Yes, I believe real estate is the best way to build long-term wealth at the lowest risk possible. However, like with all investments, real estate also has its risks. And that’s not a bad thing, or a reason for you not to invest. Risks are much more associated with not knowing them and not knowing how to deal with them, than anything else.
If you are investing in real estate with the main goal to produce income, you will face these 4 main risks:
The Vacancy risk is a risk you incur when a tenant leave and the time you won’t have the property occupied until a new person or family, rent your property. That can happen for many reasons: lack of people interested in your property, or the area, the time you need to fix issues caused by the last tenant, or because of the natural depreciation of the property, etc. And, even though this risk exists, you can reduce them in several ways.
Buying properties in areas that have higher desirability is one factor. You can look for neighborhoods with good schools, with large facilities, such as hospitals, universities, shopping malls, where the employees of those companies would like to live to reduce their commute time.
Another thing that you can do is to have longer-term contracts. Instead of renting your property for 6-12 months, you may want to extend your contracts to 24, 30, or even 36 months. The longer time you have a tenant, the lower the vacancy risk you will have.
This is basically a credit risk that you have. It is the risk of not getting paid by your tenant while he/she occupies your property. If that happens, not only you won’t receive the money from them, but also you will have to come out of pocket to pay for the property's expenses and a lawyer to do an eviction process.
To reduce that risk, you may ask for security deposits, run a credit background check on your tenant, ask for a guarantor or lease insurance, or rent the property for families that are beneficiaries of government programs such as Section 8.
In The Section 8 program, the Federal Government pays the rent for the tenant directly to the owner of the property, reducing your Default Risk, virtually to zero. Why virtually? Because you still have the risk of the Government not paying you. However, just as a reference, in 2019, when we had the US Government Shutdown, the Section program wasn’t affected, and during the pandemic, landlords with tenants members of the program were thanking God they made the decision to rent to those families.
Another risk of investing in real estate, especially if you are looking to have income-producing properties, is the risk of maintenance. As the landlord, you are responsible to maintaining the place habitable and providing the tenant the maintenance as per contract.
If something breaks, and it’s your responsibility to fix it, you will have to put your money to work, or else the tenant has the right to hold part of the rent until you do. You may reduce this risk by purchasing insurance. It will reduce your gains, of course, but, if anything happens, you just have to claim your insurance and have the Insurance Company deal with it.
And, of course, by inviting in real estate, if, for any reason, you decide to sell your property, you will face the (re)sell risk, which is the risk you have of trying to sell you property for a given price and period and not meeting non of them.
In some cases, you may mitigate this risk by having a sale option at the end of your contract term. That will give the chance of the tenant to buy your property for an agreed price and conditions, and the rent they paid may or may not be a part of the purchase price.
Knowing the risks you have is the first step to be prepared. Now that you know them, and how to manage them, it’s time to invest.