Bitcoin is a bubble that seems on the verge of bursting. Stocks and shares fluctuate at the whim of an unstable business market. See also, precious metals. The truth, unglamorous as it may be is that real estate is still one of the safest places for neophyte investors to put their money. Is real estate risk free? Absolutely not, but then we’d struggle to think of an investment that is. If you want risk free, saving is absolutely the way forward for you, but don’t expect to reap huge dividends unless you’re saving seven figure amounts.
Real estate, on the face of it, is just like any other form of investment. The trick is to buy for as little as you can and sell for as much as you can. Whether you’re interested in the prospect of flipping a property to make some (relatively) quick money, or earning some passive income by letting the property out to a private tenant, there are ways in which you can increase your chances of turning a profit while mitigating risk. The investment blog at https://highreturnrealestate.com/real-estate-investment-blog/ has some great advice on generating as much income as possible from real estate but for now we’re going to focus primarily on risk aversion. Go into your investment with any (or all) of the following in mind and you’ll find yourself sleeping easier at night…
Don’t over leverage!
If everyone had borne this in mind the collapse of 2006-2008 never would have happened. If you’ve seen or read The Big Short, you’ll know just how over leveraged the market was in the mid noughties. Leveraging refers to the amount of debt incurred in financing an asset. Of course, not everyone can be expected to invest in real estate without a mortgage, but even if you’re able to secure substantial financing on your portfolio, the savvy investor knows his or her limits. The market collapsed because investors were doubling and tripling down on their debts as the flipped multiple properties concurrently. These people were the hardest hit by the collapse, as they found themselves unable to repay their loans as they were unable to find buyers for their properties. The key to mitigating risk lies in keeping your debts manageable.
Look to the future
Gentrification of various urban and suburban boroughs has seen many an investor rubbing their hands together with glee as their property’s value sky rockets. Identifying the next ‘up and coming’ area isn’t easy, nor is it an exact science, but it can’t hurt to do a little homework when choosing the right place to invest, before the area gets too ‘hot’. Look into government urban renewal schemes and renovations. Keep an eye on where the young creative types are moving to (it worked for investors in SoHo and Brooklyn), and keep an eye on the amenities to cater to them. If a trendy restaurant, coffee shop or art gallery opens up in an area you have your eyes on, this is a great indicator that it’s time to pull the trigger. If all of this seems like too much hard work, looking for cheaper areas in close proximity to unaffordably hip areas is also a pretty decent indicator of a good investment.
Up your down payment
The more you have to put into a down payment, the more favorable your mortgage is likely to be, meaning you’ll be paying less in interest rates and gaining more equity. High debt, over leveraged financing can lead to an investment backfiring on you, should the markets take a downward turn. Increasing your deposit insulates you from some of this risk, although you must also be careful not to tie up too much of your liquidity in a property to the extent that it leads to opportunity loss.
Look for below market rents
A wise investor knows all the variables before committing to an investment, and it’s pretty much a given that if you have your eye on an area, you’ll be cognisant of what the average market rate is on rental properties of the type in which you’re hoping to invest. If you can find an area with a significant number of rental properties that are currently below market value, you’re staring at an opportunity for better cash flow (which is always a good sign for an investor).
In these instances, very little is required to bump rental prices up to market rates. A slight upgrade or cosmetic overhaul is usually enough to secure a sizeable return on your investment.
Of course, no investment is entirely without risk, but real estate is one of the few areas in which risk is quantifiably easy to avoid.
FAQs
Portfolio diversification is the process of selecting a variety of investments within each asset class, which can help those looking to learn how to mitigate investment risk. Diversification across asset classes may also help lessen the impact of major market swings on your portfolio.
How to use debt to make money in real estate? ›
You could use it to buy one investment property for $100,000, paying cash for it. Or you could buy five $100,000 properties, borrowing 80% of the purchase price for each, and putting down $20,000 apiece. Even better, debt can also improve your cash-on-cash returns.
Why is debt used in real estate? ›
Commercial real estate (CRE) debt investing is an option that can help provide investors predictable cash flow, relatively short target duration, downside protection, and a higher target return than many fixed-income alternatives in the public market.
What is debt service in real estate investment terms and refers to? ›
Debt service coverage ratio indicates the amount of net cash flow available to pay the mortgage. Both real estate investors and lenders use the debt service coverage ratio when analyzing rental property performance.
What is reducing risk called? ›
Risk mitigation is one of the key steps in the risk management process. It refers to the strategy of planning and developing options to reduce threats to project objectives often faced by a business or organization.
How do rich people use debt to their advantage? ›
Wealthy family borrows against its assets' growing value and uses the newly available cash to live off or invest in other assets, like rental properties. The family does NOT owe taxes on its asset-leveraged loans because the government doesn't tax borrowed money.
How to avoid 20% down payment on investment property? ›
Yes, it is possible to purchase an investment property without paying a 20% down payment. By exploring alternative financing options such as seller financing or utilizing lines of credit or home equity through cash-out refinancing or HELOCs, you can reduce or eliminate the need for a large upfront payment.
What does it mean to invest in real estate debt? ›
Real estate debt funds help connect borrowers (often developers) with short-term capital for commercial real estate projects like multifamily buildings, shopping centers, construction loans, and many other property types. Real estate debt funds rose to prominence in the wake of the 2008 crash.
How to use debt to create passive income? ›
By utilizing debt, money can be borrowed and put towards assets such as property or shares with the potential for creating wealth. This is what's known as 'gearing'. The value of these investments should increase over time, providing greater income and capital growth than would have been spent servicing the loan.
Why do investors use debt? ›
Many fast-growing companies would prefer to use debt to support their growth, rather than equity, because it is, arguably, a less expensive form of financing (i.e., the rate of growth of the business's equity value is greater than the debt's borrowing cost).
Debt financing often moves much quicker. Once you're approved for a loan, you may be able to get your money faster than with equity financing. Will you give up part of your business? Giving up a percentage of ownership is the biggest drawback to equity financing for many business owners.
What is the debt instrument in real estate? ›
The debt instrument is secured by a specified real estate property as collateral. Real estate debt typically takes the form of a mortgage or deed of trust. The debt instrument is often a real estate debt fund, which a private equity firm creates. The collateral (real estate property) is considered securitized.
What is the formula for debt service in real estate? ›
DSCR = net operating income (NOI) / total debt service
To calculate a property's DSCR, divide its annual NOI by its annual debt service payments, which include principal and interest. For instance, a property generating $450,000 of NOI with $250,000 in debt service would have a DSCR of 1.8.
What is a good DSCR for rental property? ›
Most DSCR lenders want to see a minimum ratio of 1.2 or 1.25. This assures them that you won't miss a payment if your rental property experiences unexpected vacancies or needs a sudden repair. A debt service coverage ratio of at least 2.0 is considered very strong and is a great goal to aim for as an investor.
What is the method used to reduce risks known as? ›
Risk management is the process of identifying and mitigating risk.
What is risk reduction in investment? ›
Risk reduction deals with mitigating potential losses by reducing the likelihood and severity of a possible loss. For example, a risk-avoidant investor who is considering investing in oil stocks may decide to avoid taking a stake in the company because of oil's political and credit risk.
What is one method for reducing risks? ›
Avoidance of risk
Some methods of implementing the avoidance strategy are to plan for risk and then take steps to avoid it. For example, to mitigate risk of new product production, a project team may decide to implement product testing to avoid the risk of product failure before the final production is approved.
What is using an option to reduce the risk of a portfolio called? ›
Hedging with futures may help reduce risk in a portfolio. Lower volatility can translate into lower risk.
