to also be in a position with your thoughts that mentally and for peace of mind you learn understand the risks involved and be in a position to manage the consequences of those risks if the time comes.

It Wont Happen To Me

Unfortunately, most people will have the “it won’t happen to me mentality” and often it is these people who make critical mistakes that can’t be recovered from. Whilst you may be a good money manager and budgeter you cannot control what other people do. What if your tenants are always late paying the rent, what if the areas suffers a natural disaster and property prices plummet. No matter how much you plan these things are generally out of your control.

What Are The Risks Involved

The most obvious risk when it comes to real estate investing is the immediate risk of losing money, your assets and your equity that you’ve built up in other assets.

A mistake for a couple in their 50’s can be a huge blow to their lifestyle, not only know but in their retirement as well.

Depending on on how large your investment was to begin with and how much other debt you carry but the worst thing that can happen during the course of a real estate investment gone wrong is finding yourself in a position of little control with banks and creditors deciding your fate.

While I’m certainly not trying to talk you out of investing in real estate all together it is a good idea to have a realistic view of the risks and the potential rewards.

Obviously the main risk you need to think about are your income and how secure this is, the possibility of tenants not paying rent or damaging the property and what if you cant find a tenant for an extended period?

Then there is the risk of making the wrong investment decisions, unfortunately this is a lot more common than people realise. Picture mum and dad living in the suburbs, over the past 10 -15 years they have been paying off their home and at the same time the property has grown in value providing equity to use for investment purposes.

They discuss investing and decide Real Estate is the safest and most common way to build wealth and therefore look at purchasing an investment property. They buy the paper and begin looking through the masses of real estate listings – this is where the trouble begins, very often people will choose an area close to their own home to invest in, after all they have done very well over the last 10 -15 years and they can also keep an eye on the property.
The problem is the area may have been a good buy 10 years ago but the growth may have already occurred. Remember there needs to be a growth driver ie, new jobs, new transport corridors, urban sprawl etc.

The second problem is that buying a property for investment purposes is a far different criteria than purchasing a home to live in. After all you are investing in an asset to make money, not to admire the gardens. As an example the tax benefits alone can be as much as $20,000 per annum different when comparing an old property with a new property.

The appliances you have can also have a large effect on the outcome ie, ducted air conditioning compared to a split system.

Another risk common to real estate investing is the fact that stuff happens. Market trends tumble, companies go out of business leaving towns and the local real estate market in shambles, accidents happen during the course of the work, natural disasters occur, and buyers change their minds and pull out at the last minute. Each of these things can have devastating consequences and are almost always events that are completely beyond your control as a real estate investor.

If that wasn't enough many investors fail to have a proper inspections conducted and find out when it is really too late that there are serious structural problems and other sorts of things wrong with the property.

These things cost money to repair and cut into profits, occasionally resulting in a loss. The thing is that once you find out something is wrong with the property you are honor bound to either reveal the problem to potential buyers or fix the problems before selling the house.

Do not allow the risks of real estate investing prevent you from taking the plunge.

They are spelled out here to remind you that prudence and caution are wise when investing in real estate not to talk you out of this potentially lucrative field of investing. If you are interested in real estate investing there is no reason on earth you shouldn’t take the time and make the effort to learn more about its potential.

Be A Little More Savvy

A savvy investor will look at property just as any other investment, first and foremost the figures need to stack up, do not ever purchase potential is a good rule of thumb – remember if the the current owner is asking a higher price as the property has potential and you agree to pay a premium on the potential you may be in fact giving away the benefit and return of that potential from day one if and when it eventuates.

Accept the fact you may have to purchase in an area that you do not know or may be purchasing a property that would not suit your requirements as a home. These are all emotional ties and just as you would not question the location of BHP’s smelters if you had shares you can not let your emotions or fear stop you from looking at the best investment option rather than what makes you feel more comfortable, sure you don’t want to be in a state of constant fear either.

Accept The Risk

There’s an old saying in business that if you are Going To Be In The Business- Then Be In The Business, as an example a shop owner who only half fills their store will soon realise that an empty store does not make a conducive buying environment. So saving money by only holding half a shop of stock is in fact a poor decision.
With Real Estate the business has risks, just like any other business, as mentioned previously some of these things may be out of your control.

So what is the answer?

