Successful investing in real estate requires managing risk, not avoiding it.
Due to the Covid-19 pandemic, the real estate market has tremendously slowed down. Last year, landlords were faced with the continued problem of rents and vacancies, while property prices fell due to the Covid-19 economy fallout. Before that, the real estate market rose year after year. If you were hoping for a breather in the property market after years of continued growth, this is your chance to snatch up a property at a bargain.
Real estate investing has always been a solid investment, despite the hiccups here and there. Most investors invest in real estate to speculate or hedge against inflation. If your goal is to build real wealth after inflation, you’ll need to note risk and balance this risk with reward.
The Risks of Investing In Real Estate
Real estate investing involves risk and reward – and the higher the risk, the greater the potential profits and losses. This does not mean that you shouldn’t invest in real estate, it just means that you should take extra precautions before doing so. Knowing the risks of investing in real estate, makes it easier to identify the trouble spots and minimize any surprises along the way.
Here are four of the main risk factors you should consider when evaluating any investment property:
A: Market Risk
The real estate market has it’s own ups and downs tied to the economy, interest rates, inflation and other market trends. Investors cannot eliminate market risk, but they can hedge it with a diversified portfolio and strategy.
B: Asset Specific Risk
The asset-specific risk is a risk that is unique with each property and independent from another; hence, a risk that can be diversified when combined with another asset. For instance, there is always a demand for apartments in good and bad economies, making them low-risk but yield lower returns.
C: Credit Risk
The length and stability of the property’s cash flow income are what drives its value. The credit risk of a mortgage on an investment property depends on the financial performance of the underlying property. The stronger the ability to turn cash, the less this risk is.
D: Leverage Risk
The more debt you have on your investment, the riskier it is. Leverage is a force multiplier: It can increase your portfolio of properties and increase returns if things are going well but, when they aren’t you’ll lose quickly and a lot.
E: Idiosyncratic Risk
Idiosyncratic risk is a type of asset-specific risk that is inherent. This type of risk can negatively impact the property such as location, environment and more. For example, if a property is located in a bad neighbourhood, this fact will negatively affect its market value and potential. Additionally, environmental factors such as pollution, political risks and even workforce risks for commercial property can affect the potential earnings and value of a property.
Learn more: Ways to Turn Single-Family Homes Into a Cash Cow
Balancing The Risk & Reward of Real Estate Investing
In order to consistently profit in real estate, regardless of the economy, you’ll need to strike a reasonable balance between risk and reward. This means you’ll need to identify the risks you are likely to face and create mitigative solutions to help you strike that delicate balance between that risk and reward.
Here are four basic rules for managing risk to build wealth in real estate, regardless of the economy:
#1: Finance With Fixed-Rate Mortgage
A great way to balance the risk of property devaluation and cashflow problems due to vacancies, long-term fully amortized fixed-rate mortgages is the way to do. If your goal is to build wealth after inflation, a fixed-rate mortgage will protect you from sudden increased in payments if interest rates rise during inflation.
Avoid fancy variables on your mortgage such as balloon payments, adjustable mortgages and short-term loans. These options transfer interest rate risk to you and can destroy your investment.
#2: Invest Well
Real estate investing is typically meant to be a long-term hold deal and require heavy investment. Thus, invest well and be picky about what properties you add to your investment properties. Right now, there are many sellers out there that are hungry to make a sale. Don’t rush your investment deals and don’t accept marginal return deals.
#3: Safety in Cash flows
A good deal is one that provides significant positive cashflows from the day you close on the purchase. Positive cashflows give you an infinite holding period since you’re paid to own and more room for error if things go bad.
When there is inflation, you’ll do extremely well and when there is deflation, the cashflows will help you weather the storm long enough to wait out the eventual return of inflation. This validates this strategy.
#4: Deleverage
When an economy is struggling, leverage tends to be the root cause of the credit problems. Therefore, be wise about it and avoid making the same mistake. The goal is to build wealth in real terms after inflation and to achieve this do not over leverage. Higher leverage may force you to abandon your property before inflation finally returns to validate your investment strategy. In short, decreasing your leverage increases your margin of safety and cashflow.
I would then estimate a good leverage position to lean towards 50%-70%, no more than 75% financing, but the final number is dependent on the quality of deals you get, market conditions and other factors beyond the scope of this post.
Learn More: 7 Common Mistakes to Real Estate Investing to Avoid
Bottom line
It is important for you as an investor to remain focused on your investment goals and strategy. If you are in it for the long-term, you’ll experience several fluctuations over the period of your investment, so just stay rooted. Stick to the basics. Investing in good quality real estate with strong positive cashflows, you’ll be better positioned to weather inevitable economy ebbs and flows.
Happy Building!
Related: 7 Common Mistakes to Real Estate Investing to Avoid
Image credits: Top by Maria Sofia from Pexels
Article Source
Business Daily. “Land, Housing prices decline on Covid-19 slowdown, https://www.businessdailyafrica.com/bd/economy/land-house-prices-decline-on-covid-19-slowdown-2298312.” Accessed on 30th December 2020.