Why is Real Estate Investing Risky?

It’s Only Risky If You Don’t Understand It.

Ask any good money manager or person who has made a lot of money. They typically stuck to things they understood in order to grow their wealth, whether it was building a business, investing in stocks, or investing in real estate. It’s only risky if you don’t understand it. Warren Buffet, the renowned investor, once stated, “Risk comes from not knowing what you’re doing.” That advice rings true in real estate investing, building a business, or investing in stocks. 

Real estate has developed a reputation for being a sound investment strategy that offers steady appreciation and passive income.

In fact, real estate has ranked as the top investment pick in the US for the past decade. In 2023, 34% of Americans said that real estate is the best long-term investment. This was according to Gallup’s annual Economy and Personal Finance survey. [1]

However, just like any other investment, real estate comes with its share of risks. Investors need to understand these risks and not just the benefits so that they can make their investment decisions accordingly.

Here are some of the risks associated with real estate investing and why you should be careful before buying an investment property.

Why is Real Estate Investing Risky?

Real estate investing carries inherent risks. For many investors, the biggest concern surrounding real estate is market fluctuations. The real estate market is subject to cyclical changes influenced by factors like economic conditions, interest rates, supply and demand dynamics, government policies, and unforeseen events.

Before the 2008 Great Recession, many investors mistakenly believed that the real estate market could only go up. But while real estate values do tend to rise over time, the actual real estate market is volatile. It is entirely possible for an investment property to depreciate in value. [1]

Market fluctuations can significantly impact property values, rental income, and therefore your return on investment (ROI). During periods of economic downturn, property values may plummet, vacancies may increase, and rental rates may decline, leading to reduced cash flow and potential losses for investors.

Liquidity Risk

Real estate is not a highly liquid asset. Unlike stocks or bonds that can be readily sold on the market, real estate typically requires a longer timeframe to sell and convert it into cash if you ever need it. Meanwhile, stocks can easily be sold if you need money or just want to cash out.

In times of economic downturn or market instability, finding a buyer willing to pay the desired price becomes challenging. Selling the property will depend on its condition, location, and other factors like market conditions or the state of the economy.

This means if an investor wants to convert their property into cash by selling it, they have to be prepared for prolonged holding periods. You may even have to sell it at a reduced price if you need the funds urgently. This lack of liquidity can be problematic, as it compromises your financial flexibility.

While there isn’t much investors can do to lower this risk, it is possible to tap into the property’s equity if cash is needed. They can take out a home equity loan for residential properties or do a cash-out refinance. For commercial properties, there is the option of taking out a commercial equity loan. [1]

Maintenance and Management

nese apartment bam capital poolProperty management is a challenge that investors need to overcome when getting into the world of real estate investing.

Owning real estate requires ongoing maintenance and management, which can be costly and time-consuming. Unexpected repairs, tenant vacancies, and property management issues can eat into potential profits and increase investment risk. Read the article, “Purchasing & Running an Apartment Complex” to learn more. 

There may be times when your property experiences unexpected maintenance issues like a leaky roof or a broken water heater. The replacement and repair costs may prove to be substantial. They can even wipe out your cash reserves. [2]

Aside from these issues eroding your profit margins, you also have to worry about managing the property. This demands time and resources.

If you don’t have experience being a landlord, this could prove to be tricky. Problematic tenants and high vacancy rates can compound the risks of real estate investing, which means proactive management is essential to mitigate potential losses.

To avoid costly repairs, make sure the property goes through a thorough inspection before you purchase it. [2]

As for property management, a single family property may be easier to manage, but a multifamily property will have the cash flow to justify hiring a property management company that will handle the daily operations of your investment.

High Vacancy Rates

Speaking of high vacancy rates, this is one of the most significant risks of real estate investing. Vacancies directly impact rental income, potentially leading to revenue shortfalls and financial strain.

Whether you own an office building, a condominium, an apartment community, or a single-family home, you need to fill those units with tenants in order to generate rental income. [1]

Aside from economic downturns, oversupply in the market and local issues can contribute to increased vacancies. Not only does this result in lost income, but it also incurs ongoing expenses such as maintenance costs and property taxes even while the property is not generating cash flow.

This is especially risky if you are relying on rental income to pay for the property’s mortgage, maintenance, property taxes, insurance, etc. [1]

Investors must carefully assess market conditions and property demand to mitigate the risk of high vacancy rates. The best way to avoid this risk is to buy an investment property in a good location. [1]

Location Problems

The location of your property is the single most important deciding factor in your investment. You can renovate and make changes in the property itself, but you cannot change where it is located. It is always going to be your first consideration when buying an investment property. [1]

Location is the ultimate factor that determines the property’s ability to make a profit. A prime location can significantly enhance property value and rental income, but a poor location can lead to stagnation or depreciation.

You will know that a property is well-located if it has easy access to amenities such as schools, transportation hubs, restaurants, malls, parks, etc. If a community or city is undergoing economic development, this is a good sign as it can affect property demand and resale value.

This means thorough market research and due diligence are essential to mitigate the risks of choosing a poorly-located investment property.

Time Commitment

Because of the demands of managing a property, investors should be aware that real estate will take up a lot of their time.

Before an investor owns a property, they have to invest a significant amount of time doing their due diligence and learning about various neighborhoods and prospective investments. They have to identify potential problems with each neighborhood and recognize if they are truly worth investing in. [2]

Once they have chosen a property, investors have to start pouring time and effort into property management and maintenance.

