​Investment Risks and How to Deal With Them

As investors, risk is something that each of us faces every single day. Every time we buy a property, we’re taking on some level of risk. While most of us accept this and recognize that it’s an inevitable part of the pathway to success, there are others that find the risks of real estate investment to be too much.

So what are the major risks that scare people away?

As I see it, there are 3 primary categories of risk in real estate investment: the property itself, the tenants, and the market. Each of these represents an array of risks - some big and some small, but all of which are manageable.

The Property Itself

First off, you’ve got the property itself, which poses a couple different risks. The first is the location, because where the property is located is one of the most important determining factors in its success as an investment. Buy a property in a declining area, and you’re not going to see the returns you want. But buy one in a market that’s trending upward in terms of population growth and employment opportunities, and you’re going to make bank.

So the risk you have with location is easy to understand. Bad location = bad investment. Fortunately, it’s also fairly simple to mitigate this. It’s called due diligence. Before you buy a property, you should be putting in several hours (at least) of good, solid research on the larger market and the localized area you want to invest in. Study the population and employment trends, investigate if any new industry is coming to the area, look at the local economy. Then, narrow your focus even further to examine the specific neighborhood you’re eyeballing. What are the property values? How many owners vs. renters are there? What are the nearby amenities? Making a smart investment starts with the location of the property, so do your homework to ensure that you’ve picked a good spot, and your risk will be much lower.

The next piece of the property puzzle is the unit itself. The actual real property that you’re buying - the land and the structure on it - can also be risky. Namely, this risk lies in the condition of the property. Purchasing an old home in need of major repair can be pretty risky due to the expense associated with renovations and other projects. However, if you’ve got a good contractor and can get the property for a steal, this risk may be worth taking on. Again, due diligence pays off here. Know what your limitations are and how much time, effort and money you want to spend making a unit livable, and weigh this against the potential profits.

The Tenants

Tenants represent another area of risk for real estate investors. The damage that some people can do a property is truly mind-blowing (ask any investor, and most will have a terrible tenant story that’s as frightening as any horror movie). From not paying rent to damaging your property to vacancy, tenants are risky business in a very real sense.

Fortunately, this type of risk is also fairly simple to deal with. How? Due diligence. Again. For risk-averse investors, thorough tenant screening is a must. Have them complete an application, then you can start running background and credit checks to get an idea of their history. Ask for references and follow up with them. You can also ask potential tenants to put down a deposit, which will eliminate a few of them right off the bat - no big deal, because you probably didn’t want them anyway if they’re unable to pay a deposit. My point is this: if you want to lower the risk level that comes with new tenants, get to know them as much as you can BEFORE they sign the lease.

The Market

Now here’s a risk category that freaks out most investors, and it’s easy to understand why. Because they have no control over it! The housing market fluctuates according to a number of factors, none of which YOU can control. Demographic shifts, interest rates, the economy, government policies and legislation, natural disasters, and more affect the housing market. Consequently, this affects your investment, which means there is risk involved.

So what can you do about it when you have no say in it? Well, first you need to understand and accept that the housing market is characterized by ups and downs, and that’s just something you have to deal with. There will likely be times when you’re struggling - it’s the nature of the game, unfortunately. Acceptance of this, and faith that the market will trend up again, are how you get through it.

Acceptance and faith alone won’t cut it, though. You need realistic strategies to help you mitigate risk that comes with the market and the other categories as well..

1. Due diligence - I’ve said it before, and I’ll say it again. Do your friggin homework. This includes running all the standard calculations to ensure you’ll come out on top, and most importantly, obey the numbers. They don’t lie.
2. Diversification - You know the saying ‘don’t put all your eggs in one basket’? It applies here, too. Don’t pour all your money into one property and cross your fingers that it’ll work out. Start small, keep some savings, and spread the wealth around if you can, whether it’s through multiple properties or different asset classes.
3. Partner up - One way to cut your risk significantly is to get a partner to go in with you. With both of you going in the investment, you’re putting forth less capital and you’re sharing the responsibility with the other person rather than taking it on all by yourself.
4. Limit liability - Consider purchasing your investment properties through an LLC to limit your personal liability if things go south.
5. Exit strategy - Always, always, always have an exit strategy in mind. How will you unload the property if you need to?

Risk is an inherent part of real estate investment and you’ll never be able to eliminate it completely. But you can’t reap the rewards without the risk, and luckily, most of it is pretty manageable. Use the tips above to help you mitigate the risk of investing, and don’t let it hold you back from taking part in this exciting and incredibly rewarding experience!