Real estate investing can be lucrative, but it’s important to understand the risks.

Key risks
include bad locations, negative cash flows, high vacancies, and problem tenants. Other risks to
consider are the lack of liquidity, hidden structural problems, and the unpredictable nature of
the real estate market.

1. The Real Estate Market Can Be Unpredictable

While real estate values do tend to rise over time, the real estate market is unpredictable—
and your investment could depreciate. Supply and demand, the economy, demographics,
interest rates, government policies, and unforeseen events all play a role in real estate trends,
including prices and rental rates. You can lower the risk of getting caught on the wrong side of
a trend through careful research, due diligence, and monitoring of your real estate holdings.

2. Choosing a Bad Location

Location should always be your first consideration when buying an investment property.
Location ultimately drives the factors that determine your ability to make a profit—the
demand for rental properties, types of properties that are in the highest demand, tenant pool,
rental rates, and the potential for appreciation. In general, the best location is the one that will
generate the highest return on investment (ROI). However, you have to do some research to
find the best locations.

3. Negative Cash Flows

Cash flows on a real estate investment refer to the money that’s left over after paying all
expenses, taxes, insurance, and mortgage payments. Negative cash flows happen when the
money coming in is less than the money going out—meaning that you’re losing money. Some
common reasons for negative cash flows include:

 High vacancy rates

 Too costly maintenance
 High financing costs on loans
 Not charging enough rent
 Not using the best rental strategy

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The best way to reduce the risk of negative cash flow is to do your homework before buying.
Take the time to accurately (and realistically) calculate your anticipated income and expenses
—and do your due diligence to make sure that the property is in a good location.

4. Problem Tenants
To avoid vacancy risk, you want to keep your investment properties filled with tenants. But
that can create another risk: problem tenants. A bad tenant can end up being more of a
financial drain (and a headache) than having no tenant at all. Common problems with tenants
include those who:

 Don’t pay on time—or don’t pay at all (which could lead to a lengthy/costly eviction
process)
 Trash the property
 Don’t report maintenance issues until it’s too late
 Host extra roommates (humans or animals)
 Ignore their tenant responsibilities

While it’s impossible to eliminate the risk of having a problem tenant, you can protect yourself
by implementing a thorough tenant screening process. Be sure to run a credit check and
criminal background check on every applicant. Also, contact each applicant’s previous
landlords to look for red flags like late payments, property damage, and evictions.

It’s also recommended that you investigate a potential tenant’s work history. Make sure they
have a steady salary that can reasonably cover rent and living expenses. It’s also a good idea to
pay attention to scattered work history. An applicant who bounces from job to job may have
trouble paying the rent and may be more likely to relocate in the middle of a lease.

5. Lack of Liquidity
If you own stocks, it’s easy to sell them if you need money or just want to cash out. That’s not
usually the case with real estate investments. Because of the lack of  liquidity, you could end up
selling below market or at a loss if you need to unload your property quickly.

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While there’s not much you can do to lower this risk, there are ways to tap into your
property’s equity if you need cash. For example, you can take out a  home equity loan (for
residential rental properties), do a cash-out-refinance—or, for commercial properties, take out
a commercial equity loan or equity line of credit.

What are some ways to diversify real estate investing?

Diversification is often the best way to reduce risks. Since directly owning several properties
may be out of many investors’ budgets, buying shares in real estate investment trusts
(REITs) can provide broad exposure to geographically dispersed properties of different types
(e.g., residential, commercial, etc.).

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