While proven to be a safe and reliable investment for decades, buying real estate, whether it’s a primary residence, an income property, or a vacation home, is not the same as investing in a GIC.
As with many investments and, really, most of life’s endeavours, there is an element of risk involved.
Much in the same way that you drive your car to get from points A to B, you’ll want to make sure you’re alert, aware of the risks, and take basic precautions to ensure that your real estate investment vehicle gets you to your financial destination — without the white knuckles.
In this article, we’re going to discuss the most common financial risks and arm you with the strategies to properly evaluate and mitigate them so that you can make decisions based on facts – and not fear.
We can provide you with charts displaying ever-increasing home values, point out that demand in Southern Ontario increased dramatically during a pandemic, and share countless motivational quotes from famous investors (as you can see, we already have!). For some, however, none of this will be enough to overcome the fear of a short-term market correction that could eat into their home equity.
You can’t control the market; you can, however, control your approach to real estate investing.
The first step to mitigating the risk of a market downturn starts with your mindset: viewing real estate as a long-term investment. This alone will help you ditch the “day trader mentality” and more calmly weather ups and downs.
The second step is to be methodical in how you evaluate the market and the opportunities available to you. By understanding national and local trends, immigration patterns, local economies and market projections, you’ll feel a lot more confident about the long-term potential of your investment when purchasing.
We’ll also mention that income properties in particular come with built-in mitigation. Because your tenants are always paying your mortgage — and, therefore, growing your equity each and every month — you’re further safeguarded against net financial losses.
“But what if I need to sell?”
It’s true that real estate, unlike a stock, cannot be disposed of immediately upon your decision to pull out. While homes are moving fast right now, there have been long periods when homes have taken months to sell. And, even in a seller’s market, it can still take months for homes to transfer ownership – and for you to get your funds.
First, illiquidity isn’t all bad. As we’ve discussed, illiquidity reduces impulsiveness, promotes stability, and, if your goal is to pass your properties down to your children, the preservation of generational wealth.
In the article we linked to above, we also talked about alternative ways to access your cash in the event that it’s needed quickly. Refinancing or tapping into your home equity line of credit are common approaches.
True mitigation, however, comes from both thinking long-term and being conservative from the outset. This means not overleveraging and having adequate financial reserves in the event of a financial emergency, such as a job loss.
The government and banks have already addressed the risk of overleveraging through the implementation of mortgage stress tests which essentially prevent you from borrowing to your true max. While understandably frustrating for some homebuyers, this does promote a stabler market with fewer mortgage defaults (which is good for everyone).
While the first two fears could apply to any property purchase, this one is a main fear for those looking to purchase an income property.
There are three main areas of concern:
- Not being able to find tenants
- Tenants not paying their rent
- Tenants not taking care of your property
In all cases, there are potential short and long-term financial implications.
When it comes to finding tenants, start with market research. If you’re purchasing a home in a great location with low vacancy rates, you shouldn’t have issues finding great tenants.
As far as ensuring your tenants pay their rent and take great care of your property, there’s no substitute for a thorough vetting process. Interviews, reference checks, credit checks, etc. Often, it’s worth it to get a property manager to take care of this process as well as the day-to-day management of your property as they have the systems and protocols in place to protect you, the landlord.
Always, and in the spirit of being conservative, you’ll want to budget a percentage of your monthly rental income to vacancy.
“What if something goes wrong with the home and costly fixes are required?”
Like cars, homes new and old will require maintenance (though condos and new builds will be on the lower end of the maintenance spectrum). So, this is a legitimate concern that you’ll need to plan for.
Education is your number one risk mitigator in this case.
Not only is a home inspection critical in helping you plan and budget for potential repairs, but it’s also important to have a general understanding of home systems and when they need to be serviced and replaced.
Furnace filter replacement, AC tune-ups, and gutter cleaning in the spring and fall are just a few of the routine maintenance measures you should know about, account for, and do! We covered many of the routine home maintenance checks and tasks here.
And, again, if you’re not handy or simply want a low-maintenance home, consider a newer home or a condo.
The Common Thread
You’ve probably noticed some recurring themes throughout this article; they keep surfacing because they’re critical, not only when it comes to buying real estate, but making many of life’s financial choices.
By having a long-term mindset, being methodical in your evaluation of the market and the opportunities before you, and taking basic precautions, you’ll put yourself in the best position to overcome fears, shield yourself from financial risk, and make big decisions with clarity and confidence.
And, finally, while this article will hopefully help assuage some of your fears, there’s really no substitute for speaking with investors who have been there, done that, and are willing to share their best practices.