.Ok, I agree. Risk management isn’t really a real estate investing strategy but it is a very important part of real estate investing. If you are considering investing, you need to make risk management a top priority in your strategy.
What is risk management?
Well it is actually the term for long/short term insurance e.g. life insurance and home insurance. The problem here is that this isn’t the only risk management you should do as a property investor. Risk management, as far as I am concerned, is planning for the unforeseen, making sure you are protected when things don’t go your way.
So how do you manage your risks?
First thing you should do is identify all the possible risks that a real estate investor could face here are a few:
If your property has a stove, cupboards, light fittings etc. you need short term insurance. The last thing you want is to have to get cash somewhere to replace a stove.
Fire and water
Another good reason to have short term insurance is because your property could burn down. Another possibility is water damage. I am sure you’ll agree that these two elements can ruin a good piece of real estate.
If you are going to be an investor you will probably have tenants that assist you in paying off the bond and maybe even provide you with a steady income. The problem is when your tenant defaults on his rent. For this reason there are some ways to manage these risks.
Firstly you could take out landlord insurance. This will assist you by paying the rental for up to 3 months if your tenant can’t pay any more. The 3 months is just about enough time to take legal action to remove the tenants from the property.
The second thing you could do is mange your cash. If you are able to put away about 8-10% of your rental each month you will build up a sufficient backup fund that could help you out when your tenant defaults or if you don’t have a tenant. It’s always a good idea to have an emergency fund available for unforeseen events.
Negative cash flow
Yeah, you will probably have negative cash flow, for a while at least. The only way you can manage this risk is by making sure you have sufficient cash in reserve to cover the shortfall until you either sell the property or have positive cash flow.
Yes the old interest rate. You need to plan well ahead and make sure you manage how interest rate changes affect your real estate investments.
You need to prepare for at least a 1% raise in the interest rate. This way you will be able to last in a downward market. I am not saying that the interest rate will only go up by 1% but this should at least give you a fighting chance.
On the other side, when there is an interest rate drop you should save the extra cash you have and build up that emergency fund. This way you’ll be prepared for ALL markets.
Death and taxes
Don’t mess with the tax man. Pay your taxes when you need to. If you are paying lots of tax, you are probably making lots of money. The last thing you want to do is go to jail.
Right enough of that now we come to death. If you die who will take care of all your real estate? Will they have the money to pay all the expenses etc.? If you are building a real estate empire that will empower your family you need to protect your assets.
You will need life insurance to cover the debt and expenses of your property portfolio. You will probably need to have all your assets in trust. This way you avoid the red tape where your estate is concerned. For more info read our article about trusts called: “Trusts: a description in layman’s terms (with a twist of Latin)”.
There are other risks you should also consider, it is always a good idea to make a list and plan for each risk you feel you have. Lastly you should review and asses your risks on a regular basis.
Next time we will talk about flipping.