Investing is all about risk and upside. We all know this, yet are often quick to forget about the risk side of things. We get so caught up in the “shiny” upside that we fail to lend as much credence to the possibility of things going sideways as we should.
But if you want to be a highly successful real estate investor who makes it in this field for many decades, you have to think about downside risk protection.
Whether you’re looking to purchase your first investment property or you already have a dozen rental properties in your booming portfolio, you have to think very carefully about the risks you face. And rather than letting those risks make you anxious or scared, you need to proactively do something about them.
Here are seven of our favorite ways to protect your downside as a real estate investor.
One of the best ways to protect your investment is to make sure you’re renting to reliable tenants. A thorough screening process helps you avoid high-risk tenants who are more likely to miss payments or cause property damage. Run a credit check, check for criminal history, and verify employment and rental references. Looking into these details gives you a better idea of each applicant’s financial stability and rental history, which can help predict whether they’ll be responsible tenants.
In addition to standard checks, consider implementing an in-person interview. This type of face-to-face interaction can reveal the tenant’s personality and sense of responsibility. While it’s impossible to eliminate all risks, a solid screening process lowers your chances of dealing with costly eviction processes or repair expenses down the line.
Security deposits serve as a safety net in case of property damage or unpaid rent. They offer you some financial cushion in situations where tenants leave the property in poor condition or skip out on rent. The amount varies by state, but a one- or two-month security deposit is generally a reasonable requirement for single-family rentals. By holding onto this deposit, you’re giving yourself the means to address minor repairs or unpaid expenses without dipping into your cash flow.
Consider clearly defining the terms of the security deposit in your lease agreement, explaining what could cause forfeiture. This transparency not only protects you but also sets clear expectations for your tenants.
Your lease agreement is more than a formality – it’s your primary tool for defining terms and protecting your property. A comprehensive lease should clearly outline expectations, including rent payment dates, maintenance responsibilities, and tenant obligations related to property upkeep. By being specific about rules and penalties, you create a legal foundation that makes it easier to enforce policies if issues arise.
To cover yourself even further, consider adding clauses to address specific risks, such as penalties for late rent payments or repercussions for property damage. You can also include clauses on prohibited activities, property inspections, and termination conditions. A detailed lease agreement can reduce misunderstandings and provide legal leverage if you need to address tenant behavior.
Basic homeowners insurance won’t cover many of the risks you face as a landlord, so investing in landlord insurance is essential. Landlord insurance provides coverage for the property’s structure and may cover lost rental income in cases where the property becomes uninhabitable due to a covered loss (such as fire or flooding). Some policies even offer liability coverage, protecting you from lawsuits if a tenant or visitor is injured on the property.
In addition to your own insurance, consider requiring tenants to carry renters insurance. Renters insurance covers their personal belongings and may provide additional liability protection. This requirement not only protects tenants’ assets but also reduces your potential liability if something happens to their belongings due to an issue with the property.
Unexpected expenses are inevitable in real estate, and budgeting for them upfront can help you avoid financial strain when issues arise. Setting aside a reserve fund for repairs, maintenance, and emergencies ensures you have the resources to address issues quickly without relying on credit or sacrificing cash flow.
A good rule of thumb is to allocate between one and two percent of the property’s value annually for maintenance costs. You may also want to build an emergency fund to cover things like unexpected vacancies, major repairs, or legal expenses. By keeping this financial cushion, you’ll have greater peace of mind and flexibility when unplanned costs come your way.
As a property owner, natural disasters are a real threat that can result in extensive damage and financial loss. You can’t predict or prevent these events, but you can protect yourself by ensuring you have adequate insurance and by taking preventative measures. Flood insurance, for example, is essential in flood-prone areas, as standard landlord policies typically don’t cover flood damage. Similarly, earthquake insurance may be worth considering in regions susceptible to seismic activity.
Alongside insurance, take steps to physically protect the property. This might include reinforcing windows, improving drainage systems, or securing heavy items in earthquake-prone areas. Investing in preventive measures may feel like an added cost, but it’s much cheaper than repairing a damaged property after a natural disaster.
If you’re financing your properties, rising interest rates can impact your profit margins, especially if you have adjustable-rate loans. Consider refinancing to a fixed-rate mortgage, which provides stability in monthly payments, protecting you from fluctuations in interest rates. Fixed-rate financing can be especially advantageous in periods of economic uncertainty or rising rates, as it locks in your costs and helps you forecast your cash flow more reliably.
If refinancing isn’t feasible, be proactive by building additional reserves to cover any potential increases in monthly payments when your loan resets. Preparing for potential rate increases keeps you in control of your finances, even in uncertain economic times.
At Green Residential, we’ve helped thousands of real estate investors and landlords across the state maximize their ROI and lower downside risk through strategic, comprehensive property management. If you’re looking to scale your portfolio without exposing yourself to any additional risk – all while enjoying better cash flow – we’d love to partner together. Contact us today for a free property analysis!
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