Managing properties involves a multitude of responsibilities such as tenant screening, property maintenance, dealing with legal issues, and handling financial matters. These tasks require substantial time and effort, especially for those who are actively involved in the day-to-day operations.

Unexpected emergencies or tenant disputes can happen at any moment, further stretching the required time investment. Investors should be prepared to tackle these issues at any given moment. For those who do not have the time or energy to deal with these problems, a third party property management company may be helpful.

Natural Disasters and Environmental Risks

There are several benefits that come with the fact that real estate properties are physical assets. However, it also means it is vulnerable to natural disasters like hurricanes, earthquakes, floods, and wildfires. Properties situated in disaster-prone areas face heightened vulnerability to these dangerous events. [3]

Environmental issues such as pollution or contamination can also affect property values and pose legal liabilities for investors. Catastrophic events can lead to structural damage and financial losses. These are all examples of direct risks.

However, there are also indirect risks to keep in mind. For example, when a disaster occurs, hotels may not be able to receive guests. In some cases, people may even be forced to move. [3]

Investors must carefully assess if a property is significantly exposed to these problems.

Best Alternative for Accredited Investors: Multifamily Syndication

While real estate investing can offer attractive returns, investors should carefully assess these risks to make informed investment decisions. By familiarizing yourself with the potential risks, you can implement risk mitigation strategies like thorough due diligence, proper insurance coverage, diversification of investments, and working with financial experts.

If you are an accredited investor, you will be pleased to know that there is an alternative real estate investment that solves some of the biggest problems in real estate investing. If you want to learn how to become an accredited investor, click the link. 

Real estate syndication involves multiple investors pooling their financial resources together to purchase a single real estate property. Because multifamily properties such as condominiums and apartment communities are known for their strong and consistent cash flow, multifamily syndication is the most popular version of this investment strategy. [4]

Because multiple investors are pooling their funds together, it makes these larger properties more accessible to investors. You don’t have to worry about the entire property, as you only have to provide a share of the capital needed to acquire it.

Multifamily properties are typically larger and more expensive, and therefore more difficult to purchase for a lone investor. But through multifamily syndication, you can get over this high barrier to entry. It is also a lot less risky compared to purchasing a large multifamily property on your own. [4]

In a syndication deal, a syndicator serves as the general partner (GP), taking on all the responsibilities in the investment. Also known as the sponsor, the syndicator will handle everything from locating the investment property to creating and executing the business plan. They will also look for real estate investors who will participate in the syndication deal.

As limited partners (LPs), investors provide most of the capital needed to purchase the multifamily property. They also pay certain fees associated with the investment property. However, they have no responsibilities or liabilities beyond that. This means multifamily syndication is a true passive investment in real estate. [4]

As you may know, real estate investing can be a good source of passive income. But it normally requires a huge time investment thanks to property management.

Through real estate syndication, you don’t even have to worry about property management since the syndicator will also be the one to handle it. Some syndicators hire property managers to cover the day-to-day operations of the investment property, but others have the expertise to handle it themselves. Either way, it is not the responsibility of the investors.

For their investment, LPs earn a portion of the property’s monthly rental income. You can just sit back, relax, and enjoy your investment. This rental income will be distributed on a monthly or quarterly basis, depending on the deal structure. [4]

Every deal is different, but investors may also earn a share of the equity upon resale. The specific details of the profit split should be found in the private placement memorandum (PPM) or the syndication agreement. Investors need to perform their due diligence and learn how the syndication deal works before participating.

Investors should remember that most of these syndication deals are exclusive to accredited investors, meaning those who fit the financial and professional criteria set by the US Securities and Exchange Commission (SEC).

Work With BAM Capital for the Best Multifamily Real Estate Syndication Deals

While real estate investing has its risks, it should not discourage investors from adding it into their investment portfolio. With the right investment property, you can mitigate these risks and enjoy the many benefits of real estate.

Additionally, through multifamily syndication, it is possible to avoid even more of the risks associated with traditional real estate investing. Multifamily syndication deals are generally safer than trying to run an entire real estate property by yourself.

To maximize your chances of success, it’s necessary to work with a trustworthy syndicator such as BAM Capital.

BAM Capital is an Indianapolis-based syndicator that is known for their consistent track record for excellence. They are considered a leader in their industry, and that is only one of the reasons why accredited investors love working with them.

BAM Capital focuses on Class A, A-, and B++ multifamily properties with in-place cash flow and proven upside potential. They then use their award-winning strategy to mitigate investor risk while creating forced appreciation. [5]

In fact, BAM Capital now has over $700 million AUM and 5,000+ units. On top of that, BAM Capital is also a vertically-integrated company, meaning they can handle every step of the syndication deal. They can guide accredited investors through the whole process: from acquiring high quality multifamily properties to renovating and managing them. [5]

Always work with a syndicator you trust. Keep in mind that no investment is without risk. Make sure to consult your investment advisor or speak to a BAM Capital investment team member before making any financial decisions.

For accredited investors who want to enjoy the passive income and all the other benefits of being in a multifamily syndication, schedule a call with BAM Capital and invest today.

 

Sources:

[1]: https://www.investopedia.com/articles/investing/122415/why-real-estate-risky-investment.asp#

[2]: https://www.accountingtools.com/articles/pros-and-cons-of-real-estate-investing

[3]: https://apg.nl/en/publication/how-do-environmental-disasters-impact-real-estate-investments/

[4]: https://multifamilyrefinance.com/apartment-investing-blog/multifamily-syndication#important

[5]: https://capital.thebamcompanies.com/