Ways to Lower Your Real Estate Investment Risks as a Landlord

The Big Picture On Ways to Lower Your Real Estate Investment Risks:

Focus on predictable rental income rather than speculative property value increases.
Account for all costs, including vacancies, maintenance, and management, using the 50% Rule as a guideline.
Conduct comprehensive background checks, including credit, criminal, and eviction reports, to minimize risks from problematic tenants.

One of the great advantages of real estate versus stocks is the predictability of real estate investing returns.

When you buy a rental property, you can accurately predict your average annual yield and cash flow. And while I love stocks too, they’re as volatile as a bipolar teenager with raging hormones.

Still, the risks of real estate investing are real enough in their own right. Anyone looking to buy rentals must plan for and mitigate common real estate investment risks, from bad tenants to lousy cash flow to bad contractors.

Here are ways to mitigate the risks of real estate investing and always come out ahead when buying rental properties.

 

Before Becoming a Landlord, Consider Passive Investing

I’ve owned 20 properties over the decades. Today I own no properties directly — but I own a fractional interest in around 3,000 units. 

I sold off my rental properties because I hated being a landlord. I hated the constant phone calls, hated chasing delinquent tenants for rents, hated hassling with contractors and city inspectors and property managers and renters. Everyone always had an excuse why they hadn’t done what they said they were going to do. 

Nowadays, I invest in passive real estate investments. These run the gamut from real estate syndications to private partnerships, private notes to real estate crowdfunding, debt funds to private equity real estate funds. 

I aim for asymmetric returns: investments likely to deliver high returns with relatively low risk. We actually teach a class entirely on how to spot low-risk passive real estate investments. 

Don’t get me wrong, direct investing comes with plenty of upsides. But I wish I’d known all the ways to invest passively in real estate when I first started investing. Active real estate investing requires far more work (and skill) than most novices realize.

Now that we’ve got that out of the way, let’s dig into how to lower your risk as a landlord.

 

1. Invest for Cash Flow, Not Appreciation

Far too many investors blindly count on future appreciation in their rental properties.

It’s an easy enough mistake to make. After all, if you look at nationwide real estate trends, home prices usually go up in value. Investors who are more familiar with stocks can be forgiven for drawing too close an analogy between real estate appreciation and stock price growth. Stock indexes always go up in value in the long term, but the same isn’t necessarily true of home values.

Individual properties, neighborhoods, and towns can all experience drops in home values. Even nationwide, home prices can fall; look no further than the 27.42% drop in the Case-Shiller Home Index during the Great Recession.

Rents prove far more resilient, however. Although home prices were in free fall, rents didn’t dip during the Great Recession. Don’t believe me? Check the Census Bureau. Instead, rents flattened for a couple of years before steep increases during the 2010s. (The ‘10s? The teens? Someone needs to develop a decent shorthand for the past decade.)

Where was I? Oh, right, investing for cash flow.

Cash flow is predictable. You know the market rent, purchase price, and prospective mortgage payment. And you should know your long-term average expenses.

 

Cash Flow vs. Appreciation Investing

For a better picture, here’s a quick comparison between the two.

Aspect
Cash Flow Investing
Appreciation Investing

Focus
Monthly rental income
Future property value increase

Predictability
More predictable
Less predictable

Risk level
Generally lower
Generally higher

Income
Immediate
Delayed (upon sale)

Market dependency
Less affected by market fluctuations
Heavily dependent on market trends

2. Use Conservative Estimates for Expenses

The most common rookie mistake and real estate investment risk is underestimating expenses.

New investors get starry-eyed when first evaluating rental properties, and they fail to adequately forecast costs like:

Vacancies
Maintenance
Repairs
Property management fees
Property taxes
Insurance (both property insurance and rent default insurance)
Accounting, bookkeeping, travel, and other miscellaneous expenses

A property’s cash flow is not “rent minus the mortgage payment.” It’s rent minus all the expenses above and then minus the mortgage payment.

Just because vacancies and major repairs don’t happen every month doesn’t mean you can ignore them. They’re irregular but extremely costly, so you have to take the long-term average cost into account for it in your monthly cash flow. For example, if the property turns over once a year and sits vacant for one month while you repaint and advertise it for rent, that’s a roughly 8% vacancy rate.

Read up on how to accurately forecast rental property returns and get a sense of how real estate cash flow looks visually. Then, run the numbers through our free rental cash flow calculator for each prospective rental investment.

As a general rule, non-mortgage expenses come to around 50% of the rent. This rule is creatively known as the “50% Rule.” And creatively named or not, it holds true remarkably often.

Remember that while good deals aren’t just sitting around for you to pluck from the Deal Tree, you can always negotiate real estate deals to improve a property’s cash flow. For that matter, you can get more aggressive with finding good deals on real estate, even in hot markets.

 

3. Avoid Low-End Rentals

Low-end rental properties offer tantalizing returns – on paper. In reality, they’re a siren song that draws you in, only dash your dreams against the rocks.

I should know. In my early days of real estate investing, I bought over a dozen of them and spent over a decade slowly strangled by tens of thousands of dollars in losses.

