#66: What Are the Risks of Real Estate Investing?

Foreign. Welcome to the Passive Income MD Podcast where we talk about creating your ideal life through multiple streams of income. I'm your host, Peter Kim. If you enjoy hearing about this stuff, make sure to hit subscribe so I can bring it to you every week. Now let's get on with the show. Hey everyone, hope you're having a great week. I want to start out this week's episode by saying thank you, thank you to all those who are listening to this. Taking time out of your busy days just to invest in yourself, in your own education. When it comes to passive income, real estate, investing, maybe even entrepreneurship. And maybe you're on a commute, right? Maybe you're listening at home or in between cases. I mean, that's amazing. And I want to thank you for the encouraging messages that you sent me, letting me know that it's bringing some value to your life. And so I really appreciate that and I'm going to keep trying to provide as much valuable content as I can on a week to week basis. If there's someone else that you think would get something out of this, please share it with them. But other than that, I'm just happy to be here and thank you for taking this time again. Now, this week we're going to be talking about something that you might not hear about a lot when it comes to investing real estate or, or something that doesn't seem to be highlighted and that is the risk of investing in real estate. I mean, people always like to talk about the good side and the upside. And I do as well. I think that the focus should be on the benefits and what you can get out of it and what can you can achieve. But I think it's also important to talk about the other side, right? The risks, how to mitigate risk. And I think as physicians and as doctors, we always think about risk benefit ratios, we think about mitigating risk because obviously in our day jobs, if things go wrong, people's lives are at risk. And so we don't want that. And so we try to mitigate that first, do no harm. Right? Now, when it comes to investing in real estate, and in particular owning rental properties, there is an element of risk involved. I mean, if anybody is telling you the opposite, right, meaning that there's no risk, 100% guarantees, obviously you should run the other way. Now it's just known that risk is an important part of any sort of investment. You know, with risk, I'd say, you know, generalization, high risk usually comes along with higher rewards and that's with anything else in life and lower risk, typically lower rewards. Right. And you can never predict how investment is going to play out, but you can at least try to identify risks beforehand and do what you can to mitigate their impact. And I think that's an important part of learning how to invest and invest well. So when it comes to owning rental property, we're going to talk specifically about that. There are seven risks that you should know about and try to mitigate those. Now, risk number one, you buy a bad property. Now, bad in this case, what am I referring to? It's just like hidden problems that aren't immediately apparent. So this could include things like structural foundation issues, some of the big catastrophic stuff. Right. Maybe that your roof is in disrepair, defective appliances, defective things in there, big amounts of mold, and these kind of things. Now, I'll be honest, no matter what happens, there are going to be some surprises after you take over property. It's a given and it's. It just always happen. So how do you mitigate this risk? It comes down to I say three things. Inspect, inspect, and inspect. Okay, that, that's one thing, but I can't stress it enough. Spend the time hiring inspectors up front. And I know that this could be for when you're buying your own home, too. You know, you're trying to skimp out on the inspection. You're trying to go the cheap route. You know, you minimize the amount of things you inspect. So maybe people do a basic home inspection, but they may not get a mold inspector, they may not get pest control inspection. Right. They might not get a contractor in there with you to inspect the property itself. But I will tell you that the more you quote, unquote, look under the hood and you pay for it on the front end, it will pay itself off. You know, on the back end, it might even pay itself off during the deal. Because oftentimes when you do inspections, you find stuff. There are ways to go back to the seller and try to get some sort of credit for it, at least bring it out if it hasn't already been disclosed. I mean, rarely is someone or anyone ever sorry that they did a little bit of extra due diligence upfront to try to uncover any sort of major issues. In fact, the opposite typically happens. People often get in there and regret that they didn't take more of their time and figure out whether they're buying a bad property. I'm going to tell you this, and be honest with you. I'm learning this lesson for myself and I've continued to learn this Lesson for myself, I can't stress enough how important it is on the front side to do as much due diligence as you can. Because once you're in, hey, you're in. So risk number two, bad tenants. Now, if you own rental property, you're getting paid by tenants. So what's a bad tenant? You know, whether they have late payments, you know, there's certain neighbors in a larger apartment building, you know who they are, right? That cause issues that cause everyone else to be really not happy about where they're living. Maybe there are people that, you know, destroy property or just a couple things, right? So how do you prevent these things? Now? Number one, you