Let’s be realistic as real estate investors: we’re in it for the money. While all those greenbacks may give us incentive to invest, we tend to forget about the risks we can encounter, including bad tenants, loss of value and regional market instability.
Here is a list of the five most important actions every real estate investor should do to protect themselves:
1. Get Insurance
Insurance should be your largest priority after you have completed the purchase agreement for your property. Those who don’t believe their property can be damaged in a fire need to change their attitudes. Fires, floods and other damages can occur without notice, especially in condos, apartments and duplexes, where walls are shared. You simply never know what will happen and having a property attached to other tenants only increases the risk of damages. No matter how much you trust your tenants, accidents still happen.
Protect yourself from financial distress by getting insurance. The type of insurance you need will depend on the regional area of your property. Ask your local insurance agent about the best type of insurance for your property.
2. Have Proper Contracts and Agreements in Place
Believe it or not, many real estate investors do not protect themselves through written contracts. In fact, there are numerous contracts and agreements which can shield you from a wide range of risks.
Most often, investors believe one agreement, the lease agreement, is enough for leasing property to a tenant. However, many other agreements are useful for a landlord. An indemnity agreement eliminates liability from the property owner in the event a tenant is harmed on the premises, as long as all repairs were up-to-date. It also holds the tenant responsible for any damage they caused while renting a property.
Other beneficial contracts include a lease amendment, which allows a landlord to make changes to a lease. As well, a rental inspection report provides a checklist to document the condition of the property prior to tenants moving in and again after they move out.
Investments equal responsibility. With only a few extra pages and signatures, these legal forms can protect you in the event of damage and ensure your property stays in good condition.
3. Timing is Essential
Another rule of thumb in investing is, “Don’t be a lemming.” If you have never heard this term before, I will give you a simple explanation. There is a fable in which thousands of these cute little fuzzy creatures called lemmings committed suicide together by jumping off a cliff. It started with a single lemming. When he saw a gigantic herd of other lemmings running toward him, he asked, “What’s going on?”, and another replied, “I have no idea, but I’ll just follow the crowd.”
That’s exactly what many investors do: they follow the crowd. They’ll hear about a hot real estate market, company stock or derivative, and join the crowd until they reach the end of the cliff and fall down.
Sound familiar? It’s called a bubble.
Be a smart investor, rather than a greedy one. Know when the timing is right and when it is wrong. The sub-prime mortgage crisis should be a lesson for those who lost big. It’s so easy to get caught up in the greed when the market is hot and forget to exit when the timing is right.
For those who are flipping properties, be sure to spend extra time doing due diligence and find properties that are extremely undervalued rather than going with the crowd and buying into hot markets.
As Warren Buffet once said, “Be fearful when others are greedy, and greedy when others are fearful.” or “Don’t be a lemming.”
4. Know Your Tenants
Being a landlord has its share of headaches, but nothing can bring on a migraine more than managing tenants in your rental property. For this reason, it is crucial to know who you are renting to. At the end of the day, your renters are the ones who will be adding to the stream of your fixed income. Conversely, they may also be the ones who will be draining out your cash flow through extra expenses.
I remember hearing from a real estate investor about a time when he had rented out a suite to a young couple. They consistently overused their utilities and frequently broke appliances. Ultimately, this led to his expense overtaking his income.
To safeguard yourself from income loss and property damage, get to know your tenants as they will be the ones who will make or break your bank. Be explicit in your lease, including terms that address maintenance, inspection and utilities. Also be sure to screen prospective tenants prior to signing any agreements.
5. Diversify Investments
In real estate investing, we often hear the term, “Don’t place all your eggs in one basket.” But do many of us really understand what that means? Simply put, it means to hedge or insure yourself by investing not only through one class of instruments, but through various instruments.
For example, if you were to invest in a beachfront property in South Beach, FL, you are putting yourself at risk for the following:
1. Targeting only high-income tenants who can afford this property limits your property’s marketability
2. Natural disasters, such as hurricanes or tornadoes
3. Regional economic risk; for instance, if Miami or Floria’s economy suddenly plummets
4. Real estate is one of the most illiquid asset classes, resulting in a possible loss in value
Whether you consider these risks will define your investment career. Some approaches to the above risks are suggested through the following:
1. High-income tenants may be less risky than low-income tenants, but this may backfire because high-income renters are a very small class of the overall renting population. Screen your tenants properly and don’t limit your renters to such a small class.
2. If all your properties are located in a disaster-prone region, such as the tornado valley or along the east coast, you may be more susceptible to geographical risks. Diversify your properties throughout different regions.
3. Let us reflect on those with investments in Detroit. The Motor City’s recent filing for bankruptcy has put it’s economy in an embarrassing downturn. However, if those investors had diversified their properties throughout the country, they would have felt less sting than an investor who has made all their investments in Detroit.
4. While there are many advantages to investing in real estate, including its relatively stable market, the main disadvantage of real estate is its illiquid qualities. It is far easier to sell one hundred shares of a company than to sell one single property. Try to diversify your investments beyond only real estate. Invest in different classes of instruments, such as bonds, stocks, ETFs, notes and more. The only real risk you face through the diversification is the macroeconomic risk.
While money ensures survival, you need to be careful and protect yourself from the risks associated with your investments. It’s so easy to get caught up in the buzz of being a lemming and enjoy the potential profits we can accumulate.
These five critical tips should be the holy bible for investors in all classes of investments. And remember, the next time you see a herd of lemmings running towards you, run against them.
Do you have any real estate investing tips to add? Please comment below!