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BlogArrowLandlording & Rental PropertiesArrowThe 4 Main Risks of Owning Rental Properties (& How to Mitigate Them)
Landlording & Rental Properties Oct 29, 2020

The 4 Main Risks of Owning Rental Properties (& How to Mitigate Them)

Ali Boone
Expertise: Business Management, Personal Development, Real Estate Deal Analysis & Advice, Real Estate Investing Basics, Mortgages & Creative Financing, Landlording & Rental Properties, Real Estate News & Commentary
170 Articles Written
taking-risks

Most would argue that the risks of owning rental properties are fairly obvious, yet you’d be surprised how many people ask me what they actually are. If you are brand new to real estate investing, it would make total sense that you might not completely understand the specific risks in a way that allows for a bigger-picture view. This is simply because you don’t know what factors to look at. Or even if you aren’t brand new, sometimes it’s just helpful to get a very general overview of things as a way to help drill it in and help you better understand it.

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Before even talking about the risks, one thing you want to be very clear about when it comes to rental properties are the numbers. I didn’t know a thing about how to run numbers on a prospective rental property when I first got interested in real estate, and I’ve since learned that most people really don’t have a clue about them.

The truth is most properties don’t make good rental property investments!

I usually hear it’s in about the 80% range that properties actually don’t pan out financially as rental properties. Why is this? Because the numbers don’t work.

What do I mean “the numbers don’t work”? It means that your actual expenses (which are usually more than what people realize) exceed the income on the property, and therefore, you lose money. Losing money is not the point of investing. Making money is.

For help on understanding exactly how to run numbers on a rental property, check out “Rental Property Numbers So Easy You Can Calculate Them on a Napkin.”

Why am I mentioning the numbers?

Because all risk involved with rental properties is directly related to the numbers. I can tell you the risks of rental properties, and you will understand them well enough. But if you really understand more about the numbers and what goes into actually receiving returns from them, the risks will just make all that much more sense.

Now for the risks!

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4 Primary Risks of Owning Rental Properties

There is something that all four of these risks have in common: They all cost you (the owner) money. See the logic there? If the whole point of owning a rental property is to make money, then all of the risks of owning a rental property would be associated with losing money, right? Say “yes.”

Related: Don’t Let the Risk of Investing in Real Estate Paralyze You: Here’s How

If you want, you can alternatively phrase the question, “What are the risks associated with owning a rental property?” as “What are all of the ways you can lose money with a rental property?” Pick your poison. Again, a seemingly pointless distinction to the more advanced investors, but at the beginning levels of learning all of this stuff, certain distinctions aren’t so pointless to make.

In no particular order, here are what I deem to be the four primary risks of owning rental properties (aka four most likely ways to lose money with a rental property):

Vacancy

This one is a bit of a trickster because it’s not as obvious as some of the rest of the risk factors. However, despite being a trickster, it can be one of the most costly issues with a rental property! Other issues can be costly, as well, but vacancies can happen often—and quickly if you aren’t careful.

The expenses associated with vacancies are: lost rental income during each month of vacancy (especially significant if you are having to pay a mortgage payment each month at the same time), turnover-induced repairs, and if you are using an agent to secure tenants, you will have to hand over a pretty decent chunk to that agent once they place tenants (usually the equivalent of one month's rent).

For some reason when I first started buying rental properties, I seriously underestimated the power of vacancy expenses. I’m not sure if I just thought vacancies wouldn’t happen or if I didn’t realize how long vacancies could last, but I definitely didn’t put enough weight into them. Take them seriously—because they are serious.

Damage/Repairs/Maintenance

This category could be just as easily called “when you have to fix something.” There are a few reasons you may have to fix something on your rental property. There could have been theft or tenant-induced damage. There could be just normal repairs, either from normal everyday wear or small things that tend to break. Or there could be more CapEx-level maintenance. This could include things like roofs and water heaters, or it can be more serious issues, like structural issues, internal wiring, or something that you may or may not have known about when you bought the property.

Fixing things can range all over the board for cost. Minor repairs could be less than $100, major repairs could hit tens of thousands of dollars, and there is every cost possibility in between. The real win happens when bigger things are covered by insurance. I’ve gotten a couple nice new roofs thanks to insurance! However, you can’t ever count on the insurance wins, so always assume the expense will be out of your pocket and plan accordingly.

