Hello, everyone! I have been reading like a mad man, and I feel like I have a pretty solid understanding of financing, renting, selling, controlling the properties you buy and a variety of other techniques and investment methods (I have not actually done any deals, however - I'm only 18). However, there's still one definite gray area that remains, and that is this: what are the risky aspects of investing? I understand that these add to risk: • Not understanding your niche • Not having a solid team • Buying bad deals • Lacking the general education needed to succeed in this field • Lacking self confidence and hope for a prosperous future But what I truly do not understand and feel that I cannot prepare for is market volatility. Here's an example of what I'm worried about: • I study my market and learn it inside and out • I am very educated in my niche • I have put together a reliable and trustworthy team • I find a house for 15% below market value (for simplicity - the house is $85k, it is worth $100k), which gives me a significant advantage in that I can have a higher cash flow and be protected against small market fluctuations • I put 20% down • I start renting out the property with an excellent property manager managing it for me • I'm making $500/month in pure cash flow after all fees, mortgage, taxes, etc. • Two years later, the market starts to take a turn for the worst, and the house drops rapidly in value by 35% • I try to sell the house before it drops too far, but no one wants to buy properties when they know prices will continue to drop • Rent no longer covers the mortgage and fees due to the incredibly cheap housing market, therefore the house is foreclosed and my credit and reputation with many partners is destroyed This. This is my worst nightmare. This is what I desperately want to learn about so that I can prevent it from happening. This is mainly the only thing that scares me about REI, so if someone could tell me some strategies, methods, or books that exist to teach people how to minimize risk in REI, I would be eternally grateful. I'm going to college in the fall and am planning on investing in my first property next year. I'm simply trying to prepare in order to minimize risk as much as possible :-) Thank you!

The last sentence above is a faulty mindset that investors must unlearn in order to be successful. It doesn't matter what you invest in, generally speaking, you don't want to sell when the prices drop. You sell when the prices go up and buy when they go down. Yes, sometimes you have to know when to abandon a sinking ship, but then there are usually other factors involved with that particular investment. Let me give you a couple of examples. From 1998 to mid 2002 gold spot prices were less than $300/oz. My husband (a coin dealer) told everyone who came in our store to buy gold - "You won't be sorry, it has to go up." Many people listened to him, and were quite happy to sell their gold for $1000-1800/oz between 08 & 11. Some who sold at $1000 wished they had waited for the higher prices, but they still made money! Some who didn't sell at the peak wished they had, but even now the price is $1300, and they still make money! In 2010 & 11 silver went from about $15/oz to almost $50. In late April 2011 a dealer friend of ours had 10,000 oz. that he had bought at $38 & he had to decide whether to sell at $43 ($2 back of spot at that moment) to a private mint or have the mint process his silver into new rounds. Unfortunately he believed the hype that metals would just keep going up, and he made the wrong decision. In the 2 weeks it took for him to get his rounds from the mint, silver had dropped to $34. He is still struggling to recover from that loss. If he had sold even half of it he would have been okay. Now the main difference between buy & hold bullion investing and buy & hold REI is that no one is going to pay you rent for the bullion while you're holding it. As long as you're not over-leveraged your tenants should carry you through downturns in the RE market. So here is my advice: • Buy when you find a bargain • Don't over-leverage • Hang on through the downturns when others are panicking • Don't be greedy when the market is rising

Many good responses in this thread. I am going to lay out some very basic, yet most important aspects for you to do in order to mitigate your risk factors for your strategy and also comment on a few things I have read in this thread. 1. Just because the value goes down below what you paid for it, that does not equate to he sole need to liquidate. As long as you are cash flow positive, you are stable. Now, there are instances where you may need to cut your losses as an opportunity elsewhere may be the better play. 2. In the example of $500 cash flow, I can tell you that is a pipe dream, no $100k value property will have $500 cash flow after ALL expenses, and if anyone says, well if you pay all cash it can, then you tell them that there is an opportunity cost associated with placing down all cash. You could have invested that cash elsewhere for a return, so if you go the all cash route, you need to also then compare the cash on cash return (COC). Ok, now for the meat and potatoes - History will tell you a lot about the future, one of the advantages of RE is that you can much more easily forecast and see what is coming compared to the stick market where a stock can go from $100 a share to $50 a share in one day with no way to see it comings therefore, knowing your investors levels, today, last month, last quarter, last year, two years ago, 3 years ago, etc will help you forecast where your market will likely be in the upcoming quarter to 6 months. You can get such info from RE agents who track this and you can star tracking yourself. Next, yo need to study job growth and population growth. These two factors in your area, both today, last year, 2 years ago, etc will tell you if you have a strong, mediocre, or poor market to sustain holding long term These items will help you understand your market and thus, mitigate much of the risk involved. The other final step is simply to fully understand all the costs associated with holding RE, how to manage tenants and or property managers, and how to find, negotiate, and fund deals below market value. The better your deal, the better your cash flow. RE Rocket science 101.