should. You should be picky about who you rent the property to. You know, that requires thorough screening. There are ways to do that both in terms of, like, full background, credit checks, you know, these kind of things. There are certain tools that you can use to help you out with that. Now, if you have a good property management company, it's one of the important things to find out how do they screen their tenants and what is their success in doing so, what is their process, how do they do that? I think it's important to keep a standard and stick to it. I mean, I know that for many of us, you're going to want to rush, you know, to fill a vacant unit, but saving yourself from having a bad tenant in there, it's totally worth waiting for. And honestly, it'll pay for itself many times over versus having a horrible or bad tenant. All right, number three, lawsuits and liability. Right? Liability is a huge thing to consider in real estate. I mean, there are always debates about the best way to protect yourself, right? How to wall yourself off against potential lawsuits. Now, I think there are two ways to really mitigate this risk. Using insurance and using entities. And we'll talk a little bit about both. In terms of insurance, you know, you can get a large policy, right? And you, on top of that, maybe you stack something called an umbrella policy to give yourself even more coverage on top of that. That way you don't ever have to worry about dipping into your personal assets in the case of a big liability suit. And, you know, just how much you need is really dependent on the property, the type of tenants, your history, your current assets. But it's important to look into that and partner up with a good insurance agent to make sure you're well covered in that scenario. Now, when it comes to entities, I'm talking about like creating, like llc, right? Limited liability companies, these are entities that really wall yourself off from any sort of liability. Right. It keeps a potential lawsuit from affecting you personally. Right. In your, your personal assets. You know, putting your personal assets at risk. You know, that's a different, you know, separate discussion in terms of the extent of what you need to do. But it's absolutely important to talk to asset protection lawyers about the situation, how to protect yourself the most. Again, you want to do this on the front end and not after there's a liability issue because it won't help in that situation. So please look into that if you're thinking about it. Don't skimp on this as well. Okay? Risk four, it's that the house or the property that you're buying, it decreases, right. In a declining market. So depending on your age and how many of these real estate cycles you've seen, you've seen the values of homes take a tumble at least once, twice, three times, many more times in your lifetime. Right. I mean, right now you probably heard that we're in the middle of one of the greatest real estate, I mean, and stock market runs in history. Now people are debating left and right, when is the party going to end. Now, I know that things are happening with the government in terms of printing cash, all this stuff, right? And so, you know, and decreased supply. And it's just really been an interesting market where things are going extremely well for everyone. However, nobody wants to buy at the peak of the bubble, but inevitably people do. So how do you risk this situation? Right. You know, I've always heard it said you lose money when you sell. So the question is, how do you buy smartly and then how do you set yourself up so you don't have to sell at a point where maybe the market's down? So you gotta figure out what is your long, long term strategy, what are your exit plans, how are you setting yourself up in terms of your leverage, your finances, so that you can withstand different swings in the market. Now this is why personally I'm not a big, you know, fix and flipper. I know that it is a strategy that has worked really well for some, and I know some of these people that have done quite well. But it's just not the strategy for me when I'm trying to provide or create long term, kind of steady cash flow. It's good for turning your money over and making an income. But again, it is like another job to me. And so for me, I'm always thinking, okay, if I buy this property, how long am I going to keep this property and what are my different exit plans? Whether it's a refinance somewhere in there, or maybe it's a sell down the line, or whether it's to keep it, whether it's to exchange it using like a 1031 exchange. It's just good to have all those things kind of mapped out at the beginning so that even if you do buy, let's say at the peak, for whatever reason, you know that the cash flow from it, right. The property is going to do well. And over time, you can sustain any sort of kind of ups and downs in the market. So I think that's really important, especially today as we see, like, record high real estate prices. All right, we just have a couple more risks here. Number five, choosing a location poorly. Now, everyone's always heard real estate is all about location, location, location. It means that, you know, it's really important because that's something you cannot change. You can change the color of the property, you can change the roof, but you can't change where the property is located. So how do you mitigate a risk like this? So you just look for key indicators, right, of things, of places that you think would do well over time. I mean, things like population growth, job growth, school systems, you know, populations growing, the economy is growing and diverse. The. These are all