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How to reduce risk when investing in real estate

8th December 2021 Print

Real estate investing is, by definition, risky. However, if you know how to evaluate deals and take your emotions out of the process, you can make some pretty smart (and lucrative) decisions.

Dealing With Risk

It’s impossible to totally separate risk from real estate investing. By definition, there has to be some level of risk (otherwise it wouldn’t be an investment). There are, however, plenty of ways to control risk and reduce it to manageable levels. Typically, risk reduction falls into one of three basic categories:

- Risk avoidance. Anytime you can avoid risk, you should. For example, if you’re looking at two rental properties with similar cash flow and one has a pool and the other doesn’t, choose the property without the pool. This helps you avoid the risk of drowning lawsuits.

- Risk control. If risk can’t be avoided, you can try to control it. Using the same pool example, you might purchase a fence to go around the pool. This controls much of the risk that you’d otherwise face.

- Risk transfer. If risk can’t be avoided or controlled, it should be transferred. For example, you might increase the insurance on your property to transfer risk to the insurance company. 

When you think about risk in terms of these “buckets,” it becomes easier to look for strategic ways to protect your downside. Sometimes, it’s all about perspective.

6 Specific Risk Reduction Tactics

You’ll have to decide the best way to reduce risk in a given real estate investment, but here are some different tactics that tend to work really well:

1. Use Conservative Numbers

Never get emotional about an investment. When emotions get involved, you end up bending the numbers just to make a deal work. Instead, we recommend taking an objective vantage point and using very conservative numbers.

For example, you might think you can purchase a rental property, charge $2,000 for rent, and keep the property occupied year-round. However, a conservative approach would be to assume you’ll only get $1,800 in rent and that it’ll be vacant one month out of the year. So instead of banking on $24,000 in rental income per year, you’re estimating more like $21,600. If the ROI still makes sense at this figure, do it! This allows you to account for the worst-case scenario.

2. Make a Higher Down Payment

If you’re ever worried about cash flow on an investment, making a higher down payment is a safer way to go. This gives you more room in your budget and reduces some of the risk associated with the property. And depending on the amount of money you put down, it could help you avoid costly forms of insurance (such as private mortgage insurance).

3. Do Thorough Due Diligence

Always do thorough due diligence when investing in a piece of real estate. More specifically, focus on the property’s ownership and title. Hiring the right conveyancing service could prevent you from making a serious mistake that threatens your ownership and equity. For example, a conveyancing expert in Brisbane could offer peace of mind if you live in Australia.

4. Buy a Location, Not a Structure

As an investor, you always need to focus on location over structures. In other words, don’t get blown away by how cute or attractive a property is. Instead, focus your attention on where the property is located and what sort of cash on cash return you’re getting. Structures can wither away, but location never changes. If you have a property in the right location, you’ll never have to worry about getting maximum value. 

5. Lock in an Interest Rate

While variable-rate mortgages and loans can certainly give you a lower-than-average interest rate, leaving your rate up to chance is very risky in this current environment. Interest rates are almost certain to rise in the coming years, and you want to do anything you can to lock in a fixed rate. 

6. Buy Plenty of Insurance

Insurance is not something that’s fun or exciting to purchase. It is, however, one of the best options for transferring risk in scenarios where it can’t be avoided or controlled. Insurance premiums are a small price to pay for peace of mind. It could very well save you from losing the investment.

Adding it All Up

You can’t go into a real estate investment with a fearful attitude or posture. You should, however, always have a plan for protecting your downside. By proactively addressing the risk involved in any investment scenario, you can put yourself on the path to success.