@Jeffery Lester Getting a $100K property for $85K is not much of a deal. You can do better. You make your money when you buy. I bought a property with an existing long term tenant. I spoke to the tenant prior to purchase and they plan to stay for 3 more years. I purchased it for $65K and get $1500 month rent. I am doing minor repairs that prior landlord did not do that will total $10K over the course of 6-12 months. It will then be worth about $120K. After tenant leaves I will decide if I should sell it or rehab more extensively and sell for $200K. You can do better than 85% and that's what will protect you. Also, if you're cashflowing and paying down the principal.... that will further secure your investment. In my example above, I paid cash. After 3 years of rent payments minus taxes, I'll have recouped $42K of my $75K investment and then I get the $ from selling it :)

@Jeffrey Lester I don't think investing is very risky. As an investor, I do lots of things to take risk out of the equation. Here are a few: 1. The deal has to cashflow from day one... this gives me room to lower rent and still make money.1 2. I buy it below true market value. Its not even always easy to find properties 15% below value... but the more value you buy, the more cushion you have. 3. I don'y buy for appreciation (its icing on the cake). This keeps me from chasing the hot markets. Usually, the steeper the climb, typically the stepper the drop. This limits the upside on appreciation, but lowers your risk. 4. I screen tenants well and have a willingness to wait another week or two to find a tenant that meets my standards. 5. I budget for CAPEX. The only true cashflow is whats left after the 50% rule and financing. 6. I keep a stockpile of reserves that are from the cashflow. When you aren't living off the cashflow, then even if you have a rough year, you had good years before and after that year to make up for the bad stretch. 7. I budget into my purchase price to tenant proof and repair all aging part of the house. EX: If the hot water heater is 7+ years old, I leave it, but budget a new one into my purchase price. This limits large ticket surprised down the road. 8. I calculate my sales expenses into my purchase price. Real Estate is a costly asset to sell, so i budget 8-9% for this. Dont let risk scare you off. Calculate really what the risks are, and know that you have accounted for this and will still make money. When you do so, investing wont be risky... it will be risky not to invest!

@Jeffrey Lester I bought my first property in college. My advice would be, if you can manage to have a job and study, then get a job. You will need at least 1 year of income to qualify for a mortgage. Since you will only have a high school diploma, you will likely qualify as low income. Most cities have first time homebuyer down payment assistance programs for low income persons. If you were to use the down payment assistance to purchase a homepath property you would be doing amazingly well. You would have the city helping you with the down payment (normally either a forgivable loan, 0% interest loan or grant- the amount and terms vary from city to city) and you would be able to purchase a property before investor competition. All in all you would have beat out investors with little to no money out of pocket. I did this and basically did what @Blake C. did and got a roommate to cover the monthly expenses. It was a great way to start. Be careful to make sure you can meet the residency requirements the owner-occupant and down payment assistance programs require and you'll be off to a great start!

@Jeffrey Lester I am a bit south of you but if you feel the urge to sit and talk about real estate or take a tour of some of mine I would be glad to do so. Good luck on your investing

