4 Ways You Can Manage Real Estate Investment Risk
Many naive real estate investors associated with get-rich-quick real estate schemes have lost money on their real estate investments because the get-rich gurus failed to warn them that risk magnifies with the returns on highly leveraged real estate.
Too often, these poor real estate investors simply lost touch with reality and expected the market values of their properties to appreciate at such high rates that they barely cared how much they paid for the property or how it got financed.
The idea, of course, as far as the real investor was concerned, was that the investment property could get sold in a few years for twice the amount they paid for it.
We know better than that. So here are four ways you can legitimately manage the risk on your next real estate investment opportunity.
1. Don’t expect appreciation. When you need high rates of appreciation like 10 percent or more a year to make your investment look attractive, you set yourself up for a big loss.
2. Beware of negative cash flows. Unless your investment pays for itself through the income it produces, you’re speculating, not investing. If that’s what you want to do, fine, just recognize that speculating creates high risk.
3. Don’t overextend yourself. When you finance with a high loan-to-value ratio (high leverage) it usually means that you will make large mortgage payments relative to the amount of net income that a property brings in. This makes you vulnerable to negative cash flows, vacancies, higher-than expected expenses, or generous rent concessions to attract good tenants.
4. Avoid overpaying for a property. Little or no down payment deals cause many real estate investors to buy overpriced properties. The old real estate investment adage “You make money when you buy” should be memorized.
Yes, over the long term, owning real estate will make you rich. Real estate investing has made many real estate investors millionaires. But to get to the long term, you may have to pass through several downturns, and unless you have tons of cash (or credit) reserves to defend against these slumps, you’re better off remaining cautious.
Author: James Kobzeff, July 29th, 2008
