How to Manage Your Real Estate Investment Risk

real estate investmentMany naive real estate investors associated with get-rich-quick real estate schemes too often lose money on their real estate investments because the get-rich gurus fail to warn them that in addition to the returns, risk also magnifies on highly leveraged real estate.

These unfortunate real estate investors simply lose touch with reality and generally expect the market values of their properties to appreciate at such high rates that they barely care how much they pay for the property or how it gets financed.

The idea of course, as far as the wide-eyed real investor is concerned, is that the investment property will get sold in a few years for twice the amount they paid for it no matter what.

Of course, we know better than that.

Therefore, in response to what most would deem risky real estate investing practice, here are eight ways for you to legitimately manage the risk on your next real estate investment.

  1. Don’t expect appreciation. When you need high rates of appreciation like 10 percent or more a year to make your investment look attractive, you set yourself up for a big loss. If your investment appreciates in value at a significant rate and you make money overnight, great; just don’t rely on it happening when you’re making the investment.
  2. Beware of negative cash flows. Unless your investment pays for itself through the income it produces, you’re speculating, not investing. If that’s what you want to do, fine, just recognize that speculating creates high risk.
  3. Don’t overextend yourself. When you finance with a high loan-to-value ratio (high leverage) it usually means that you will make large mortgage payments relative to the amount of net income that a property brings in. This in turn makes you highly vulnerable to negative cash flows, vacancies, higher-than-anticipated operating expenses, or unforeseen rent concessions needed to attract good tenants. Choose a financing package that doesn’t push you too close to the edge.
  4. Avoid overpaying for a property. Little or no down payment deals cause many real estate investors to buy overpriced properties. The old real estate investment adage “You make money when you buy” should be memorized.
  5. Look for bargain-priced properties. You build a financial cushion into your deals when you pay less than market value. If you really purchase right, you’ll have equity when you get the keys to the property. “Only buy on Monday what you can sell on Tuesday” is a safe philosophy for real estate investing.
  6. Buy properties that you can profitably improve. Sweat equity is a proven way to build wealth and reduce the risks associated with leverage. It’s always a smart real estate investment technique when you can add value to your properties through creative remodeling and renovation.
  7. Buy properties with below-market rents. Whenever you can raise rents to market levels within a relatively short period (six to twelve months), you’ve got a winner known in real estate investing as “upside potential.” As you increase your rental income, you will reduce the strain of high mortgage payments and add value to the property at the same time.
  8. Buy properties with low-interest financing. This should be obvious to any real estate investor. Low interest rates boost your ability to handle high debt safely. Look for mortgage assumptions, buy downs, or seller financing.

Yes, over the long term, owning real estate will make you rich – real estate investing has made many real estate investors millionaires.

To get to that position, though, you may have to pass through several downturns. And unless you have tons of cash (or credit) reserves to defend against these slumps, it’s best to remain cautious and do all that you can to safeguard your real estate investment. Do it by the book.