Decreased Rents

This one isn’t quite as obvious as vacancies and repairs. What you are looking at here is how much the property is bringing in in rental income. This is imperative because, well, how much it brings in is really the crux of the profits because you need enough money coming in to cover the amount of money going out—your expenses.

So when does this become a risk? The risk comes in cases where economic conditions of the market change such that you can no longer get as high of rental income as you once could. If general rents decrease, and therefore you have to decrease how much rent you ask for on your property in order to stay competitive, suddenly you could have an income level that doesn’t necessarily support the expense level of the property.

Make sense?

Or maybe the economic conditions don’t change at all, and for some reason, you were just able to charge a certain tenant a really high rent, but then when that tenant leaves, you can’t find another tenant who will pay that much. The key here is always having rents that surpass what you are paying in expenses. Rents being forced down is a risk for rental property owners.

multifamily-market

Related: How to Assess Your Risk Profile to Know Which Real Estate Niche is Right for You

Decreased Property Value

Now, I want to be very clear, very quickly about what I mean by the value of the property being a risk factor. The value of a property does not matter unless you are buying or selling it (or refinancing it).

Did you hear that? Let me say it again. The value of a property does not matter unless you are buying or selling it (or refinancing it). So when I say that property value can be a risk, it actually only has to be in extreme circumstances.

The one extreme circumstance that I can think of is when the market the property is in declines in such a way that you can no longer collect high enough rents (or any rents) to cover your expenses, so you are losing out every month (potentially rapidly), and the only choice is to sell. But the value on the property has tanked. Then what? Well, that’s not good. Unless that scenario happens, though, you don’t have to worry too much about the value.

I had a property during the last big crash that lost around 45% of its value and put me underwater on it. But none of that mattered because I didn’t try to sell it or refinance it at the time. I just held onto it, kept renting it out, and nothing financially changed about it. So in that case, value didn’t matter and therefore wasn’t a risk factor. So it’s only if you need to offload a property that the value decreasing may cost you money.

Well, are you totally terrified of rental properties now? Don’t be. Yes, all of these are risk factors because they can all cost you money (potentially a lot of money), but they are part of the risk of investing, and there are actually fairly simple mitigations for each. Nothing is ever guaranteed to prohibit any loss of money with any investment, but you can certainly lower your risks pretty substantially.

Risk Mitigation

Here are very simple ways of lessening your risk in each of the above-mentioned areas.

Vacancy

Buy in a growing market. The more population continues to move into a particular market, the more housing that will be needed. Don’t buy in a saturated market, meaning a market that has so many rental properties that prospective tenants have a million options for which property to move into.

Research vacancy rates in the general market and the sub-markets so you have an idea ahead of time what to expect. Don’t buy in a neighborhood that typically only attracts owners, meaning you can’t find renters for a property. (Seems strange, I know, but it happened to me. Check out “Is There Such Thing as Buying Too Nice of a Rental Property? [Hint: The Answer is Yes]“).

Also, try to attract longer-term tenants. The less transient tenants are, the less vacancy you can expect.

Damage/Repairs/Maintenance

There are two major things you can do here. First, try to attract the highest quality tenants you can. Even high-quality tenants can turn on you and cause damage or goof things up, but you lessen your chances the higher up the quality chain you go.

Second, be diligent about the properties you buy. Never, ever buy a property without a getting a full, professional property inspection done on it. Make your goal to be that there is nothing about the property you don't know when you buy it. You don't want unexpected large-ticket items that you will have to pay to fix.

Always include estimates for repairs and CapEx and maintenance and such, as appropriate, in your calculations. But as a general rule of thumb, the nicer the property and the nicer the tenant quality, the less chance of major expenses towards damage and repairs and maintenance. Keyword less chance, not no chance.

cash-on-cash-return-real-estate

Decreased Rents

Buy in a solid growth market. Not a market that is just stable (and certainly not one that is declining), but one that is in a solid trend of growth. For more information on markets, check out “How to Know if a Real Estate Market is Wise to Invest In (With Real-Life Examples!)”

