How to Lower Your Risk in Real Estate Investments

Posted in Blog  
  on Apr 14, 2016

Every type of investment comes with some inherent risk, and real estate certainly isn't an exception.

There are, however, things that you can do to lower your risk. Start with these four tips, and make it easier on yourself to start earning money from an investment property.

Do Plenty of Research Before Buying a Property

The more research you do, the more information you have to make smart decisions.

When deciding whether to purchase an investment property, you should look at:

  • Its capitalization rate (the property's annual operating cost minus its market rate)
  • The surrounding neighborhood
  • Likely developments in the area
  • The property itself

Doing research involves more than crunching numbers and walking around the property though.

You should also spend time in the neighborhood and talk to the people who live there to learn more about the area. They may have insights into factors that you won't notice.

For instance, a resident who has lived in the area for several years or longer may tell you about:

  • Demographic changes over the last decade or more
  • Problems with wildlife in the area   
  • Flooding and other problems a seller may be reluctant to reveal

Take your time, and talk to as many people as possible.

That's one of the best ways to ascertain your investment property is one that attracts tenants and grow in value.

Look for Affordable Funding Options

Unless you have cash to purchase an investment property, you need to find a funding option.

Most lenders believe that rental properties are bigger risks than primary residences, so you also need to meet stiffer requirements.

That makes it imperative to compare offers from several lenders before you decide which funding option to accept. Most importantly, you have to compare interest rates and points.

Points are a kind of interest that you pay in a lump sum. Each point equals one percent of your loan amount. So, if you borrow $100,000 on a three-point loan, you will pay $3,000 upfront.

As of 2016, the interest rate for a 30-year fixed mortgage has been between 3 and 5 percent for several years.

Even with a good credit rating, though, lenders might not want to give you a rate under 6 or 7 percent.

Lenders might also charge extra points. Few, however, charge higher interest and extra points.

With a little legwork, you can find an option that has only one or the other.

The option you choose depends on how you want to spend your money.

Since you have to pay points upfront, they could lessen the amount of available cash you have to put into your down payment. Interest payments get spread out over the life of your loan, so you do not have to pay that cost upfront.

Typically, you will pay more if you go with the no-points, higher interest loan since repayment generally takes anywhere from 15 to 30 years.

Find a Partner to Split Costs With

Since you can't get PMI (private mortgage insurance) for an investment property, you have to make a down payment equal to at least 20 percent of the property's value. That means you'll need $20,000 or more just to get a loan on a modest $100,000 home.

If you split the cost with a partner, it's more likely that you can qualify for a low-interest loan.

The financial advantages of finding a partner can benefit you for decades to come as you split the expense of things like building repairs and management services.

You also stand to lose less money if something unfortunate happens.

For example, instead of losing a $100,000 investment as the result of destruction from a catastrophic event, you'd only lose half of that.

Finding a good partner may not be easy. You must evaluate the person's financial health and intentions before you consider forming a partnership.

Once you do find the right person, meet with a lawyer so you can sign a contract that specifies each person's responsibilities.

This is an essential step — even if you've known the person for years.

You never know what is going to happen in the future, so it's smart for everyone involved to protect themselves with a contract.

Get the Right Insurance Policies

There are several types of insurance policies you can buy to lower your real estate investment risk. Some options you should consider include:

  • Rental property insurance
  • Liability coverage
  • Rent loss coverage
  • Rent guarantee coverage

Rental property insurance is one of the most important things for you to buy.

It protects you from the high repairs costs associated with damage caused by storms, fallen tree limbs, earthquakes and other unhappy events.

Even if you pay cash and owe nothing on the property, you should purchase rental property insurance. Without it, you could face repairs that exceed the building's value.

Liability coverage is also crucial because it protects you from liability should someone, such as a renter, get injured on your property.

Rent loss insurance pays you if your property becomes untenable.

For example, if a flood forces your tenants to move out for a few months, the policy will replace the money you were collecting from them.

Rent guarantee coverage protects you from tenants who don't pay their rent. It's different from rent loss insurance because the tenants still live in the rental property — they just refuse to pay. This can come in handy when you have to go through a long eviction process to remove bad tenants.

 

No matter what you do, you cannot escape risk. Taking the right steps, however, can minimize your risk and increase your chances of successful landlordship.