Real estate has ranked as one of Americans' top investment picks for decades with 34% identifying it as the best long-term investment in 2023, according to Gallup’s annual Economy and Personal Finance survey. That puts real estate ahead of gold (26%), stocks and mutual funds (18%), savings accounts and certificates of deposit (13%), and bonds (7%) as the favored long-term investment.
But like any investment, real estate investing has risks and property owners can lose money. Consider watching out for these seven real estate investment risks if you’re thinking about buying an investment property.
Key Takeaways
- Real estate has consistently ranked in the top place among Americans as the best long-term investment for decades.
- Real estate investing can be lucrative but it’s important to understand the risks.
- Key risks include bad locations, negative cash flows, high vacancies, and problematic tenants.
- Other risks to consider are hidden structural problems, real estate's lack of liquidity, and the unpredictable nature of the real estate market.
1. An Unpredictable Real Estate Market
Many investors wrongly believed that the real estate market could only move in one direction before the 2008 Great Recession: up. The basic assumption was that if you bought a property today, you could sell it for a lot more later on.
Real estate values do tend to rise over time but the market is unpredictable and your investment could depreciate. Supply and demand, the state of the economy, demographics, interest rates, government policies, and unforeseen events all play a role in real estate trends, including housing prices and rental rates.
You can lower the risk of getting caught on the wrong side of a trend by doing careful research and monitoring your real estate holdings.
Real estate is not a set-it-and-forget-it investment. You should monitor your investments and adjust your entry and exit strategies as necessary.
2. Choosing a Bad Location
Location should always be your first consideration when buying an investment property. You can’t move a house into a more desirable neighborhood, nor can you move a retail building out of an abandoned strip mall.
Location ultimately drives the factors that determine your ability to make a profit: the demand for rental properties, types of properties that are in the highest demand, tenant pool, rental rates, and the potential for appreciation. The best location is typically the one that will generate the highest return on investment (ROI) but you have to do some research to find the best locations.
3. Negative Cash Flows
Cash flow on a real estate investment refers to the money that’s left over after covering all expenses, taxes, insurance, and mortgage payments. Negative cash flows happen when the money coming in is less than the money going out so you’re losing money.
Some common reasons for negative cash flows include:
- High vacancy rates
- Costly maintenance
- High financing costs on loans
- Not charging enough rent
- Not using the best rental strategy
The best way to reduce the risk of negative cash flows is to do your homework before buying. Take the time to accurately and realistically calculate your anticipated income and expenses and do your due diligence to make sure that the property is in a good location.
4. High Vacancy Rates
Whether you own a single-family home or an office building, you need to fill those units with tenants to generate rental income. Unfortunately, there’s always the risk of a high vacancy rate in real estate investing. High vacancies are especially risky if you count on rental income to pay for the property’s mortgage, insurance, property taxes, and maintenance.
The primary way to avoid the risk of high vacancy rates is to buy an investment property with high demand in a good location. You can also lower your vacancy risk if you:
- Price your rental rates within the market range for the area
- Advertise, market, and promote your property, being mindful of where your target tenant might look for property information
- Start looking for new tenants as soon as a current one gives notice that they're moving out
- Make sure your property is clean, tidy, and well-maintained
- Offer incentives and rewards to keep tenants happy
- List your property with a real estate professional
- Develop a reputation for being fair and renting quality properties
5. Problem Tenants
You want to keep your investment properties filled with tenants to avoid vacancy risk but that can create another risk: problem tenants. A bad tenant can end up being more of a financial drain and more of a headache than having no tenant at all.
Common problems with tenants include those who:
- Don’t pay on time or don’t pay at all, which could lead to a lengthy and costly eviction process and litigation
- Trash the property
- Don’t report maintenance issues until it’s too late
- Host extra roommates (humans or animals)
- Ignore their tenant responsibilities
You can protect yourself by implementing a thorough tenant screening process. Be sure to run a credit check and criminal background check on every applicant. Contact each applicant’s previous landlords to look for red flags like late payments, property damage, and evictions.
It’s also recommended that you investigate a potential tenant’s work history. Make sure they have a steady salary that can reasonably cover rent and living expenses. It’s a good idea to pay attention to scattered work history. An applicant who bounces from job to job may have trouble paying the rent and may be more likely to relocate in the middle of a lease.
Be sure that you and your investment properties are adequately insured against losses and liability.
6. Hidden Structural Problems
One sure way to lose money on an investment is to underestimate the costs of repairs and maintenance. You could be looking at as much as $100,000 to repair a seriously faulty foundation and more than $10,000 to fix or replace the central AC or furnace, both of which will eventually wear out over time, usually in about 15 years.
Thankfully, you can reduce this risk if you thoroughly inspect the property before you buy it. Don’t skimp on hiring a qualified and reputable property inspector, contractor, mold inspector, and pest control specialist to “look under the hood” and uncover any hidden problems. Find out how much it will cost to fix if a problem is discovered and either work that cost into your deal or walk away if it would prevent you from making a reasonable profit.
7. Lack of Liquidity
It’s easy to sell stocks if you need money or just want to cash out but that’s not usually the case with real estate investments. You could end up selling below market or at a loss because of the lack of liquidity if you need to unload your property quickly.
Keep in mind that the seller of a property is typically the party who's responsible for paying the real estate commissions that are incurred in the sale. These commissions can add up. You can adjust the price you're asking for your property to accommodate them but you'll want to factor them into your decision if you're selling because you urgently need cash.
The issue of broker compensation is weighty enough that home sellers brought a lawsuit against the National Association of Realtors over the issue. The suit was settled in 2024 although the settlement is still pending court approval. In addition to a hefty cash settlement, NAR agreed to prohibit members from making offers of broker compensation on the Multiple Listing Service but compensation can still be negotiated privately.
There are ways to tap into your property’s equity if you need cash. You can take out a home equity loan for residential rental properties, do a cash-out-refinance, or take out a commercial equity loan or equity line of credit for commercial properties. But you'll want to assess your options ahead of time before you find yourself embroiled in a worst case scenario.
What Are Some Ways to Diversify Real Estate Investing?
Diversification is often the best way to reduce risks. Directly owning several properties may be out of many investors’ budgets but buying shares in real estate investment trusts (REITs) can provide broad exposure to geographically dispersed properties of different types, such as residential and commercial properties.
How Can I Minimize the Risks of Being a Landlord?
You can keep your property costs down over the long run in several ways, including paying attention to regular maintenance and upkeep. Paying relatively small expenses now can save you from large costs down the road.
Run a credit report and check on tenants’ references to minimize the chances of problem tenants. Ask their prior landlords how they were as tenants. Finally, choose a good location that will be less likely to experience crime or have low occupancy rates.
How High Can a Landlord Raise Rent?
A landlord is allowed to increase the rent depending on local and state laws and pursuant to any language that exists in the lease. There might be no legal limit to how much a landlord can increase rent in places with no rent controls.
The Bottom Line
Real estate has traditionally been considered to be a sound investment and savvy investors can enjoy a passive income, excellent returns, tax advantages, diversification, and the opportunity to build wealth. However, real estate investing can be risky, just like other types of investments.
You can limit your risks by doing due diligence and conducting a thorough real estate market and rental property analysis. Be sure to hire professionals to inspect the property, screen potential tenants, and learn everything you can about the real estate market.
And keep in mind that there are plenty of ways to invest in real estate without owning, financing, and operating physical properties. Options include REITs, real estate stocks, real estate partnerships, and real estate crowdfunding. Thebest real estate crowdfunding sitescan help investors diversify their portfolios without the challenges of property ownership.