They look good on paper because your cash flow calculations usually don’t account for hidden costs like vandalism, break-ins, or professional tenants gaming the system to draw out the eviction process. For that matter, even numbers included in the calculations, such as vacancy rates, maintenance, and property management costs, tend to be wrong because of the high turnover rate and high property damage.

Yes, there’s a niche for buying homes in the hood or becoming a Section 8 landlord. But unless you go to pains to learn that niche by apprenticing under a mentor who specializes in them, avoid low-end rental properties and save yourself a world of pain and unforeseen real estate investment risks.

4. Be Careful of Over-Leveraging

Leverage is one of the great advantages of real estate investing. You can buy assets worth hundreds of thousands of dollars, financed mostly with other people’s money.

And it’s also one of the most significant risks of real estate investing.

While leverage can amplify your real estate investing returns, it can also amplify your losses. All the more reason why you need to accurately calculate each rental property’s cash flow before buying!

We talk about rental property loans and financing all the time here at SparkRental because we know you probably don’t have $200,000 lying around collecting dust to be invested in real estate. So we break down tricks like the BRRRR method to invest with 100% financing or clever ways to come up with a down payment for your next rental.

However, we also clarify that more leverage comes with more real estate investment risks. That risk virtually disappears for experienced investors, but new investors must be extremely careful when they leverage themselves to the hilt by buying their first few rental properties.

Always remember that it takes cash to invest, not just in real estate but in anything. If you’re light on cash, consider starting with house hacking to finance most of your first property and live for free to supercharge your savings rate. Play around with our house hacking calculator to understand the numbers, and enjoy rent-free living!

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Real estate investments? Awesome. Being a landlord? Less fun.

Learn how to earn 15-30% on passive real estate investments in one free class.

5. Don’t Start with Large-Scale Renovation Projects

When it comes to fixer-uppers, start low and go slow.

Managing renovation projects is a skill in itself. Hiring and managing contractors are among the most challenging tasks that real estate investors face, and that says nothing of permits, inspections, unexpected costs, and other higher real estate investment risks that come with significant renovation projects.

One option is to avoid fixer-uppers altogether and buy turnkey rental properties. Beyond being easier in general, buying rental properties long-distance is far more practical, whether through the traditional MLS, turnkey rental property platforms like Roofstock, or off-market deal databases like Asset Column.

This is not to say that buying fixer-uppers to flip or following the BRRRR method is a bad strategy. Using repairs to force equity is incredibly effective—if you know what you’re doing.

Toward that end, start with properties needing only minor cosmetic repairs and gradually start tackling more prominent and larger renovation projects as you build trust with contractors and comfort in managing them.

 

6. Tenant-Proof Your Property

Tenants are hell on rental properties.

They bang and scuff the walls, scratch the hardwood floors, and knock over drinks on the carpet. And that’s just the grownups; kids and pets are even more distressing on properties.

However, protecting your property from damage is part of your job as a landlord, and you can do this by tenant-proofing your units with these rental property improvements.

Not all tenant-proofing involves physical repairs, though. Some of it takes the form of protective legal clauses in your lease agreement that help you put more legal liability on your tenants and make it easier to deduct from the security deposit.

Tenants are inherent among real estate investment risks, but that doesn’t mean you can’t mitigate those risks with preventative planning.

 

7. Screen the $%!# Out of Your Tenants

If there’s one risk of real estate investing that landlords always underestimate, it’s the risk of bad tenants.

Bad tenants come in many flavors. You’ve got your “I’ll pay the rent when and if I feel like it” variety and your “This isn’t my property, so I don’t need to take great care of it” types. Then there’s the “This is the perfect property to run my heroin business out of” variation. All will kill your cash flow and profits.

Start with a thorough rental application to collect basic information about your applicants, but don’t stop there. Here’s a quick rundown of additional tenant screening for every single applicant.

Credit Reports

An applicant’s income tells you if they can pay, while their credit history tells you if they will pay.

Not everyone wants to admit it, but some people have good financial habits and would be mortified ever to pay a bill late. Others never see a bill they want to pay on time.

Run a tenant credit report through our site or one of our competitors, but always run one on every adult 18 and over.

Criminal Reports

Simon might pay all his bills on time, but if he’s an axe murderer, you still have a problem.

And yeah, that’s a bit of a hyperbole. So fine, we’ll get more realistic: do you really want to rent to someone with a history of writing fraudulent checks, stealing identities, or dealing drugs?

No. You don’t.

Eviction Reports

Often overlooked in the tenant screening conversation, eviction reports actually reveal whether an applicant will make a good tenant.

If they breached another landlord’s lease agreement to the point where they had to file eviction, you better believe there’s a higher risk of them violating your lease, too.

In some ways, this tenant screening report is even more critical than the initial two.

Income

Collect copies of pay stubs, then call the applicant’s boss and verify their employment, income, and likelihood of continued employment.

I even ask probing questions about their reliability and character. Do they always show up for work on time? How good of an employee are they? Would you entrust them with your firstborn child?

Well, that last one might be awkward. But you get the idea.

 

Housing History

Have they paid their current landlord on time? And because you can only trust the current landlord so far (they might be trying to get rid of them), call their former landlord, too. They’ll give it to you straight.

