How to Manage Risk with Rental Properties
If you’ve been following for a while now, you know that I bought a house in 2016 with the intent of eventually turning it into a rental property. I started off living there while renting out the basement so that my living expenses were reduced by more than half. As of about a month ago, I moved out and rented out the entire townhouse which covers the mortgage and I make a bit of income each month.
I had someone DM me the other day saying that they “don’t agree with ‘good debt‘ as having a rental with a mortgage. If you are doing that, it is risky and how people can go bankrupt. If your renters can’t afford rent or leave you are stuck paying that mortgage plus your own mortgage/rent. In a perfect world where renters pay every time it would be nice. It just becomes super risky to have an investment property that you will own on. People build wealth and minimize the risk by paying off the property then renting it.”
I wanted to address this in a blog post because I know that a lot of people would agree with this person. However, there are effective ways to manage the risk and not just avoid bankruptcy but actually make money. The key to real estate investments, and any investment is how you manage risk. When Colby and I trade FOREX, which is considered one of the most risky types of investing (by the general population), we only risk 1% per trade. So we would have to lose 100 times in a row to lose all our money (highly unlikely, even if we tried!).
With real estate I manage risk in the following ways:
I use a third party company to conduct background checks, check credit score, and income verification. I don’t HAVE to accept any anyone that applies. I have very specific criteria that a potential tenant must meet including a clean background, high credit score, and income that is at least 3x monthly rent. If someone has a credit score of 750 and has never had a late rent payment, that significantly lowers the risk of my investment.
I use the same third party company to write the lease. Remember that the lease is a legal contract. If the tenant doesn’t pay their rent after a certain number of days you are legally allowed to start charging interest. If they continue to not pay their rent then you are legally allowed to evict them.
I ensure that I can afford both the mortgage and my current rent. Of course it’s not ideal to pay both, but if I absolutely had to, I could. I also have funds set aside in case my current tenant decides not to renew the lease once it’s up. I know that there will be a gap between the current tenant moving out and finding a new one, so I’ve financially planned for that.
I provide exceptional service. This may seem like it’s unrelated to managing risk but by providing exceptional service I’m increasing the chances that my tenant will renew their lease, thus minimizing the chances that I have a gap month where I have to pay the mortgage.
I also want to address the idea that “people build wealth and minimize the risk by paying off the property then renting it.” It usually takes 15-30 years to pay off a house. By then, the house probably needs to be upgraded – new appliances, new roof, etc. This is usually when people go to the bank to get a HELOC (Home Equity Line of Credit) in order to afford those upgrades. Then they have to pay off that loan and they’re back to being in debt. Even if you don’t bother with upgrades and go ahead and rent it, you’re doing 2 things. One is that you’re putting yourself at risk because you’re not proving exceptional service by providing an upgraded place to live. And two is that you’ve missed out on A LOT of money by then.
I personally have a 30 year mortgage. If I waited those 30 years before renting it out, I will have missed out on over $78,000 in profit! And that’s assuming I never raise the rent in 30 years.
All investments have their risks. The bottom line is that all wealth is built upon investments. Therefore, you must learn to manage the risk of those investments, think ahead of all the challenges you may come across and prepare for those challenges.