Determining Acceptable Risk

Sit down with any financial advisor prior to making an investment and the conversation almost immediately turns to investment goals and acceptable risk. Investing in real estate is no different. Before purchasing that first property, the rental property investor must decide how much risk they are willing to take.

Perhaps the biggest risk one may think of in real estate is a property that produces a poor return on investment due to low monthly net income or slow appreciation in value. An old saying goes money is made on real estate when it is purchased, and I wholeheartedly agree. Pay too much with some bad financing and a real estate may never achieve the desired return on investment.  

However, I am firmly convinced, in most areas of the nation, the likely hood of striking out on real estate is fairly low. Real estate can often be a safer bet than the market. I’ve blogged previously about the importance of determining expected capitalization rate before a purchase. As long as this critical math problem works out, in my humble opinion, real estate is a solid investment. Therefore, in this blog, I’m not going to focus on risk to return on investment, but rather risks on a more personal level.  

Investing in real estate, requires personal sacrifice and a level of deprivation which are not present in other investment products. While it takes near term sacrifice for any worker to save and invest money on a tight budget, real estate investing requires the additional sacrifice of time. Losing time is just as much of a risk as losing money. After all, to use the old expression, time is money.

Simply put, buying real estate takes capital and for the average joe or jane building capital usually requires depriving oneself in the near term.  There may be times when a real estate investor may feel “poor” because all their hard-earned capital is tied up in a property, but actually they have several hundred thousand or millions in equity! The equity in real estate is a long-term investment and certainly not liquid. It cannot be tapped easily. In the near term (think 20 years) real estate investing will most likely not lead to an exotic sports car or lavish lifestyle.

That is why the risks to personal finances when tying up capital in real estate must be weighed and considered carefully. If with a partner, taking the plunge into real estate absolutely must be a mutual decision. It has been tough for my wife and I at times over the years. We could have used the money we invested into real estate to buy a bigger house, better car, nicer smart phone or just about anything. But instead, we kept our capital tied up in real estate and sunk our monthly net gains back into more properties. Once invested in real estate, capital is tied up for several years!

Of course, the payoff occurs down the road and usually comes in the form of early retirement, kid’s college paid in full and debt free living. But we as humans are sometimes terribly short sighted. I can’t stress enough review and acknowledge the risk (or sacrifice) to personal finances that investing in real estate requires. It is somewhat difficult to undo once the plunge is made.

Another personal level risk is the time a real estate investment will consume. Unlike putting 10% of a paycheck into a retirement account and letting someone else worry about it, investing in and actively managing real estate requires giving up personal time. One should expect that plumbing, air conditioners and the 100s of other things that can go wrong will go wrong on a Saturday night. If not on a Saturday night, a Tuesday night after a long day’s work at the day job. There is just never a good time. Even if something isn’t broken or you’ve entrusted your portfolio to a manager, rentals take near constant decision making. Actively managing rental properties means giving up free time to tend to the investment. For me, this sometimes came at the expense of time with my family. 

Lastly, buying and renting property to others is inherently a people business in so many ways. From working with the banks and real estate agents to managing tenants. There are ways to reduce the contact, but at the end of the day finding, buying and managing rentals takes near constant human interaction. Anytime people are involved in an investment, risk is introduced. I am talking all sorts of risk, from deadbeat tenants to major repairs or damage. We’ve been doing this for 15 years but still get surprised from time to time!

The word commitment is thrown around a lot, but it is certainly applicable in real estate investing. There really is no comparison to just squirreling away funds in a retirement account. This is probably a big reason why not everyone accepts the personal level risks required to invest in real estate! Before jumping into rental properties, one must determine how much risk is acceptable; it is not something to be ventured into unprepared!

Interested in rental property investing? Look for “Collect Rent, Don’t Pay It: A Beginner’s Guide to Rental Property Investing” on Amazon to learn how our family turned rental property investing into a successful side hustle!

The commentary provided in this blog is for informational purposes only and is not intended to be a source of financial or investing advice.

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