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3 Ways To Protect Yourself Via Risk Reduction
Everything you do has it’s financial risks. So it’s an interesting paradox when people refuse to entertain investments due to potential risks. Your negligence in a restaurant can bring you a lawsuit, so does a moment of recklessness when you are driving.
But I guess the type and level of risks in everyday life is at a very different level when you go into real estate. Even if you are someone who does not even blink when placing a $1,000 bet on football, you should take appropriate steps to protect your real estate business and investments. Business is, after all, based on decisions linked to logic.
Here are the 3 best ways to build your own financial fortress.
If you are a rookie and the question of what is your biggest risk comes about, your answer would probably be vacancies. But if you ask the same question to a veteran who has been around the block, the answer almost always is tenants.
Typical property insurance will protect your property from fire hazards or personal losses. But what you are most afraid of, what will cause your legs to wobble, are lawsuits from tenants. In our easy-lawsuit way of life these days, anyone can basically sue anyone for anything. And you can be sure it will be on the mind of your tenant if your negligence causes them to suffer any injury.
Don’t forget that you will probably not going to be sued for the hospitalisation and treatment bills. If your tenant obtained advice from an experience attorney, he is going to claim for the grave psychological damage the accident have caused as he no longer dares to walk on tiles that look glossy. He will also go for the costs of physiotherapy sessions that he has to pay for the rest of his life. It doesn’t matter if he seems perfectly fine judging from the power walk he is displaying while walking into the courtroom. As long as a doctor verifies these claims, the jury and judge will think that you are just another one of those people who only care about the bottom line and failed to take care of your own property.
If you look at it this way, you could very well be one lawsuit away from losing your assets. Isn’t that a scary thought?
Enter insurance. Umbrella policies usually provide coverage for liability up to a certain limit. This means that should you get on the losing end of a brutal lawsuit and have to pay damages, your insurer will pick up the tab. This is when you start feeling that insurance is a god-send. How high that limit is depends on how much premium you pay.
Other people’s money
It could be hard for many people to fully embrace the capitalistic animal inside them. But if you have been in the game long enough, you will know that embracing that animal is the only way to build great wealth. If you still have reservations on using leverage to manage and acquire assets, I can bluntly tell you that you are not ready to get to the next level of investing.
More than being a game of profits, real estate is a game of cash flow. And you bulk up your cash flow by leveraging other people’s money. Let’s illustrate this with an example.
Imagine that you have a $2,000 mortgage on your house. And whenever you have a chunk of free cash, you start making partial redemptions on your loan. This is a logical move as you save on total interest charges by reducing the principal. But what you did not prepare for is that your monthly payments remain the same. At this point you would have a lower principle, little cash on hand, and a constant mortgage payment. What happens if you lose your job? You won’t have enough cash to keep yourself afloat. Think the bank will sympathise with you and give you a discount? Think again.
If you had kept your cash in the bank or in liquid assets instead of paying off your mortgage, you should be able to survive and prevent foreclosure. But when you are dried up on cash, you are staring at the worst experience you can give to your family.
This is why you should not blindly use spare cash to make additional mortgage payments. Don’t feel any guilt that you are high on debt. As long as you are not defaulting, you are not disappointing anyone. By embracing other people’s money and keeping your own cash pile, you are reducing your risks of financial catastrophe.
Limit your liability
You are basically crazy if you intend to run a long term business without doing it through a company. Let’s not even touch on the tax advantages. When you are constantly dealing with businesses and people, you are taking on a huge financial risk should things go wrong.
If you operate through a limited liability business structure, the maximum amount that you can be liable for is the paidup capital of the company. This means that nobody can get anything more out of you no matter how much they claim. Unless your creditors somehow manage to take shot at you through your personal capacity, your maximum liabilities have a very clear ceiling.
This is why sometimes when you are dealing with huge organisations, they insist on working with companies with a higher paid up capital. This is so that the company has more to lose for failing to deliver. That would be a deterrent for the company to be complacent.
Since we have touched on starting a company, remember that you will also have control over the risk of too much tax. If you are earning your own income as an individual, your rental income will be taxed at an individual level. But in a company, you list that income as gross revenue which is subject to operating expenses. Sometimes, you might find that you have no need to pay taxes after taking your expenses into account. These are just the basics of tax planning. Do check with your accountant on what you can do.