Understanding the Risks of Investing in Real Estate

Americans are big fans of using real estate to build wealth . According to a 2024 Gallup survey, participants believe real estate is the best long-term investment opportunity. But investing in real estate, like rental properties, comes with risks, too. Market fluctuations, economic downturns and changes in interest rates can all impact property values and rental income. A property’s location and legal considerations can also add risk. Before buying a property, consider these real estate investment risks and prepare for the potential ups and downs that come with the opportunity

Before investing in real estate, consider speaking with a financi a l advisor to see how your investments fit into your overall financial plan.

Is Real Estate a Risky Investment?

Real estate can be both a stable and risky investment, depending on different factors. Unlike stocks, which can fluctuate in value in the short term, real estate often provides more consistent returns over time, especially in growing markets. Properties tend to appreciate in value, and rental income can create a reliable cash flow.

However, stability isn't guaranteed. Economic conditions, interest rates, local market dynamics and other factors can all affect property values and rental demand. Understanding the following risks and knowing how to mitigate them can help you maximize profits and limit your losses when investing in real estate.

Potential Risks of Investing in Real Estate

Any investment type presents risk, but real estate investing comes with unique considerations. Anyone looking to enter the market and purchase a rental property should understand the following potential risks before getting started.

• Market volatility: Real estate markets can fluctuate based on economic conditions, interest rates and local supply and demand. A downturn in the economy or a rise in interest rates can lead to lower property values, making it harder to sell or refinance a property.
• Cash flow: Real estate comes with expenses, including mortgage payments , insurance, taxes and more. If these expenses add up to more than you're collecting in rent, your cash flow will be negative, and you'll lose money over time.
• Location: Location is important when it comes to real estate. It's the one thing you can't change, and so much depends on it, like your ability to find a tenant, the amount of rent you can charge and your property's rate of appreciation. Choosing a bad location can bring on a range of potential risks.
• Liquidity issues: Real estate isn't as liquid as other investments like stocks or bonds. Selling a property can take time, especially in a slow market, which can be challenging if you need to access cash quickly.
• Tenant risk: If you rely on rental income, the risk of tenant default is a big concern. Vacancies or unreliable tenants can interrupt your cash flow, causing financial strain and potentially forcing you to sell at a bad time.
• Maintenance costs: Properties require ongoing maintenance, and these costs add up. Both unexpected and regular repairs, along with property taxes and insurance premiums, can eat into profits, making it essential to budget for these expenses ahead of time.
• Legal and regulatory risks: Changes in zoning laws, property taxes or housing regulations can impact the profitability of your investment. Disputes over property boundaries or tenant issues can also lead to expensive legal battles.

Tips for Minimizing Risks When Investing in Real Estate

While real estate investing comes with risks, there are ways to plan for and even mitigate their negative impacts. Here are some ways to help reduce the potential downsides of real estate investing.

Do Thorough Market Research

Before purchasing an investment property , analyze the local market, considering factors like economic trends, population growth and employment rates. Understanding the dynamics of the area can help investors choose properties that are more likely to appreciate in value and maintain high occupancy rates.

Diversify Your Investments

Rather than putting all resources into a single property or market, consider spreading your real estate investments across different types of properties and geographic locations. This approach can help cushion against market fluctuations and reduce the impact of a downturn in any one area. Real estate investment trusts (REITs) are another way to diversify. These portfolios allow investors to profit from commercial real estate without actually buying or managing any property.

Maintain a Financial Cushion

Real estate investments often come with unexpected costs, such as repairs, vacancies or changes in property taxes. By setting aside plenty of cash, you can weather these challenges without being forced to sell at a bad time or taking on additional debt.

Consider Professional Property Management

Professional property management services can help mitigate risks associated with tenant issues and property upkeep. Having a service that maintains your property, finds tenants and collects rent can save you lots of time and energy, especially if you live far away from your property. They'll help ensure your investment is well-maintained and generates consistent income. It comes at a cost, though: property managers typically charge between 8% and 12% of the monthly rent .

Bottom Line

While real estate can offer generous returns and a stable income stream, it also comes with plenty of challenges, including market volatility, liquidity issues and unexpected costs. By thoroughly researching the market, diversifying investments, maintaining a financial cushion and considering outsourced management, you can better mitigate these real estate investment risks and benefit from a smart investment strategy.

Tips for Investing in Real Estate

• Opportunity zones offer tax incentives for real estate investors who reinvest capital gains into qualifying properties located in designated economically distressed areas. By holding the investment for at least 10 years, you can potentially eliminate taxes on future gains from the opportunity zone investment, making this an attractive strategy for long-term, tax-advantaged growth.
• A financial advisor can help you plan for a major investment, like buying a rental property. Finding a financial advisor doesn't have to be hard. SmartAsset's free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you're ready to find an advisor who can help you achieve your financial goals, get started now .

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