@Jeffrey Lester If you are clearing $500 a month in cash flow in your example, that means that you have a lot of available cushion to weather some major fluctuations as you could lower your rent by over $500 a month before you started having to put money into your investment. Now this is only true if you have taken into account all of the items you should account for when calculating cash flow to begin with. In your example above of the 100K valued house that you purchase for 85k. Your are investing 17k for a down payment (20%) and let’s assume you have no closing costs associated with the purchase and the unit is completely rent ready after purchase (so you are only out the 17k). Now your expenses to keep and run the property might seem small since you are only paying for a couple of the monthly expenses (as this might be all you are accounting for) so when you are calculating your cash flow it looks fantastic. for an example let’s say the location rents for 1500 a month and you are figuring 500 a month in various expenses so that leaves you with 1000 to pay your mortgage which is around 358 (based on a 30 year mortgage at 4.875% for the balance of the property 85k-17k=68k) so you think you are clearing $642 a month. But then the roof on the unit needs to be replaced -6000 in cash flow, a year later a tenant moves out and you need to replace the flooring -3000 and you need to paint the inside -1500 and the unit is vacant for a month while you are fixing it back up to rent ready state. As you can see there are a lot of variables that you need to do your best to account for ahead of time so you know that you will have cash available to handle when the time arrives. This is where the 50% rule comes into play, or people that talk about setting up reserves and or maintenance funds out of their rental income. You have to find what you are comfortable with and when doing so your $642 a month cash flow might turn into $200 a month cash flow but you will be better off down the road as there will be money set aside already for when major repairs come up for the property. Investing is always a risk no matter what the investment is. The question becomes what have you done to mitigate as much of that risk while still creating a return you are comfortable with? This is the true science and art of investing in anything.

Hi Jeffrey, IMHO too much leverage may be one of the biggest risks. Underestimating the true cost of operating the property is another of the risks but this can be mitigated by the 50% rule: Assume it is going to cost 50% of your rents to operate your property (excluding financing... ie add financing to the 50% cost to calc true cashflow). If you have not contravened the above... then in your example where the market dips 35%... you just hold and continue to make a bit less cashflow (if you need to drop rent) and continue to make your mortgage payments. This assumes that the 35% is a macro event rather than a local cause. I think you probably would have seen a local event coming. IMHO when intending to buy and hold you look at long term demographic drivers - population, employment, school quality, low availability of land... I don't think these will catch you by surprise. BTW congrats on having such a great interest and understanding at 18!!! If you haven't already, join a local real estate group and find a mentor or 3 to run any numbers :-)

Sorry no books to offer. Dave Lindahl is one guru who talks about market cycles. Personally I believe the cycle that count are the ones that are so obvious you don't need statistics and charts to tell you it is happening. The best advice comes from Warren buffet.

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What exactly makes REI risky?

Jeffrey Lester

Real Estate Investor · Great Falls, MT · Member since 2014 · 46 posts · 6 votes

Hello, everyone!

I have been reading like a mad man, and I feel like I have a pretty solid understanding of financing, renting, selling, controlling the properties you buy and a variety of other techniques and investment methods (I have not actually done any deals, however - I'm only 18).

However, there's still one definite gray area that remains, and that is this: what are the risky aspects of investing?

I understand that these add to risk:

Not understanding your niche
Not having a solid team
Buying bad deals
Lacking the general education needed to succeed in this field
Lacking self confidence and hope for a prosperous future

But what I truly do not understand and feel that I cannot prepare for is market volatility.

Here's an example of what I'm worried about:

I study my market and learn it inside and out
I am very educated in my niche
I have put together a reliable and trustworthy team
I find a house for 15% below market value (for simplicity - the house is $85k, it is worth $100k), which gives me a significant advantage in that I can have a higher cash flow and be protected against small market fluctuations
I put 20% down
I start renting out the property with an excellent property manager managing it for me
I'm making $500/month in pure cash flow after all fees, mortgage, taxes, etc.
Two years later, the market starts to take a turn for the worst, and the house drops rapidly in value by 35%
I try to sell the house before it drops too far, but no one wants to buy properties when they know prices will continue to drop
Rent no longer covers the mortgage and fees due to the incredibly cheap housing market, therefore the house is foreclosed and my credit and reputation with many partners is destroyed

This. This is my worst nightmare. This is what I desperately want to learn about so that I can prevent it from happening. This is mainly the only thing that scares me about REI, so if someone could tell me some strategies, methods, or books that exist to teach people how to minimize risk in REI, I would be eternally grateful.

I'm going to college in the fall and am planning on investing in my first property next year. I'm simply trying to prepare in order to minimize risk as much as possible :-)

Thank you!

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What exactly makes REI risky?

What exactly makes REI risky?

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