That said, I will stipulate up front that investing in real estate as a way to achieve financial independence is not a sure-fire proposition. In twelve years as a licensed broker, I've watched people make bad decisions and walk right off the end of the pier. Here's my short list of the risks of holding rental properties as a long-term investments.
- Lower than Expected Rate of Appreciation - In 2005 many people became 'investors" by mortgaging their own homes and using the loan proceeds to buy other houses, with the idea of holding the houses for a couple of years and selling for a big profit. Many of these folks lost their shirts - but they weren't really investors and they weren't really investing; they were naive speculators who were playing against the basic rules of real estate investment strategy - the real return is the monthly cash flow from rents during the period of the investment. Intelligent investors were sitting tight or selling in 2005, not buying. The appreciation we seek is the annual increase in rents!
- Increased Payments on Variable Rate Interest Loans - Investors in 1-4 units don't really need variable rate financing... fixed mortgages at competitive interest rates are available from just about any lender. Investors in apartment buildings use variable rate and short-term financing all the time. The trick is not to settle for a bad loan. If you can't comfortably achieve your investment goal while paying the highest possible rate on your loan, why are you using this financing?
- Lower than Expected Rent - This usually happens as a result of the investor not doing enough homework about rent prices in the area and rent roll history of the investment.
- Damage to Property - Don't have any illusions... when you own investment real estate, you own a business. Businesses have to manage risk and minimize losses. This means choosing high-quality tenants, enforcing the rules, and maintaining adequate insurance. The great news about real estate investing is that there are lots of ways to invest indirectly, and avoid the hassle of running a business.
- Tenants Who Don't Pay - See above. This is rarely a problem if you will take the time to properly screen tenants. The banker's axiom "a well-made loan is half collected..." applies here too. Many investors simply use the services of professionally-licensed property managers. Fees usually range from 6-10% of rents collected and are negotiable.
- Eviction Costs- Avoid eviction costs by avoiding evictions (see pitfall #5). I've been a landlord since 1995, and I've never been forced to sue for eviction.
- Maintenance Problems - If it seems too good to be true, it usually is.... buildings that first appear to be bargains on paper often turn out to be in need of repair and deferred maintenance. Avoid these problems by understanding what you are buying before you close the deal. You must do your due diligence and pay to have the property inspected by professionals - building, roof, pool - or else risk an unpleasant surprise once the place is your responsibility.
- Vacancy - Would you buy a business that had no customers? Don't buy vacant properties. Landlords expect about 95% of units to be leased at any time - lower vacancy means rents are probably too low, and higher vacancy rates indicates that the landlord is asking too much rent. The simple fact is that vacancies are part of the landlord business - savvy investors know vacancy rates and factor them into their investment calculations.
The key thing to remember is that the factors on the list are all things you can control. Direct ownership of residential income property is a business. If you choose properties to meet a well reasoned investment plan and manage your business properly, you can create a substantial income and net worth.
