The 5 biggest risks of owning a rental property are vacancy rate, location, market conditions, negative cash flow, and bad renters. Here's how to minimize each of them.
Vacancy is your enemy
Since the most significant risk is wasting money on your rental property, vacancy is directly related—because your tenants are, technically, your source of income and not the property itself. So, the higher the vacancy rate for a property, the lower your cash flow will be. Bankruptcy is just around the corner if that happens.
It's possible to be cash positive with a vacancy rate of 30% in commercial real estate, but savvy owners know that striving for anything below 10% is smart. In residential, if rent is affected by just one tenant, this becomes a zero-sum game, and zero tenants mean 100% vacancy and 0% cashflow. Therefore, savvy residential investors buy many doors in one deal — to be able to suffer minimal vacancies without drowning.
It's also why banks and lenders take occupancy rates seriously when lending money—as a red flag and risk factor. Often, a financial institution won't loan you cash for your real estate endeavors unless you can prove occupancy north of 70%.
So, when doing your due diligence before pulling the trigger on a deal, make sure to have a firm grip on the expected vacancy rate, how much it'll cost if you experienced it, and for how long you could withstand it—if push came to shove.
Location, location, location
Location in real estate is a definitive factor. Most only look for the area's main highways, schools, and crime rates. Still, it's also essential to know if public transportation is nearby, the walking distance from everything, what zoning laws are, and what sports teams are moving to the area—which will cause a value increase.
When honing in on an area for your rental property, don't be misled by thinking low rent in C-class areas means less risk because it's affordable. Instead, the risk still exists, but it'll take a different form: possible thefts, vandalism, and higher insurance costs, alongside more repairs and agony.
Market shifts
Financial literacy is a weapon most investors wield. The more properties you own (and in more states/countries/continents), the larger the scale you'll be required to understand the economy.
The rule of thumb is: money is made, paradoxically, when buying—not selling, and the strong get stronger in economic winters - when others can't survive. So, leveraging such times to buy cheap and accumulate equity is beneficial, and doing the opposite, buying in peaks, is ill-advised.
Negative cash flow
Your cash flow is the amount of profit you can earn from a property after paying all expenses. Because, in the end, it's not how much you made, but how much you get to keep after:
- Taxes
- Loans
- Insurance
- Screening Fees
- HOA fees, etc.
A negative cash flow means you're left with nothing and even at a deficit. On the other hand, a positive cash flow means you have some fats (profits) left after all expenses. To reduce the risk of negative cash flow, you must calculate your costs meticulously before signing.
This includes estimating all the expected and unexpected costs related to your investment, such as maintenance and repair costs, vacancy rate, and property management. It is imperative to be as thorough as possible, as even the most negligible expenses will add up to a considerable amount over a long period.
Bad Tenants- Criminal Background Checks with a Trusted Screening Process
The bane of every investor is letting a bad tenant into their property. It could take months until you're able to get rid of them, and you'll lose not only money - but also sleep, time, and energy.
And even if you conduct background checks before leasing to someone, you can still get a rotten apple, as people fake their documentation, such as bank statements and eviction history.
To reduce this risk, it's best to authenticate the documents prospect tenants submit to you. This way, if a potential tenant has criminal records, a bad credit report, or shaky employment history, you'll have access to all the information you need to make an informed decision. The best tenants have outstanding personal references, good rental history reviews from landlords at previous addresses, and pay stubs included in their application form. However, even good tenants might have something missing from their form. That's why it's best to always use your judgment for each applicant.
Having a tenant screening report can assure you don't fall into the same trap previous landlords have. You might be renting a property to a felon, sex offender, or someone with some other colorful criminal history they artfully hid from their rental application. It may not even have to be that dramatic. Maybe they have a bad credit score. Whatever your prospective tenants might be hiding, Snappt will uncover it without an extensive tenant screening process.
To learn more about the state of apartment screening survey please download our report:
2022 Snappt State of Apartment Tenant Screening Survey
