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5 Ways to Reduce Financial Risk When Buying Real Estate (& a $100k Deal That Went Terribly Wrong)

Real estate investing…

A business model where mistakes, market fluctuations, or bad tenants can cost you tens (or even hundreds) of thousands of dollars. In fact, check out this video from my brother, Ryan Dossey, about a friend of his who just lost $100,000 on a deal gone wrong.

And whether you’re a new or seasoned investor, the risks persist. Naturally, you want to mitigate those risks as much as possible.

You’ll never escape them altogether — just as every business carries financial risk, so too does real estate investing.

But you can reduce the chance of financial blunders crippling your pocketbook with a bit of forethought and planning. Here are 5 ways.

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1. Keep your fingers on the pulse of the market

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The real estate market constantly experiences fluctuations. And each market fluctuates differently, keeping up with nation-wide trends or falling a bit behind.

2005, for instance, saw 7.08 million existing homes sold, but the year 2008 saw a major decline in only 4.12 million existing homes being sold.

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Real estate investors who had shifted their businesses to face a market with decreased buyer demand and inventory costs survived — thrived, even. Those who didn’t fell to the wayside and maybe even went back to their ol’ 9-5 grind, W2 day-job.

Point is, you should always have one finger on the pulse of the market. Where is it heading? Where do other experts think it’s heading? How long until it gets there? And, most importantly, how can your business be prepared?

(What’s working right now isn’t going to work forever…)

The National Association Of Realtors consistently releases reliable reports about the state of the U.S. real estate market. It’s worth checking out every now and again.

Of course, there’s no bad market for real estate investing, just different markets that require different strategies.

2. Spend plenty of time on due diligence (extra if needed)

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When looking at a property to invest in, err on the side of more due diligence and better, more thorough comps. You’ll probably never think to yourself, “Dang — I wish I wouldn’t have spent so much time learning about the property.” But if you buy a difficult-to-sell piece of property, then you will wish you had spent more time on your comps.

In the video at the beginning of this article, for example, Ryan Dossey’s friend could have avoided losing $100,000 by better understanding how the property was zoned by the county.

It’s a learning mistake, to be sure — and learning mistakes are important to deal with in business — but an expensive learning mistake. It’d be far better to learn your lessons during the due diligence phase of buying a property than it would be to rush in and learn once you’ve already spent several thousand dollars.

Don’t let anyone rush you — take your time, check your boxes, and ensure that the deal is a good one.

Here’s an extremely thorough (too thorough?) checklist you can reference during your due diligence.

3. Always screen your tenants

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If you do buy-and-hold real estate investing or you have rental properties, then it’s important to always screen your tenants. For your pocketbook’s sake, you don’t want to get the wrong people renting a property of yours.

Who are the wrong people?

Oh you know… people who don’t pay their rent, people who destroy the property, and people who force you to evict them. In 2016 alone, 2.3 million evictions were filed in the U.S., which adds up to a rate of 4 evictions per minute.

You can avoid that (or mitigate it, at least) by taking the time to screen your tenants and ask all the right questions. I know it’s tough when you just want to get someone in the property to pay the monthly mortgage, but having bad tenants is a whole lot more expensive than waiting a little while for the right tenants.

Here’s a helpful list of questions that you can ask tenants when screening them.

4. Make generous financial estimates (in your favor)

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You’re probably familiar with the 70% of ARV rule for flipping homes. Basically, it states that a house flipping real estate investor should pay 70% of the ARV (After Repair Value), minus the cost of repairs, to acquire the property. And while the guideline is just that… a guideline, the concept of knowing your numbers has merit.

At the very least, you need to know what you’re going to be able to sell (or wholesale) the property for before you buy it, you need to know how much money you’re going to sink into it, and you finally need to determine what your maximum buying price is — give yourself some wiggle room with that last number. Better to make financial estimates in your favor than to end up with a much smaller payday than you planned for.

5. Make smaller investments

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With deep pockets, you’ll naturally gravitate toward bigger deals with wider profit margins. It’s just good business sense. After all, you can either scale your business by doing more deals or by focussing your time and energy on more profitable deals. That choice is an easy one.

Still, there’s something to be said for splitting your money into smaller investments. With less money sunk into each individual property, financial risk naturally lessens — if one deal goes sour, you might only lose $10,000 instead of $100,000, for instance.

Of course, doing a lot of smaller deals rather than one big deal requires more of your time and energy, even if it does mitigate financial risk.

So the choice is yours. If you’re a beginner who’s just dipping your toes into real estate investing, then start small. If you’re a seasoned investor looking to mitigate financial risk, consider going smaller than you are now.

Or… go big. And use the other four points in this article to mitigate financial risks. 😉

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