Decreased Property Value

It’s the same mitigation with this one as with the rents—buy in a growth market. If a market is growing, values should go up. If a market is declining, values are likely to go down.

Further mitigation would be to not buy at the top of the market (i.e., when properties are most expensive). The latter isn’t so much of an issue if your cash flow numbers work out, but it’s always best to buy at the beginning of an expansion cycle (of a growing market) if you want the maximum increases in property value.

Related: How to Successfully Raise Rents Without Risking Costly Vacancies

There is risk associated with every single method of real estate investing. If there wasn’t, more people would do it.

You can never completely eliminate risk, and things can happen even when the highest levels of risk mitigation have been achieved, so always know what you are getting into. Don’t completely fry yourself with analysis paralysis, but spend some time to get educated on the risk factors associated with any investment opportunity.

Ultimately, real estate investing should be fun! Be smart about it, but have fun with it!

Any other cool risk mitigations for people interested in buying rental properties that I didn’t hit on?

Be sure to leave a comment below!

By Ali Boone
Ali Boone is a lifestyle entrepreneur, business consultant, and real estate investor. Ali left her corporate job as an Aerospace Engineer to follow her passion for being her own boss and creating t...
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Ali Boone is a lifestyle entrepreneur, business consultant, and real estate investor. Ali left her corporate job as an Aerospace Engineer to follow her passion for being her own boss and creating true lifestyle design. She did this through real estate investing, using primarily creative financing to purchase five properties in her first 18 months of investing. Ali’s real estate portfolio started with pre-construction investments in Nicaragua and then moved towards turnkey rental properties in various markets throughout the U.S. With this success, she went on to create her company Hipster Investments, which focuses on turnkey rental properties and offers hands-on support for new investors and those going through the investing process. She’s written nearly 200 articles for BiggerPockets and has been featured in Fox Business, The Motley Fool, and Personal Real Estate Investor Magazine. She still owns her first turnkey rental properties and is a co-owner and the landlord of property local to her in Venice Beach.
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36 Replies
    Mike McKinzie Investor from Westminster, CO
    Replied over 4 years ago
    Ali, right on again. To expand a little on the Capital Expenditure items, be careful how old certain systems are in the house you are buying. Is the roof five years old or twenty five years old? Is the HVAC system almost worn out?. As a matter of fact, these items can be used when considering how much to offer to start with. In today’s Sellers market, it is a little tougher, but when a buyers market comes back around, you can explain to a seller that you estimate X dollars in the next 2-3 years for major repairs and that is why you are offering what you are offering. And if another buyer offers more, let them have the house. Like Ali said, most buys are NOT good buys. Buying an $80,000 house that rents for $900 a month sounds good until you have to drop $10,000 in the first two Years for Cap Ex costs. If you had a $500 mortgage, you just lost two years of profit, not counting all the other expenses, i.e. Management, small repairs, insurance, property taxes, and God forbid, a vacancy! Looking back, $65,000 for that house would have made a lot more sense.
    Ali Boone Business Owner & Investor from Venice Beach, CA
    Replied over 4 years ago
    All excellent points and info Mike! Thanks for sharing 🙂

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    Brian Cumberledge from Mc Kinney, Texas
    Replied 3 months ago
    Since people are replying. You have to plan for these replacements. If you don’t plan - you will be forced to replace an AC for a tenant in the middle of hot summer and pay full price. If you plan - you can replace them before needed and get a good price and even 0% financing. I prefer to replace and upgrade before it’s time. Nothing worse than major expenses when you don’t expect them. And most will say no way but at times I carry home warranty on rentals. Issue is the delay but I do cash out option and then get my own contractor. However waiting for AC to die could be a long expensive wait.
    Annielle Mbida New to Real Estate from Mckinney, TX
    Replied 18 days ago
    Hi Brian, curious since you chose to carry warranty "at times". Can you share what makes chose the warranty at times? is it the age of the house or other things. Thanks!

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    Pablo Gomez from Cleveland, OH
    Replied 3 months ago
    All good points. I am on the same page as you. Thank you, Brian!