But beyond the reliability of rent payments, also look at how often they move. Turnovers are expensive for landlords and raise your risk of losses from vacancies and future bad tenants, so lower your real estate investment risks by only leasing to tenants who plan to stick around for many years.

Current Home Care & Cleanliness

Some people treat their homes like pigsties. Others are clean and respectful.

There’s only one way to tell the difference: go to their current home and check it out.

 

8. Use a Hyper-Protective Lease Agreement

I touched on this earlier, so I won’t belabor the point here. However, too many landlords blow off their lease agreement (and other leasing documents like disclosures and addenda) as a formality.

It’s not a formality. It’s the shield that guards your property and your profits. It can either be rusty and full of holes or bulletproof.

For example, does it include a Move-In/Move-Out Statement of Condition form? If so, do you actually use it, walking through the property before the tenants move in, to mark down all pre-existing damage? If not, don’t expect to be able to deduct from the security deposit for damage.

As another example, does your lease agreement include a guest policy clause? If not, what happens when your sweet, innocent tenant starts having her deadbeat, heroin-slinging boyfriend spend five nights a week at the property?

Try these landlord-protective lease clauses to lower your real estate investment risks and protect your profits.

Want to compare investment property loans?

What do lenders charge for a rental property mortgage? What credit scores and down payments do they require?

How about fix-and-flip loans?

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9. Automate Your Rent Collection

One of the great risks of real estate investing is that your tenants stop paying the rent. When that happens, you can pay the mortgage by yourself until you’ve completed the eviction process.

A process that takes many months – I’ve had evictions take eleven months before.

Tenant screening helps, but once you sign a lease agreement, it also helps to automate your rent collection. Set up online rent collection so your tenant can set up automated recurring payments to go out on the first of every month. We’re even planning to launch reporting to the credit bureaus to incentivize tenants to pay their rent on time.

Finally, we’re working on reopening our complete automation service, which deducts the tenant’s rent from their paycheck. (We had to temporarily pause it for technical reasons.) It’s a great way to ensure you get paid before the tenant can spend their paycheck on anything other than rent.

 

10. Require Tenants to Have Renter’s Insurance

Make renter’s insurance a must-have for your tenants. The cost won’t break the bank — around $15 to $20 per month — and it’s a win-win for everyone involved in the rental deal.

Tenants can breathe easier knowing their stuff is covered if things go south, while you, as the landlord, get an extra safety net for your investment.

For example, if your tenant accidentally starts a kitchen fire or leaves the tap running, the renter’s insurance will save the day instead of you covering a massive repair bill.

Most policies include personal liability coverage, so tenants needn’t worry if someone gets injured on their watch.

As a bonus, some policies offer temporary housing if the rental becomes unlivable—it’ll keep things smooth between landlords and tenants during hard times.

 

11. Insure Against Rent Defaults

The best way to truly protect against this particular real estate investment risk is to insure against it literally.

If your tenant stops paying the rent, the insurance company starts paying it until you’ve completed the eviction process. Premiums are affordable (usually a few hundred dollars), and you get to sleep at night knowing that even if your excellent tenant loses their job and can’t pay the rent, you’ll still receive rent, and it won’t set you back thousands of dollars.

For full rent default insurance details, check out Steady’s program (they’re the only program I know of in the US at the moment).

 

12. Set Up LLCs to Limit Liability

LLC, short for “Limited Liability Company,” does exactly what it says on the tin — it limits liability. Though not entirely for beginners, this is worth knowing.

Let me simplify it. If you set up an LLC for each property in your portfolio, you can create a legal shield between your personal and business assets. Your personal wealth stays safe from potential lawsuits or financial hiccups tied to your investment property.

Say a tenant gets injured on the property and decides to sue — only the assets within that LLC would be on the line, which means your other properties and personal finances are kept out of harm’s way.

LLCs come with some pretty tax perks, too. They allow investors to enjoy pass-through taxation while getting corporation-level liability protection.

13. Prioritize Tenant Retention

It’s worth reiterating here: tenant turnovers are expensive.

You often need to repaint, replace the carpets, fix all issues around the property, advertise the unit, show it, run tenant screening reports, do walk-through inspections, sign the lease agreement, mess around with security deposits… it’s where 90% of the work of being a landlord lies.

And 90% of real estate investment risks because if you breeze through the tenant screening process like many landlords do, you may end up with a terrible tenant.

So take care of your good tenants. Do your way to ensure they know they’re appreciated, even as you conduct your semi-annual inspections and enforce the lease agreement.

Use these tricks to retain your good tenants – you’ll simultaneously increase your real estate investing returns, reduce your headaches as a landlord, and lower many of the risks of real estate investing.

Final Thoughts

If all that sounds like a lot, well, at least you can lower your risks and control your real estate investing returns. How much control do you have over your stock returns?

Remember, if you cannot predict your rental property returns accurately, you’re doing it wrong. Follow the tactics above to reduce your real estate investment risks and enjoy ongoing high-yield rental income for years.

 

How do you lower your real estate investment risks? What’s worked in the past to boost your real estate investing returns?

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