Just as with any investment, real estate investments are not without risk. However, that doesn’t mean you should avoid investing altogether. In fact, taking risks with investments is what allows you to reap the benefits. The key is to find a balance between risk and reward that you’re comfortable with.
While it is true that real estate can be a solid investment with great returns, it is important to consider the potential risks and if they fit within your risk tolerance. From determining your individual risk tolerance to learning the best ways to diversify your portfolio and protect your investment, here are a few things you should consider before deciding if real estate investing is right for you.
What Is Risk Tolerance?
An important component of investing, risk tolerance is the measure of risk that an investor is willing to carry in an investment. Another way to look at risk tolerance is the total amount of loss an investor is willing to endure.
An aggressive investor opens themselves up to higher risk, but is okay with doing so because of the potential for larger returns. Conversely, a more conservative investor will have a lower risk tolerance but may see lower returns. Essentially, the more aggressive your investment goals, the higher the potential for both risk and reward.
The biggest factors in determining your risk tolerance are age, investment goals, and income. One of the best ways to determine your current risk tolerance is to discuss your situation with a financial advisor that can help you form the best strategy to protect you while maximizing your returns. There are also online risk tolerance assessments that can be done to get a general idea of your risk tolerance.
Your individual risk tolerance will likely change over time as your investment goals and finances change. It is best to constantly reevaluate your risk tolerance and the types of investments you are making to ensure you are on par with your risk tolerance.
Risks of Real Estate Investing
There are a few risks associated with real estate investing that you should be aware of before you decide whether or not it's the right investment for you.
First and foremost, there's the risk of financial loss. Since most real estate investments require a large amount of up front capital, you are risking your original investment. If you are not careful with due diligence and the property doesn't appreciate in value or generate enough rental income, you could be losing money. You also have to consider the possibility of vacancy - if you cannot find a tenant to fill your property, you may end up carrying the cost of the mortgage until you do.
There is also risk of legal complications when investing in real estate. If the tenant doesn't pay rent, they damage the property, or there are other issues, you could end up in a lengthy and costly legal battle. To prevent against this, it is important to have the correct entity structure in place to limit your personal liability as well as ensuring you have strong, full coverage insurance in place to save you the financial burden.
Limiting Your Risk
Just as important as maximizing your benefits in real estate is minimizing your risk. By lowering the potential for risk, you can be more secure in your choice of investment and have higher returns. Here are some things you can do to limit your risk in real estate investments.
The risks of real estate can be mitigated by doing your research beforehand. By having the most efficient entity structure (likely an LLC), ensuring you have done your due diligence and have reasonably estimated your rental income and appreciation with the help of a professional in that local market, and ensuring you have strong insurance to cover any issues, you can protect your initial investment even further.
Another great way to limit your risk when investing in real estate is to diversify your portfolio. As you accumulate more properties across different markets, price levels, and with varying investment strategies, you have multi-layer protection if a property sits vacant or if one of your target markets sees a decrease in rental income.
Fractional real estate can also be considered a lower risk investment opportunity as the investor. When you invest in fractional real estate, you are not taking on single-property risk alone. The financing, insurance, and management for the properties is obtained by the SPV and not by you as an individual investor. With the lower cost of entry and multiple offerings that fractional investing provides, it allows investors to more easily diversify their portfolio across different markets and property types.
Become a HomeStakes investor to start diversifying your portfolio with fractional real estate investments today.
Benefits of Real Estate Investing
If you take the correct steps to limit your risk and have done your due diligence, real estate investing can provide you with a steady stream of income and continually making strong investments can be one of the best ways to generate long term wealth.
One of the most obvious rewards from real estate investing is the potential for cash flow. Cash flow is the net profit of a property after your expenses and mortgage payment have been subtracted from your rental income.
Since real estate values tend to appreciate slowly but steadily over time, it can be a good choice for investors who want to generate long term wealth. As the property is appreciating year over year in value, your debt is also being paid off by your tenants. This is one of the quickest ways to gain wealth since the amount you owe is decreasing and the amount the property is worth is increasing.
One of the more overlooked benefits of investing in real estate is the tax benefits it brings. The IRS allows you to deduct certain expenses related to your rental property including repairs and maintenance costs from your taxes. Beyond that, a cost segregation study can be performed and accelerated depreciation can be taken advantage of to deduct a large percentage of the original purchase price in the first year. Because of these tax breaks that can be capitalized on, you will likely be paying less in taxes on any cash flow that your rental property brings you.
The Bottom Line
There is no question that real estate investing comes with some risks. Only you can decide whether the risks vs rewards of real estate investing are worth it for you. By taking the correct steps to determine and minimize your risk, you can increase the potential upside and start (or continue) your real estate investing journey.
When considering investing in real estate, be sure to have a good idea of what your risk tolerance is and what kind of return you can expect. Once you have done this, you can determine if real estate investing is the best investment for your financial future.