You need to assume that the risks involved are going to happen and not might happen and therefore you need to have contingencies in place. You also need specialist help in setting up your finance structures to minimise your exposure and a professional adviser to work out the what if strategies.

Most people would consult advisors before spending over $300,000 on the sharemarket – property is no different

Exposing the risks of Real Estate investing and understanding how the majority of people make mistakes is not meant to put you off investing, in fact armed with the understanding that you are not an investment expert this will help you make that decision to obtain independent advice prior to investing.

Just like most things we undertake – Failing To Plan is Planning To Fail

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Vacancy Rates and Rental Properties

From time to time you will have vacancies in your investment rental property and an astute investor will plan for these occurrences. It could even be that when you purchase the property, it could be vacant.

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It is said that on average the amount of time a property is not rented throughout a year will be between 2 - 6 weeks with 4 weeks being the average. You will often see a term called "vacancy rates" which basically will tell you how many rental properties are vacant at any one time. As a guide a vacancy rate below 4% is ok whilst anything below 2% shows good rental demand.

Be sure to compare apples with apples and compare the condition and age of the property in your calculations. Naturally, renters will like a newer property over an older one and if the property has a lot of maintenance issues or has not been well maintained, this will also lead to a higher turnover of tenants and indeed the quality of tenant.

As a Landlord it is always good to remember Good tenants will not have to live in poorly maintained houses.!

Whilst having a low vacancy rate and a quick turn around is important, not having the property tenanted may not be as expensive as you first think.

Whilst you will lose income on the other side though, if you are claiming the expenses of the investment property as a tax deduction the return for the period that the rental property is not tenanted will therefore also reduce your tax liabilities for that period.

It is important to take note though that cash flow should always be your first consideration, Can you afford to maintain the payments etc until the tax relief is available.

In most circumstances you will naturally want to rent the property as quickly as possible so that you do not lose out on any rent money, however if the property needs an update or maintenance this could be the ideal moment.

In this scenario not only will you receive extra tax benefits from receiving no rent, you are also improving the capital value of the property and these improvements may also be a further tax deduction.

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Why Do Properties Not Rent?

There could be many reasons why it could potentially take some time to find tenants. Perhaps the location is affecting it. Or, it could be that there are simply a number of properties for rent in the local area.

Regardless of why your property is vacant you will need to get it rented as quickly as possible.

For every month that your property is vacant, you are losing money in revenue. Whereby if you reduce the rent by say 10% or 20% for the next 12 months you are still receiving 80% - 90% of the income you would like - much better than 0%

The key here is short term leases so as you can increase the rent as prices increase.

There are some other things you can do to reduce the amount of time that your property is vacant;

You might also consider providing some type of incentive ie a new dishwasher or TV in order to get your property rented more quickly. Certainly this will cost a bit of money but in the long run it is often less expensive to provide an incentive in order to get your property rented more quickly than to allow it to sit vacant for a period of time.

You might think about installing something in the property that would be appealing to prospective tenants such as a washer and dryer.

Make sure you making strong efforts to market your rental property by running ads in all of the local papers and hanging up flyers at places of interest.

You can also have a For Rent sign posted on the property so that everyone who drives by will see it and know the property is available for rent or lease.

Once again, a small amount of money spent on marketing is less expensive than the amount of lost revenue you could incur by allowing the property to sit vacant.

In addition, take be proactive and begin the search for tenants before your current tenant moves out if you have reason to believe that they will be leaving soon.

It is never a good idea to wait until the last minute and then try to fill a vacancy.

You could even ask the current tenants if they know of anyone who might be interested in renting the property.
It could be quite possible that they have friends who have visited and would jump at the chance to rent the property once it is available.

Keep in mind; however, that you still need to conduct a thorough screening. The first time you receive an inquiry on the property, you need to begin the screening process. Take the time to obtain some basic preliminary information about applicants while also providing information about your rental property.

Some people will find just as having an expert adviser take care of their finances they will want an expert to manage their property. Whilst finding a tenant may be quicker and easier wusing a Real Estate Broker or Letting Agent there is a cost involved and you are abdigating your control to this company or person. Therefore you should spend just as much time screening and qualifying your property managers as you would potential tenants.

See our Post on Selecting The Right Agent or Real Estate Broker Here