20 Jan The Big Risks of Rental Property – and How to Alleviate Them
Beginners in rental property may be able to piece together some real estate investment risks, but until you’ve done the work, there’s sure to be some hiccups that surprise you. If you’re a seasoned veteran, there’s likely some areas you’re well-versed in, while having less experience in others.
With that said, whether you’re a first-timer or an old pro, it’s a good idea to occasionally evaluate the main risks involved with investing in rental property.
Knowledge is power, and knowing the risks involved before you are forced to face the consequences will better prepare you for the future, and make you more capable of handling them.
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Crunch the Numbers
When it comes to real estate investing, most people fail to accurately crunch the numbers so their income outweighs expenses. It’s no secret that the expenses of getting a rental property move-in ready can have a hefty price tag – but are you actually tracking each expense?
A majority of rental properties don’t have shiny numbers because of failed expense tracking – that is, the cost of expenses outweighs the income coming in. It’s simple math – if the numbers don’t add up, the success of your rental property won’t either. It’s not uncommon for expenses to exceed the original budget, especially because many expenses are hard to anticipate, but those numbers add up.
Remember – landlords invest to earn money, not lose it. With that said, when it comes to rental property – the “risks” involved are generally all the ways your investment can cost a pretty penny. We’re in this business to make money, so any associated risks are a threat to income. The good news is, the more you are aware of the risks – the better you can alleviate them, and ensure a steady income for years to come.
Risk #1: Vacancy
You may not think of it when making the investment or evaluating risks, but vacancy is a major risk to rental property.
At its very foundation, rental businesses require tenants in order to have a steady income – and if your property lacks tenants, there will certainly be a lack of income. Vacancy can be manageable in the short-term, but you’re still going to suffer a hit – especially if you’re responsible for monthly mortgage payments.
Not only are you out the income, but other expenses could still mount such as needed repairs. And of course, don’t forget the costs involved in securing new tenants, such as agents fees or advertising.
The daunting thing about vacancies is that you may be in a scenario with little to no control over how long they last – meaning you could be rolling the same empty unit over for several months. The lost income will add up as the months go by, and so will the expenses of trying to find someone new. Suddenly, your numbers don’t add up, and you’re stuck with a net loss.
One way to avoid the risk of an increased vacancy period is to buy in a growing market. Markets on the up-and-up have potential for increased jobs, and therefore a larger population with the need for housing. Saturated markets lack the availability to fill units because housing options outweigh new prospects, so up-and-coming areas are your best bet to avoid vacancies.
It’s also important to study the market in your area. Avoid buying property in neighborhoods where ownership is trending – you’re looking for renters, after all. Additionally, investing in areas with working professionals and long-term prospects are a great way to build extra security into filling those units. If a tenant plans to stay for the long-term, that’s one less vacancy you have to worry about down the line – and you’ll have the security of steady income.
Risk #2: Maintenance and Repairs
As a landlord or rental property owner, you are responsible for providing maintenance and repairs as necessary to both the common spaces and individual units. This could come to fruition in many ways – whether it be routine landscaping, a faucet fix, or a petty thief.
These expenses tend to be on the minor side, making it easy to ignore the expenses all together – but as soon as there’s a major plumbing issue or a new roof is needed, you’re in for a rude awakening. You may be thinking, Aren’t repairs and maintenance inevitable? How can I possibly avoid them? The short answer is – you can’t always.
Repairs are bound to come around, and they need to be dealt with regardless, but there are some things you can do to offset the frequency or extremity of repairs needed.
First up, try to attract tenants that are reliable, trustworthy, and professional. Filling units with people who care about their living space are much more likely to treat the property as if it is their own. Sure, there’s no way to really know someone before renting to them – but it’s best to err on the side of caution and narrow the search to highly qualified individuals.
Additionally, it’s vital to evaluate maintenance and repairs before you buy. Having the option to do a full property inspection performed by a professional should be a requirement in the purchase contract, and it could save you quite the headache later.
There shouldn’t be any major red flags that make you re-evaluate buying upon inspection, or it may be a good idea to look elsewhere. Maintenance is a relatively manageable task when repairs cost under the $100 threshold, but any building owner is in for a hefty expense occasionally.
Since this is a risk that is almost certain to be due in the long-run, it’s best to build a good cash reserve to address major repairs when they present themselves. Some insurance policies will cover structural repairs such as foundation or roofing, but you can’t bank on it – so pad your own bank first.
We all know repairs are inevitable sometimes, but the better prepared you are for them, the easier they are to fix (and pay for).
Risk #3: Lower Rent Prices
You should be aware of exactly how much money your property brings in month-to-month in order to offset expenses and still provide a steady income. This tends to be a relatively steady return in good economic times, but should the economy reach a recession or you experience a slow season of business, you may find yourself lowering those rent prices and suffering from the potential income lost.
Economic downturns can cause general market rates to decrease, and you will likely need to stay competitive by lowering rent prices to fill units. It’s important to keep in mind that lower rent prices are not as detrimental as having a vacancy, since there is at least some income coming from the unit as opposed to none.
Even still, you are missing out on the difference, and expenses don’t decrease when rent does. The secret here? Buy in a steadily growing market. Stable markets have the risk of plateauing soon, and declining markets are, well, in decline. Getting into a market that exemplifies strong upward growth will help you avoid the need to decrease rent – and if you’re lucky, you may even be able to tick prices up a notch.
Risk #4: Decreased Property Value
The value of a property can be a risk factor in buying or selling rental property, but as the owner of rental property, this likely isn’t something you’ll have to worry about. There are extreme circumstances for everything, however, and it’s important to consider all potential risks. With that said, in circumstances where the area’s property market has severely decreased, you may find yourself unable to charge the initial rent fees in order to fill units.
This could result in you actively losing money each month after expenses and payments, and month-to-month losses can add up much faster than you’d think. It’s the same age-old secret here: buy in a growing market.
Growing markets equal higher values, and therefore less risk of having to decrease rent, suffer losses in selling, or deal with vacancies. While growing markets are a good sign, avoid buying at the top of the market (when property values are at their highest) to ensure a profit down the road. This leaves the majority of property value increases to you – which will benefit you in the long run, should you ever choose to sell.
Accepting the Risks
At the end of the day, there are risks involved with any investment, and real estate is no different.
Risks are not meant to send you running for the hills, but rather inform you of potential needs that may present themselves down the road. The more knowledge you have of them upfront, the better prepared you can be to handle them in stride.
The key to successfully investing in real estate is preparing for the risks by accepting their inevitability. Knowledge is power when it comes to investments – so know what you’re getting into, analyze the trade-offs, and make decisions that are strategic for you.
At the end of the day, real estate is exciting territory – and anything exciting has some risk. Be one step ahead of the game, and you may be saved from a major headache down the road.
