Before you invest in a property, it is crucial to evaluate all the risks involved. Doing so will help you identify and address potential problems and avoid costly mistakes.
Here’s what you need to consider.
#1 Market risk
Real estate market risk is inherent to all property purchases. Market changes like shifts in supply and demand or market cycle variations can negatively affect the value of capital and future income from a property.
Here’s a quick illustration
If you buy investment properties at a time when everyone’s buying property, they may be over-priced. This means you risk selling for less than the initial purchase price (Even if the properties generated income through rental fees). The loss in value might cost more than you made while renting the property out.
You should always study the market and follow forecasts to prepare for potential downturns to avoid/mitigate this risk. This will help you decide whether purchasing a property is a beneficial investment decision and keep you from making emotional decisions.
The UK real estate market is doing reasonably well and is projected to stay on this trend. However, it’s not guaranteed that this performance will continue. The property market is known to mirror economic performance, which means it tends to suffer during periods of recession and uncertainty (which could occur if there is another lockdown).
Here’s a more detailed explanation
#2 Bad locations
Location is everything in real estate. It should always be a priority when you’re considering a purchase.
Location affects supply and demand
It is tempting to think that a region with low prices would be great for investment, but this isn’t always true. Sometimes, low-priced areas may have declining populations or lousy job markets. Such factors will negatively affect property values.
Locations with a high crime rate may have lower prices and high occupancy rates (since people often prefer renting to purchasing homes), but you’ll be at higher risk of being robbed or vandalized. Both events would lead to unexpected expenses and repair fees, and time-consuming legal proceedings.
Location affects real estate appreciation
Investing in a neighborhood suffering low/negative growth means low appreciation, which could cause negative returns on investment when you finally decide to sell the property.
The best way to manage this risk is by carefully choosing your real estate investment locations. It can be tempting to buy cheap property, but sometimes the risk isn’t worth it.
You will need tenants to make rental income. However, there’s no guarantee that your property will quickly achieve 100% occupancy. This risk can be really problematic if you use rental incomes to pay the property’s insurance, mortgage, taxes, and maintenance fees.
The best way to avoid high vacancy rates is to purchase investment properties with increased demand. You may also lower vacancy risks by doing the following.
- Market, advertise and promote your property (remember to target the channels your ideal tenants will use to find the properties).
- Start looking for new tenants the moment your current ones notify you that they’re moving out.
- Price your rentals within the region’s market range.
- Ensure that you keep your property clean, organized, and adequately maintained.
- Build a reputable brand: if people know you for being kind and offering high-quality properties, they’ll refer prospects.
#4 Bad tenants
Problem tenants will be an unwanted inevitable part of your business. While a comprehensive tenant screening process will help you sort the bad from the good and protect your business, a few troublesome individuals will eventually find their way to your properties.
A person who has been known to pay on time may suffer financial troubles and skip payments. An eccentric tenant may decide to paint the walls neon green. Even the best screening process can’t identify tents who have a bad temperament.
There are a few ways to deal with each kind of client.
Late rent payments
The best way to deal with late payers is to avoid compromises. You should be firm regardless of how nice they (or you) are. Anything short of that approach will invite trouble cause trouble in the future. If you didn’t inform them that late fees are irrevocable, please do. It would be particularly helpful to say the fee is built into the accounting system, as it would keep them from trying to negotiate a way out.
Property damage is arguably the second most common problem that landlords have with tenants. If you don’t have a mobile inspection application, you should get one. Besides significantly reducing the time needed to inspect a property, it can take photos with your phone and embed them into an inspection report. So, if there’s damage, you have photos of the property in its original condition as evidence.
There might be problems when there’s a disagreement about unapproved “improvements” that you feel are not improvements at all. You may have to evaluate these cases individually. That said, if the lease says the property must remain in the same condition as before the move-in, you have the right to take the tenant’s damage deposit or to have them restore the property.
#5 Negative cash flow
Cash flow is the profit you earn from a property after settling all your bills, taxes, and mortgage payments. An ideal property should produce positive cash flows, which means you should have money left over after covering your bills. However, this doesn’t always happen. Sometimes, your taxes and payments will take more money than what you earn from rent, leading to losses.
You’re at the highest risk for negative cash flow when you don’t conduct proper market analysis. So, the best way to avoid it is to accurately calculate your income and expenses before you purchase the property and ensure it’s in a prime location that yields the highest possible returns.
Even the smallest real estate expenses can accumulate into significant debt, so it’s essential to be thorough. You may want to consider using an automated rental income calculator to avoid making unnecessary mistakes.
We’ve covered some of the most significant risks you need to consider before purchasing an investment property in this article. But there’s a lot more to look at. Joining our community grants you access to everything you need to learn about real estate risk management.