Key Takeaways
- Investors should maintain an optimistic attitude by hoping for the best, but it is always good to have back up plans.
- Risk assessment is crucial to the success of any real estate investing business.
- Always plan for the worst when entering a deal so you are ready for any unexpected obstacles that come your way.
Most investors are optimistic in nature. They think they can turn any property into a home run, regardless of how many people are telling them they can’t. This kind of excitement and positivity works great on certain properties, but can also come back to bite them if they are not realistic. When evaluating a property or your current portfolio, it is wise to hope for the best plan for the worst. You don’t have to dwell on it, but you do need to know what is possible and more importantly how to prevent it.
If you currently have rental properties, you may think a tenant’s refusal to pay rent is a worst case scenario. This is certainly not an ideal situation, but one you could deal with if you had to. If someone is injured by your negligence or if the house catches fire, you are in for a lot more trouble. While rare, these things do happen. It is true that they probably will never happen, but what if they do? Do you have the proper homeowners insurance? Is the language on your lease strong enough to protect you from tenant injury? Hopefully you will never need to deal with this, but instead of ignoring the possibility, prepare for it.
The same could be said when looking at prospective properties to buy. You may think breaking even or even taking a small loss is the worst that can happen. However, neglecting due diligence could land you a property with significant problems that hurt your bottom line. Not only is there the potential for costly fixes, but if they are bad enough, they could deem the home not fit to sell or rent.
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Top Risk Reduction Strategies For Smart Investors
Getting in and out of properties should not be the goal when finding new deals. Looking at them and finding these potential red flags, however, is. You should be looking for water marks in the basement or any freshly painted walls that could be covering something up. Sometimes these issues are very difficult or even impossible to discover until after you take ownership, but you need to do everything possible to prevent that from happening. If and when it does, you need to have a contingency in place for the best emergency exit strategy. This option won’t be great, but it will be easier to make if you have at least thought about the possibility.
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Use Strong Language In Leases
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Prioritize Insurance
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Mind Your Due Diligence
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Watch Out For Red Flags
Lease Language
A comprehensive lease agreement is crucial to the security of any rental property. Real estate investors need to ensure that both landlord and tenant are protected in the event of an unexpected surprise. Before you ever draft your first lease, implement a rental application process to weed out any bad tenants. Ask for previous landlord references and proof of income before approving a tenant for the property. This will protect you from potentially disruptive tenants, or ones who may prevent you from earning stable rental income.
When it comes to the actual lease agreement there are a few important areas to address. These include writing out the obligations of each party, a list of liabilities, and an outline of the rental price and lease length. To fully plan for the worst, a lease should also outline the procedures in the event of a breach. The lease language should be clear and specific, and both parties should understand what they are responsible for. Follow these tips to draft a fool proof lease, and perhaps have it reviewed by a real estate attorney.
Insurance
One of the best ways real estate investors can plan for the worst and hope for the best is through insurance policies. It is recommended to have property, liability and in some cases flood or fire insurance for each home you own. Some investors will also require tenants to have rental insurance on top of that. The purpose of all of these policies is to protect you, your property, and your business in the event anything goes wrong. While insurance may not be cheap, it is crucial to think of it as a necessary expense. Always factor in the cost of insurance when analyzing a deal to get a true understanding of the operating costs (and potential cash flow) of a property.
Insurance is designed to protect your business from property issues, but there are also policies that can protect you from any business issues. As you start your real estate investing business, take the proper steps to establish a holding company or limited liability company (LLC). The purpose of a LLC is to protect you from liabilities incurred by your business. For example, if there was a lawsuit related to one of your rental properties the structure of an LLC would prevent you from being personally liable. For more information on how to start a real estate holding company, be sure to read this article.
Due Diligence
Before purchasing, rehabbing, or working with a property in any capacity it is critical that you mind your due diligence. This means taking a moment to evaluate the entire situation, including anticipating potential worst case scenarios. In doing so you can avoid potentially harmful real estate deals and instead move towards those that will be successful. Here are just a few way real estate investors can mind their due diligence when analyzing a deal:
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Run The Numbers In Advance: Every successful real estate investor has one thing in common: a strong deal analyzer. While their systems may be different, there are a few numbers you must run when evaluating a property. Try using our rental property calculator to help you get started.
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Choose The Right Market: In real estate, one factor reigns above them all, location, location, location. You can change almost anything about a property, but you can’t change where it is located. Take time to find the right market before choosing to invest, even if it may be outside of where you are located.
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Screen Tenants: As I mentioned above, it is always a good idea to implement a rental application process for your property. This will help you weed out tenants with a history of missing rent payments, unpaid utilities, or other occurrences you may want to avoid.
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Obtain Proper Financing: Financing a rental property can get sticky, depending on how your business is structured. Make sure to follow the proper contracts and legal procedures when obtaining financing from any business partner, lender, or fellow investor. This can go a long way as you prepare for the worst.
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Know The Laws In Your Area: Failing to check housing laws is a rookie mistake in the world of real estate investing, yet it happens to investors again and again. Whether it is rent control laws or tax questions always double check the regulations in your area when making business decisions.
Red Flags
Property tours and home inspections are both great ways to plan for the worst when searching for potential investments. These practices both provide the opportunity to search for physical red flags within a property that could undermine the integrity of a deal. Professional help, such as a home inspector, can be extremely helpful during these processes but there are a few things investors can look out for initially as well. When you tour a potential investment property, assess the outside for structural issues or glaring damages in the home. Always come prepared with a flashlight, note pad, and camera when touring. Look for foundational problems, cracks, mold, and other signs of damage. Each of these red flags could signal costly repairs should you move forward with the investment.
After your initial walk through, it is still crucial to call in a professional to inspect the home. They will be able to give you a thorough write up on the status of the house, which could help make your decision to invest or walk away easier. Over time, you will get a better idea of what to look for and avoid when making investment deals but that should never replace a traditional home inspection. Home inspectors are trained to catch things even the most skilled investors could miss, which is invaluable as you consider purchasing a property. It is only natural to hope for the best when you find a potential investment; just be sure to plan for the worst by searching for potential red flags with the home.
Summary
While cliché, things can always be worse. The next time you bemoan the fact that you didn’t sell for top dollar or may have missed an opportunity to increase the rent $100, take a step back and think about what could have happened. You don’t have to run your business with constant fear, but you should at least have the thought cross your mind on each and every deal. It is the acceptance of these fears that will prepare you for potential complications.
Bad things happen in real estate all of the time. If you do enough deals, you will start to see things that you would have never thought were possible. Remember plan for the worst hope for the best. You may get ridiculed and laughed at for taking out the extra home warranty or having an attorney make changes to your lease, but that’s ok. It is far better to have the protection and not use it than be left scrambling when something happens.
In what ways do you plan for the worst case scenario? Share an example of your best risk reduction strategy below.
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