If you talk to any seasoned investor, they’ll probably talk about the benefits of investing in real estate. Historically, real estate prices have risen in almost all areas of the United States, and there are dozens of different ways to take advantage of real estate investing. You can invest in residential or commercial properties, you can optimize for cash flow or long-term appreciation, and you can even invest in real estate investment trusts (REITs) if you don’t have the capital to buy actual property.
All these are great benefits that are undeniably true, but is real estate ever a risky investment?
All Investments Come With Risk
First, we need to acknowledge that all investments come with risk. There’s no such thing as an investment with no risk. Life is full of uncertainties, and there are ways for all investments to either fail or cost you more than they benefit you.
For example, no matter how promising a company has performed in the past, there’s a chance it could go under in the future. Precious metals are often seen as a safe haven for recessionary and inflationary periods, but volatility can still affect your returns.
Real estate is no exception. No matter how much experience you have or how carefully you plan your decisions, all your real estate investments will come with at least some risk.
The questions are, how much risk is there and are you willing to tolerate it?
Risks to Consider
These are some of the most significant risks you’ll need to consider when investing in real estate:
- Property depreciation. Purchasing a property, even at a low price, doesn’t guarantee that you’re going to see a positive return on your investment. Generally, we expect real estate prices to rise given enough time; even though prices will fluctuate, sometimes rapidly, in the short term, historical trends indicate that real estate prices consistently go up.
However, for a specific property in a specific area, this is far from a guarantee. If the house isn’t properly maintained or if it suffers from disrepair, its value could actively decline. The same is true if the neighborhood undergoes a negative transformation, with fewer work opportunities, higher crime rates, and falling quality in local schools. You can guard against this somewhat by doing your due diligence and only investing in areas with promising opportunities for the future – but again, there’s no guarantee here.
- Hidden issues. One of the biggest risks faced by new investors is the possibility of discovering hidden issues in the properties you purchase. If you find a cheap property you want to flip, or if you purchase a rental property with the hopes of achieving positive cash flow, you might be surprised to learn that the foundation isn’t as solid as you thought or that there’s a heavy mold infestation in the basement. Hidden issues can be costly to remediate, jeopardizing your investment and sometimes completely negating whatever return you otherwise would have made. Fortunately, a thorough home inspection can prevent this problem in most cases.
- Lack of rental demand. One of the most popular ways of investing in real estate is purchasing rental properties, with the hopes of renting them to tenants. But if there are no tenants interested in your property, it’s going to remain unoccupied indefinitely. During this vacant period, you’ll be responsible for actively maintaining the property and making payments on it, but you won’t have any income to subsidize those payments. Again, you can minimize risk here by doing your research proactively and only choosing areas with strong demand.
- Excessive costs. House flippers and remodelers face the significant risk of underestimating the time and monetary costs of fixing up a property. When you first tour the building, you might ballpark the costs as being $10,000, generating a financial plan around that foundation. If the costs turn out to be $25,000, it’s going to be much harder to turn a profit. To minimize risk in this area, consider intentionally overestimating all your expenses, so you have a buffer to protect you from unexpected developments.
- Major market changes. All property investors are subject to the whims of the market. It’s not uncommon for the market to experience volatile changes, including price increases and price decreases. If you’re unlucky in your timing, you could end up on the wrong end of a deal – and end up losing much of your investment in the process. Timing the market is extremely difficult, so the best way to mitigate risk in this category is to practice something akin to dollar cost averaging (DCA), investing in smaller amounts on a regular basis over a longer period of time.
- Overleveraging. Real estate is attractive in part because it allows you to take advantage of financial leverage, borrowing money as investment capital. But there is such a thing as borrowing too much money and becoming overleveraged. Overleveraging is different for different people, but there’s a certain point where you owe too much money and you don’t have enough income to compensate for it.
Your Personal Risk Tolerance
Keep in mind that there’s another variable you should consider when calculating and thinking about risk: your own personal risk tolerance. Risk isn’t necessarily a bad thing, and it’s usually associated with opportunities with very attractive upsides. The key to being a successful investor is understanding which risks you’re willing to tolerate and which ones are too much for your strategic objectives. Generally speaking, the younger you are, the higher your risk tolerance will be, allowing you to make riskier decisions in pursuit of higher gains. But you’ll also need to consider your current income, net worth, and the balance of the rest of your portfolio.
Are you interested in delving into the world of real estate investing? It’s much easier when you have a buying agent or property manager to help you make more effective decisions. If you’re ready to start looking for real estate in the Texas area, or if you aren’t sure where to start with your real estate investing strategy, contact us for a free consultation today!