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3 Major Aspects Of Risk Tolerance In Property Investing
It goes without saying that for every category of investments, varying levels of risk tolerance in an individual would be more suited for different classes of assets.
And while real estate is well-known to be one of the most stable and “safe” investments available to the average person, there are still various types of risks that the individual has to comprehend before taking the step forward.
Saying that, it is important to add that as people experience changes in lifestyle and shift in mentality, risk tolerance and a person’s perspective of risks can change as well.
This is why it’s critically important that investors continually evaluate their personal goals, career status, and risk tolerance, etc, and make changes to their investment portfolio and commitments when required.
When it comes to real estate, there are 3 main aspects of risks.
No everyone can be called a people person.
Some loathe working with people, yet are good at it. Some love working with others but absolutely suck at it. Then there are those who hate it and are bad at it, yet have to go through the motions as they need to put food on the family table.
What type are you?
Tenants play a starring role in the world of property and landlording. But a lot of would-be landlords don’t put enough emphasis on this factor.
People who first consider investing in rental property often think about financing, remodeling, maintenance, rental income, etc, when evaluating real estate.
What they often refuse to put more thought into are managing tenants.
Unlike a typical trading business where business owners manage inventory and logistics in a warehouse, landlords have to take on the ongoing task of managing relationships with tenants.
And it is not as easy as most people put it.
Sure you might run into perfect tenants who never bother you with any issues or problems. And continually deposit monthly rents into the payment account without need your intervention.
But just one tenant from hell can turn your world upside down.
If for example, you are the proud owner of 3 single-family homes that promises a rental income that covers 120% of the mortgage payments, consider that just one tenant failing to pay one month’s rental can turn your cash flow inside out.
If it goes to the extreme, you might then have to take the strenuous route of eviction. This can be both a tiring and costly effort on your part.
And in the end, you might not get back what you are due!
Yes. You might be able to claw back unpaid rental via legal routes. But is the time and effort worth the trouble?
Most investors in real estate implicitly understand this risk. Which is why they have a backup plan to cover losses from tenant risks…
2) Property value
Many property investors are actually more than willing to make a loss on their rental properties because they are of the view that appreciation in property value would cover all losses and even bring in considerable profits in the form of capital gains when the property is sold in future.
This can seem like a sound line of thought when we consider that real estate values have proven to rise over time.
The best case scenario is that monthly rental income would comfortably cover mortgage payments with extra to spare. These extra will then accumulate your profits when the financial year end approaches.
On top of that, when the time comes to sell the property, you bank in a substantial capital gain from the proceeds of the sale.
While this situation is ideal and happens frequently for real estate investors, don’t for a moment that it is a given.
There is always a risk that real estate values stagnate, depreciate, or don’t appreciate enough for your to make a tidy profit.
3) Cash flow
As explained in the previous point, the ideal ending for investors is to continuously collect a rental that comfortably exceeds the mortgage, and then letting go of the house to a buyer paying well above the initial price paid for the property.
Yet there are real estate investors who have little to no interest in selling their property assets to profit from capital gains.
To these types of investors, they are perfectly satisfied with perpetual positive cash flow.
They might never see a month of profits into the six-figures. But they are more than happy to continually book-in profits monthly for as long-term as they can predict.
There is nothing wrong with this investment approach. Different people have different ways of viewing personal finance.
And for this category of investors, positive cash flow is overwhelmingly more advantageous than one-time capital gains.
The challenge here is thus, in keeping and maintaining this positive cash flow.
Repairs, upgrades, overhauls, etc, might benefit a house in the long run. But it can eat into profits in the short term.
This can be easily manageable when you have buffer funds or collecting incoming rentals on a timely manner. But it can throw your operations into chaos when you don’t have full tenancy or somewhere close to that.
Looking into these 3 main areas of risks in real estate investing, it would be wise to look closer at yourself before looking closer at a potential rental property to acquire.
Because unless you are very clear with your strategy and approach into the world of landlording, there is every chance that your might exit it with a bad taste in your mouth.