Real Estate Investing – Eliminating Risk

What would it be like to create business plans so clever that they are virtually infallible? A lofty goal, but an attainable one, for real estate investors willing to take the time to create a series of safety nets for their investments.

The premise works as follows: no matter how long term your investment goals are, investors are wise to consider and allow for contingencies forcing them to extend their ownership exposure for the property. In plain English, that means that you should invest with backup plans in place in case you have to hold onto the property.

From a practical perspective, how is this done?

If you flip real estate contracts, and your ownership exposure is (ideally) none, you probably are only concerned with how cheaply you can acquire a real estate purchase contract, and how expensively you can sell it. But what happens when your buyer bails out at the last minute? Or you can’t find a buyer? You’re stuck settling on the property yourself, which means the next fastest way to turn a profit is to sell the property. But of course, you now had to pay all those settlement expenses, and you’ll have even more expenses to sell the property. How do you recover that profit?

The answer is that you’ll have to create value in the property. The easiest way to create equity in the property is to improve it, so when you’re scouting for houses, even if only to flip the contract, look for fixer-uppers, because they’re easier to scrape a profit from if you’re forced to settle. As a bonus, you’ll be selling to a homeowner instead of a fellow investor, which means they’ll be buying retail instead of wholesale, improving your sales price further.

What’s the next safety net, if you can’t sell the property? You probably have a mortgage that you’re carrying every month, which means you’ll have to do something to cover that hefty expense, and fast. This means renting the property to a tenant, so that someone ELSE pays that monthly bill. So the trick here is minimizing your monthly costs (i.e. mortgage) and maximizing your monthly income (i.e. rent). Some neighborhoods lend themselves far better to rental properties than others, so consider the market rents when you buy a property (or put a contract on a property intending to flip it).

Neighborhoods that tend to make for good rental investments are college neighborhoods, immigrant neighborhoods, gentrifying yuppie neighborhoods, and stable blue-collar working neighborhoods. Each of these has their own pitfalls, but they make for a good place to start looking.

Once the property is rented out, you can sell to a fellow landlord or real estate investor at your leisure, if you so choose. If that fails to offer the profit your books need, what’s the next safety net?

The final safety net is to limit your exposure to neighborhoods that you feel are appreciating in value. Thus, if you can’t flip the contract, can’t renovate and resell, and can’t sell after renting out, you can always simply allow the property to appreciate on its own, after which you can refinance for cash out, or (finally!) sell the damn thing for a profit.

Just as with each of our previous safety nets, our last one has certain indicators to bear in mind. Areas that are likely to appreciate must, first and foremost, have some sort of intrinsically valuable location. This could mean anything from an urban neighborhood close to a body of water, or close to the site of planned sports stadium, or an area with access to existing or planned transportation, or any number of other factors. Keep an eye on demographic patterns, and if you see a neighborhood that starts appealing to young professionals, it’s a strong sign, as they tend to be the first in the door of a gentrifying neighborhood.

The next time you consider buying an investment property (or contract), consider all of these safety nets, and look for fixer-uppers, areas with strong market rents relative to pricing, and neighborhoods likely to appreciate. Don’t assume your first plan will work, because it may be your last real estate investment if it fails.