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    William Morrison Investor from Silver Spring, Maryland
    Replied over 4 years ago
    Nice read Ali, I like your recap of how value is not as relevant as cash flow when holding a rental that’s under water in value if you attempted to sell or refi. It is very similar some semi cash assets like bonds and dividend aristocrat stocks. If you don’t have to sell it’s just a number on paper. Some have recovered but there are still many in my area still under water. In my so called disaster planning, ie what is my long term worst case I look at rents reduced by 25% or more on properties I have leveraged and the question I ask myself is can I make ends meet.
    Ali Boone Business Owner & Investor from Venice Beach, CA
    Replied over 4 years ago
    Good info, William. And yep, I have no idea why people panic and sell a property (oftentimes a primary home) just because it goes underwater on paper. Oh well, only education can help!

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    Kevin Andrews Investor from Seekonk, Massachusetts
    Replied over 4 years ago
    Nice article. Not only do you explain the risk factors but also give suggestions on how to best prevent them from becoming larger issues after you buy a property. Obviously like you said you can’t stop these factors from happening but the best we can do is do our best to prepare for them.
    Ali Boone Business Owner & Investor from Venice Beach, CA
    Replied over 4 years ago
    Exactly Kevin!

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    Nancy
    Replied over 4 years ago
    Hello Ali, That was a good article clear and on point. Thanks for the reminders! Nancy
    Ali Boone Business Owner & Investor from Venice Beach, CA
    Replied over 4 years ago
    You bet, Nancy! 🙂

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    Timothy Friars
    Replied over 4 years ago
    You didn’t have to drop your rent at all on that property that had the value tank?
    Ali Boone Business Owner & Investor from Venice Beach, CA
    Replied over 4 years ago
    Nope, not once Timothy. It was an amazing market, partially for that reason. All the values tanked but the rents only kept going up. I definitely increased the rent on that property while the value was still in the toilet. It was fantastic.

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    Dave/ Texas
    Replied over 4 years ago
    Hi Ali, guess lucky here in Texas , we have lots and lots of properties, under 30,000 dollars…many are mobile homes on private lots and some are wood frame houses …we limit our buys to 25-30 k cash, then we limit our refurbishing to 5k for a max of 35 k out. Again no note, no leveraging, cash on the table, we close at the lawyers office, we pay for a title policy on everything except Tax foreclosures. We then set rents 15% below the area and pick our tenants very carefully- at 500 a month rent , with all new appliances and fresh outside condenser unit we usually get 5 years no big maintenance issues. That’s a 17.1% gross return on a 35k investment. After one year of no missed rents or drama, we sell the home to the tenant on a warranty deed and add the interest on top of the 17.% we are getting….. everything is held in a series LLC which allows us leeway to sell or trade without using a big mouth title company- our lawyers don’t disclose anything to anyone. Our property values cant go any lower, but our taxes also cant get any lower , our maintenance after the first year is non–existent. I guess your article is for people who need to borrow to buy?? PS we are looking at property in Nicaragua for growing coffee- any good Managua lawyers YOU can recommend?
    Orlando Rivera from Dallas, Texas
    Replied over 4 years ago
    Hey Dave, where in Texas are you referring to? if you don’t mind me asking.
    Dave
    Replied over 4 years ago
    Killeen area, including Temple Texas, Houston. South San Antonio- where are you?
    Orlando Rivera from Dallas, Texas
    Replied over 4 years ago
    The DFW area. The market is on fire here and home prices have increased 9% as of last month which is the highest increase in the country. So buying here is becoming increasingly difficult

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    Ali Boone Business Owner & Investor from Venice Beach, CA
    Replied over 4 years ago
    Hey Dave! Sounds like you’ve got a great thing set up there…congrats! All sounds very cool. Outside of my realm of knowing how to do things, but I love the idea! No, unfortunately I never met a solid lawyer in my journeys down there, sorry.

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    Justin Gottuso Rental Property Investor from Columbus, OH
    Replied 3 months ago
    Smart system you’ve developed

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    No Nonsense Landlord
    Replied over 4 years ago
    rental property can be great. I just retired and am living 100% on it. Far too many people think that making money with rental property is a god given right. They pay too much to begin with, go in it with little or no education on Fair Housing laws and how to manage tenants, and have minimal back up capital.
    Ali Boone Business Owner & Investor from Venice Beach, CA
    Replied over 4 years ago
    Completely agree.

