Real estate in the past decade has ranked as top investment for the majority of Americans, but is it really safe and what are the risks involved with the prize? Let’s find out.
7 major risks you would want to know before making any real estate investment for an educated decision in the near future.
As we all know the current issue is the interest rate and the economy. While interest rates continue to rise, both the residential and the commercial real estate markets are affected.
The second most important risk is a bad location.
Now, most agents will tell you to buy in a good and safe neighborhood. What I will tell you is, don’t buy in good or bad neighborhoods, because guess what? They change, like anything else. Just because a neighborhood is safe right now it doesn’t mean it will be safe in a few years from now. And just because a neighborhood isn’t safe right now it doesn’t mean it won't be safe in a few years from now either. Instead, do the reverse engineering. Buy in a neighborhood that you can see it's future. You want the one that’s going to be the ‘Next” big move. But guess what buying in a bad neighborhood offers? Well, less likely to depreciate since it’s already a bad neighborhood, it reduces your risk already.
Then for the location take a look at the schools, transportation, local amenities, how the location affects value? What’s more important the location or the house? You can always update a house but can’t update a location.
Once you pick a neighborhood then start to choose different areas within that neighborhood. Always consult with a local realtor.
Next risk you should consider is the negative cash-flow if investing.
Cash flow is generated by rental income. A negative cash flow will be a rental property that does not generate enough income to pay for operating expenses and debt. For example the monthly rent price is too low or vacancy levels are too high. In this case an investor will have to pay from his own pocket each month to cover the shortage in expenses. Why negative cash flow? Well sometimes it is because a property might be located in a neighborhood that is not attractive to tenants or the economy is going underwater. Some things to consider when trying to fix this issue will be to cut or lower some of the operating expenses, increase the lease if it makes sense according to the market, update and remodel the property to attract qualified tenants, and have a better screening process for tenants.
However there are many investors looking specifically for these types of properties, to turn the negative cash flow into positive. They come in, update the property, raise the rent, improve tenant screening, so they can justify the higher monthly rent and then sell when the timing is right. That's easy.
The 4th risk is - considering vacancies.
This is the biggest mistake that investors make in underestimating vacancies. Vacancy rates are a good indicator whether a market or neighborhood is strong. The mistake investors do is calculate an average vacancy rate, and not looking into detail the vacancy rate in their neighborhood (you can find info from property managers and realtors) For example a market with high vacancy rate may have an oversupply of rental units, meaning it will take you longer to rent yours, resulting in a higher risk to you as the investor.
5th risk includes problems with tenants.
And here starting with maintenance conflicts (who’s responsible for what? When it comes to property damage or maintenance repairs. Damages like mold, pest, damaged plumbing, structural defects are something the landlord must fix, so the tenant can have a habitual living space) then Issues with nonpayment - self explanatory in case tenant does not pay on time that could lead to a costly eviction process, issues with the security deposit - which is a one time fee that becomes refundable upon terminating a lease and vacated by the tenant if the property has no damaged from the time rented. The security deposit is not required by law, but most landlords choose to include it as a financial protection in the event the tenant fails to pay rent or does significant damages to the property.
6th risk is lack of liquidity.
The liquidity measures the rate at which an asset can be purchased or sold on the market at a price that reflects its current value. (Add photo) in small terms the liquidity refers to how easy an asset can be traded for money without affecting its market value. The reason that real estate is considered an illiquid asset is because, well
- you deal with private markets, unlike stocks, bonds or ETFs where you can publicly find anything about that company before investing, in real estate there is a lack of transparency. Therefore you need to do your own research, personally be in touch with the realtors, inspect the property in person, and perform all the due diligence necessary.
- Real Estate are Complicated Transactions and incredibly time consuming- the process of finalizing a transaction involves many parties - You as the buyer, sellers, realtors, lenders,title agents, attorneys, inspectors, appraisers. On top of that there is a lot of paperwork to be done. It could take days,weeks or months to actually sell or buy a property.
- The illiquidity is also determined by the fluctuation of the market. Inability to transform the property into cash when needed because the price can vary considerably.
7th is hidden structural problems.
And in here includes bad sewer lines or rusted pipes, hidden water damage, rotten wood or termites, huge cracks in driveway if it’s a house, bad or old ventilation or windows, radon leaks, outdated wiring, septic system or AC issues, bad roofing, electrical issues, etc.
The law requires the seller to disclose all known material facts about his property. If they forget or refuse to provide this disclosure, a buyer can cancel the sale. But what i’ve seen happening, for example homeowners who never lived in the property and are not aware of the defects, that’s when you get burned. In that situation you need a really good property inspector and a competent realtor for the due diligence.
If you discover defects after the sale, you’re pretty much taking the property As-Is and are limited to recovering money from the seller. Sometimes the default in discovering these defects is not always on the seller’s side, it can be the inspector or the realtor. Not performing the due diligence properly. However when they are found to be in default, it can only be in the hook for the cost of the inspection, as opposed to the cost of the defect.)
At times the seller can be found liable for the defects if it was not disclosed, and the buyer can prove that the seller knew about it, or should’ve known.
The bottom line is that real estate has been considered a great investment and savvy investors can benefit from it’s passive income, tax advantages, opportunity to build wealth and excellent long term returns.
Just as any other investments, real estate can be risky but that’s why you have to align yourself with professionals that know this business and can help you in the due diligence process, and conduct a market analysis that will benefit you.
Keep in mind that there are many ways of investing in real estate besides owning, financing and operating actual properties. If you want to learn more let me know in the comments below or reach out by email or text. I usually reply to all my emails and texts in a timely manner.
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Angela Andronache
Broker Associate | Lpt Realty LLC
Miami FL, 33131
305-306-0375
Info@AngelaAndronache.com
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