things that are readily available. You can find these things with just a little bit of research and you can know whether the area that you're choosing is a good location. And in a growing area, you have to do your own homework. A little bit of due diligence. There are websites like City Data, and, you know, you can talk to local property managers to educate yourself. And again, this is something that if you do your due diligence upfront and you do it properly, you're going to at least reap the rewards later on. Risk number six is that of something called liquidity. Now, one of the disadvantages of owning real estate is that is what's called liquid in nature, meaning that if you're in a bind, you can't just, like, hop online and sell the asset, you know, instantaneous with like a click of the button, right? Like you can with certain stocks or, you know, with crypto or things like that. Now, for those of you who have been through the home selling process, I mean, I know things are going really, really quickly, but it can still be a lengthy process. You know, I have another business where I help physicians buy and sell homes. So I know that, you know, this process takes a while. So when you buy a property or buy, you know, purchase into an investment you need to understand that you can't easily offload it in a pinch if you're in a cash flow, you know, poor situation. So you got to know your exits like I talked about before and your different options. Now, just so you know, even though you can't sell it in a pinch, there are ways that you can tap into the equity of your place if you need it. Mean that you can pull money out of the house, like technically on paper. And one way is to do some sort of refinance of the property or to put some sort of thing like a home equity loan or line of credit on the property so you can pull from it if you need to. And so there are ways to create a little bit more liquidity in your investment. That way in a bind, you can always draw from that and you don't have to worry about selling the property if needed. The last risk is leverage. Now we all know that leverage, when I talk about it, I'm talking about debt, right? Getting a mortgage on the property, it can definitely be a double edged sword, right? I mean, it can help produce massive returns. And I think that's why so many smart real estate investors use leverage to their advantage. Like on the flip side though, it can hurt you badly if things don't go well. It can make a bad financial situation much worse. So let's also remember, right, I mean, when you buy a property and use leverage, use some of your own money, but you usually use a lot of the bank's money. And at the end of the day, actually the bank kind of still owns the property. Meaning that even though your name is on title or whatever, your company name's on title, but if you decide not to pay, what happens? The bank takes it over. Right? And the bank takes what's theirs. You know, I hope the situation never occurs to anybody where they can't cover their leverage or the debt payments. But it happens. And it's happened in 2008, it's happened years before that it's going to happen again. So one way to mitigate this risk is to have a cash flowing rental property. I mean, what does that mean? It means that the income from the property exceeds all the expenses of running the property. That cash flow allows you to have a buffer in case you lose some renters, in case you have some additional expenses that are unexpected. It helps you save for those moments and be able to weather different storms so that you can kind of get through this, right? And so if you're going to have some leverage and you're Going to have some debt on the property, which can do amazing things for you as an investor. Make sure on the flip side, to have some cash flow to coverage that leverage and just to, you know, in case things don't go perfectly. So I know what you're thinking. We talked all about investments and we talked about risk. So here's a question. Is real estate investing risky? I mean, I believe everything has a level of risk, but what are the benefits and how much risk are you willing to take on? Now, I think that for most people when they invest in real estate, they understand that the benefit can far outweigh the risk or downside. And if you can mitigate your risk, you can really put yourself in a position to succeed. Take advantage of all the benefits. I mean, for anything in life, right? I mean, risk is necessary for any sort of gain in life. You're taking a risk every time you walk out your door, drive down the street. But at some point the benefit is worth it. And I think absolutely. Real estate is not riskier than any other asset class. In fact, I find that you can mitigate again, so many of these risks up front with just a little bit of intelligence, some time and some, just some of your homework up front. And so, you know, just putting together a good game plan. And I hope everyone is able to do that. And by listening to this, you're going to be a little bit more prepared going into your next investment. Anyways, have a great week. Hope that's helpful. Let's talk again soon. See ya. Enjoy the show. Let me know by dropping a review in the podcast app you're listening to us in. And if you haven't already, make sure to hit subscribe. Are you part of our community yet? Join thousands of physicians who are also on this journey to creating their ideal lives through multiple streams of income. You can join us on our Facebook group, PassiveIncome Docs, and you can always learn more at our website, passiveincomemd.com thanks again for allowing me to be a part of your journey. See you next time.