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    Adam Britt from Bessemer, Alabama
    Replied about 3 years ago
    Hah wow, it is as if you are describing me! No knowledge of Fair Housing, no experience with tenants, and minimal back up capital. I’m hoping a solid PM can solve problem 1 and 2. 3 still frightens me, but I’m trying to “creative finance” my way around it.

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    Young Moon Investor from Fairfax, Virginia
    Replied about 4 years ago
    Great post, Ali. I would add that getting good tenants is key to success in rental property investing. And the converse is true. Would mitigate risk of bad tenants by buying in nice neighborhoods where people want to live and screening diligently. As for risk of repairs, if folks are really worried about big expenses, like water heater, hvac, appliances, etc, they can be covered by home warranties. That can cap your total exposure per year on such big ticket items. May be cheaper in the long run to self fund these expenses if you have the money, but for those starting out, a home warranty may be the answer. Generally speaking, it is a very good idea to have a decent amount of money in the bank to absorb the shocks of vacancy, repairs, etc.
    Ali Boone Business Owner & Investor from Venice Beach, CA
    Replied almost 4 years ago
    Great input Young! I completely agree. Bad tenants, to me, are the most costly issue with rental properties. I’d much rather increase my chances of having better tenants by having a nicer property. It’s no guarantee of course, but it’s all about risk mitigation. And great info about the home warranty.

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    Justin Gottuso Rental Property Investor from Columbus, OH
    Replied 3 months ago
    I’d add that not buying a great deal will cost you money. Why? Because if you’re only making 100 NOI after expenses, if something happens there goes all your profit for the year. Don’t settle for ‘good deals,’ wait for great deals.’ Also, of course, having a mortgage takes away most of the profit you could have if you owned it 100%.

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    Abdul Hamid
    Replied 3 months ago
    Good article. Here in DFW it's getting difficult to find properties with great numbers for rental. Hoping things will get better after the elections.
    Brian Cumberledge from Mc Kinney, Texas
    Replied 3 months ago
    Indeed. We bought 4-10 years ago and it was much better. Right now rents are not increasing over last two years. However the rents are not low so that is good. In DFW vacancy is not really a potential risk. If house is maintained you can bet high risk. Ah but we also know God takes cares of as we do bless with profits.

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    Terry Lowe
    Replied 3 months ago
    I think liability can be a big loss as well. Keep your property safe, and carry adequate insurance.

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    Mike Terry Investor from Fort Myers, FL
    Replied 3 months ago
    There is one huge risk not mentioned here. Liability!!!!!! Mitigation: business umbrella liability insurance, know your liability included in your investment property insurance, properly maintaining an entity, most commonly LLC.
    Brian Cumberledge from Mc Kinney, Texas
    Replied 3 months ago
    I have personal umbrella which covers rentals on policy. It’s cheap considering the value.

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    Andrew Nguyen
    Replied 3 months ago
    why not investing in commercial net leases instead?

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    Philip Remeneski
    Replied 3 months ago
    There are far more risks in investing in residential rental real estate than are put forth. I've been doing it for 30 years and have had thousands of rentals. It is very misleading to imply that, if you can deal with the four risks mentioned, you'll be fine. In actuality there far greater risks.

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    NJ Ram
    Replied 3 months ago
    Agree with Philip above. We invested in student housing 3 years ago, and the cash flow was terrific, plenty of demand, zero vacancy... and then the pandemic hit, and the universities went online. Now we have two buildings which are 25% rented and losing money, and propped up by loans or forbearance and just holding on.

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    Jason Hunsaker
    Replied 2 months ago
    Under what circumstances were you able to get your roofs covered?

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    Allen Tracy from Chatsworth, CA
    Replied 2 months ago
    Nice article Ali, thanks for sharing.

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    Navjeet Chabbewal from Northern Virginia
    Replied about 1 month ago
    Great article Ali and great additional pointers provided by other folks. As a new investor who just put an offer for the first property with older construction, all of these points are very useful to me. So thanks a lot.

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