Risk Management

There are risks involved in real estate investment just as in any investments. This white paper covers these risk factors and possible ways to manage them.

Risk Factors

In general, we divide investor risks into the following categories:

The concern here is that a tenant or another party will sue you and you end up losing the property or other assets. To protect against this you can put each property (title) under its own separate entity so the exposure is limited to that one single property. Below are links to the Nevada do it yourself LLC site:

You will need a local agent (a Nevada resident) whose only purpose is to receive any official mail send to the LLC. I am the local agent for many LLCs and you are welcome to as well. You need a local address for the LLC forms. The address on all my emails is that of my broker and there is no way of knowing if/when I will change brokers so please use the address below. This is a post box which I have had for many years.

Eric Fernwood
7345 S Durango Dr, #107-102
Las Vegas, NV 89113

Know that we are not attorneys so you need to seek competent authority before making any legal decisions.

Price Risk

You pay too much for a property relative to the rent and cannot make a profit. This is the easiest one to manage because you decide how much to offer for the property. Make all offers based on your desired return and not the listing price. There is another protection in that lenders require appraisals and they will not loan more than the property is worth. Lastly, as long as you buy investment real estate in a good area, all but the worst mistakes will be corrected over time through appreciation, inflation and rent increases.

Vacancy and/or Rent Rate Risk

This is potentially the most serious risk because if you can't rent the property at a profit, you have the nightmare of a never-ending cash sink. This is why buying an investment property in the right location (both at the metro level and at the area level within a metro) is critical. You need to look at the location in which each potential investment property is located both as is today and how it will likely be in the foreseeable future.

The current situation is not hard to analyze as long as you include all the major cost drivers (property taxes, landlord insurance, state income tax, etc.). The challenge is what will likely happen over the next 10+ years. Some factors you must consider include:

Rehab Risk

We have heard of situations where people started a rehab and discovered huge problems. The best way to avoid this is to work with a skilled property manager, Realtor and property inspector. Each can provide valuable insight. Below are examples:

Maintenance Risk

Maintenance issues will happen, especially during the first year. In addition to the inspections and such during the due-diligence period, buy a one-year home warranty which covers all the significant costs like the water heater, AC, heater and more. You need to be careful selecting a home warranty company because many do little more than taking your money and denying claims. Talk to your property manager concerning who they would recommend.

Another important aspect of maintenance risk (or cost management) is a good property manager. The property manager we work with tracks every service call they receive. If a tenant has frequent maintenance requests, they proactively deal with the situation. Also, when the property manager's service people are in the properties they check the condition of the property. If the tenant is not taking care of the property the property manager proactively addresses the situation. Don't forget preventative maintenance. A good property manager monitors the properties and when (for example) tree limbs start touching the house or the roof they are trimmed back before they do damage.

Landlord insurance is critical. If there is major damage and the property is unrentable, most policies pay you market value rent until the property is back online in addition to the cost of repairing the property.

Tenant Risk

To manage the tenant risks the property manager must have an effective screening process. In addition to a detailed credit inspection, the property manager must also check:

One of the major issues you also need to consider is the laws affecting landlords and rental properties in the area you are considering. For example, an eviction in Las Vegas usually takes less than 30 days and costs less than $500. Clients tell us that in California, if the tenant knows what they are doing, it can take up to one year and cost thousands of dollars to evict them. The property manager can tell you all about the relevant laws and regulations in the area you are considering.

Summary

In this article we covered the major risk factors you should consider with purchasing an investment property, as well as the measures you can take to manage them.