How to Reduce Risk in Real Estate Investing
Real estate investing is not without risk
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Real estate investing is not without risk. You can lose money. High vacancies, tenant issues, and expensive repairs can kill cash flow.
These are the fixes needed on my 3 duplexes over the last 2 years:
Installing new garage door opener- $417
Replacing 2 mini blinds- $61
Fixing frozen water lines- $180
Replacing fill valves in 2 toilets- $125
Fixing dishwasher- $65
Replacing dishwasher- $677
Unclogging toilet- $86
Fixing another toilet- $81
Fixing garbage disposal- $65
Repainting interior/tenant damages- $1372
Removing carpet & installing new carpet- $1024
Carpet & paint materials- $406
Installing/programming new garage door opener- $150
Garage door opener- $177
Unclogging toilet- $65
Adjusting garage door sensors- $65
Fixing AC- $112
Replacing broken sprinkler head- $83
Total: $5211
$5211 paid on repairs, maintenance, and tenant damage. Brutal. I didn’t consider these properties to be risky. They still make money, but it’s easy to see how a very risky property can destroy you.
How do you reduce risk in real estate investing?
The easy answer is to Invest in less risky rental properties. Less risky properties tend to have lower potential to make fat stacks. Finding a comfortable place between risk and reward can be a balancing act.
To simplify things, we can look at risk through 3 lenses:
1. High Risk/High Reward
I did a quick search on Realtor.com and found a house in Flint, MI selling for $17k. The property description says it can rent for $600 per month. Those are insane returns! On closer inspection, the neighborhood is ultra-dangerous, and the house is falling apart. I imagine it’s tough to find quality tenants when the house has no windows or doors. This is an extreme example. High risk properties can definitely pay off. You just have to decide if the tradeoffs are worth it.
High risk properties tend to have these characteristics:
Very old
Terrible shape/massive repairs needed
Bad location: high crime rate, too rural, no industry, extreme weather
Attracts poor quality tenants
2. Medium Risk/Medium Reward
Medium risk rentals can have similar characteristics to high risk properties, but to a lesser degree. One of my duplexes is in a more blue-collar neighborhood. The property is 20 years old. Due to the age and tenant quality, this duplex has needed more repairs and maintenance than my newer rentals. The cash flow is higher though, so it’s worth it. Value-add properties would also fall in this medium risk category. An example of a value-add investment would be buying a rental that needs repairs. Once the repairs are done, you can charge more rent. Or sell the house for more than you bought it for.
3. Low Risk/Low Reward
An example of a low risk real estate investment would be buying a new home in a nice neighborhood. Newer houses need less repairs than old houses. Nice neighborhoods attract higher quality tenants who are less likely to destroy your house and skip rent. Rental income will be more stable, but cash flow will be less than the other risk profiles. You can’t buy a new home in a nice neighborhood for $17k. Higher purchase prices mean higher mortgage payments, which will eat into cash flow.
How do I reduce risk in real estate investing?
So far, I’ve only bought houses built within the last 20 yrs. Newer houses need less frequent repairs than older houses. Major repairs will be needed at some point. But, I would rather have several years of steady cash flow before that day comes. Obviously, new houses can still be jacked up. I don’t want to buy jacked up property. And I don’t want to take on a massive risky renovation project. Another way to minimize risk is to be conservative with the numbers when evaluating a rental property. If worse comes to worst, and the rental property loses money, you can always sell it. It’s going to be a lot easier to sell if you buy newer rentals in nicer areas.
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