We’re all long tired of the term “unprecedented” to describe the times in which we live. Even though the word has overstayed its welcome, it is still accurate.
We’re in the middle of a global pandemic that has impacted virtually every area of life – opening us all up to new health, economic, and social considerations. The impact of the pandemic has rippled out into real estate, too, spreading a sense of unease and unpredictability through investors and industry professionals.
While in some regards this has been exciting – after all, the real estate market took a surprisingly vibrant (and profitable) turn in 2020 – there is still the question of an unknown future.
Investors can speculate all day long about how the market will change and move but mitigating your risks may be more important than anticipating the next big thing.
3 Ways to Mitigate Real Estate Investment Risk in the Unknown
1. Avoid Overleveraging
Throughout the pandemic, we’ve seen record low mortgage rates. These rates – sometimes dipping below 3% – have been a significant incentive for homebuyers and investors to pull the proverbial trigger on a property acquisition. But it’s not all beneficial. Studies show that household debt ballooned by $87 billion in the third quarter of 2020.
Many homeowners have sought to refinance during the pandemic – sometimes to take advantage of low interest rates, but also to acquire extra cash to cope with financial strains. As a result, plenty of households have seen a rise in their debt-to-income ratios.
We’ve also seen, due to the frenzy of real estate demand, buyers overpaying – and thus, overleveraging – to win the bidding war.
There’s a real danger here investors need to be aware of. Right now, it might not seem like you’re overleveraging. Your debt-to-income ratio may be comfortably below the recommended 36%. Be mindful though – economic crises, emergencies, and unexpected market turns can cause you to struggle to pay your debts each month.
While you do want to scale and diversify your portfolio, don’t do so at an unsustainable, unsafe pace. Buying too much too quickly means you’ve compounded your debt. Be sure you have the safety net and the wiggle room to manage your debts even if your financial situation takes a turn for the worse.
2. Investigate Your Markets
Investing in the right places is key to effective risk management. Investors will often chase after the hottest up-and-coming market without considering its long-term potential. Comparing different markets allows you to see a more robust scope of benefits and drawbacks. Before you choose a market, work through your desired investment and growth strategy. You want to target a market with the ideal environment for your specific portfolio rather than the most popular cities on the map. Look at economic indicators, population growth, property values, and rental demand, among other telling metrics.
Make apples-to-apples comparisons as you narrow down your market choices. You can always expand into multiple markets later, but your first pick must have the strength and resilience to provide reliable cash flow and growing equity.
3. Diversify Your Portfolio
There is an art to effective portfolio diversification. It takes time to master, but it is essential for managing risk and growing long-term wealth. When you diversify – whether by buying more properties in the same market, expanding into a different market, or acquiring a mix of asset classes – you decrease the potential negative impact of a struggling investment.
We will all experience low points and rough patches. What matters is not preventing this from happening (as it is usually beyond our control) but having a portfolio that can sustain you through those tougher times.
Not only does diversification minimize the impact of a negative turn, but it amplifies the benefits of good market conditions. When things are good across the board, your wealth grows more quickly and effectively.
In the pandemic era, portfolio diversification is that much more important. Because there’s a level of unpredictability to each market contingent on factors like vaccination rates, variant spreads, economic activity, local mandates, and unemployment rates, dipping into different markets turns a portfolio-destroying disaster into a temporary nuisance.
Protect your assets. Think of it like a sports team. You can have just enough players on the field, but if someone is injured, there’s a big gap in both offense and defense. When you have alternates standing by, you can fill in the gaps and still come out on top!
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