The Art of Hedging Risk in a Real Estate Investment Deal

Without some level of risk, real estate investing wouldn’t be lucrative. But what’s the optimal amount of risk you should take with any deal? And are there ways …

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Without some level of risk, real estate investing wouldn’t be lucrative. But what’s the optimal amount of risk you should take with any deal? And are there ways to reduce the risk you face? The more you know on this topic, the better.

4 Tangible Ways to Reduce Risk

It’s impossible to remove risk from the investing equation. If there were no risk involved, wouldn’t everyone pour their life savings into real estate and reap the rewards of high returns? So, your goal as a real estate investor isn’t to find risk-free investments. What you need are ways to reduce unnecessary risk, while taking on high leverage strategies that offer the promise of a healthy return on investment.

Here are a few practical ways you can hedge risk in any deal.

  1. Purchase Insurance to Cover the Loss of Income

Many real estate investors like to have a portion of their assets in income producing real estate – such as rental properties or apartment buildings. The beauty of rental properties is that you not only get the appreciating asset, but you also get a monthly return on your investment. The problem is that you depend on tenants in order to make the investment profitable.

One way to reduce risk with an income producing property is to purchase an insurance policy that covers vacancy and liability.  Apartment building insurance is one popular option. Like any insurance policy, you might not ever need to use it, but it could save you when/if the market takes a downward turn.

  1. Improve Forecasting Methods

Warren Buffet famously said, “Risk comes from not knowing what you’re doing.” If you’re simply guessing and tying up money in investment deals that you don’t really know anything about, you’re asking for trouble.

One of the best ways to mitigate risk is to improve your forecasting methods. Look at an investment from every possible angle and consider hiring third-party partners to conduct thorough due diligence for high-dollar investments. If nothing else, this will give a confidence boost.

  1. Diversify Types of Real Estate Deals

Diversification is obviously an important investing principle, but it’s arguably most important when it comes to real estate. Investing all of your money into single-family rental properties, or all of your money into REITs, is never a good idea. Spread your investments out across a variety of deals and niches in order to hedge your bets. If one investment crashes, you have some others to prop it up.

  1. Make Higher Down Payments

The lending market has finally loosened up after the recent recession. And while the banks aren’t nearly as generous as they were before the crash, they’re again offering low-down financing to certain investors. While they look attractive, these loans make it easy to flip upside down before you blink. Have you considered making a higher down payment?

“Raising your down payment will take more cash upfront, but it will reduce the amount financed and lower payments,” real estate broker James Kimmons notes. “When payments go down, cash flow goes up.  Refinancing is always an option later.”

Learn to Balance Investment Risk

You shouldn’t be opposed to taking on risk in an investment deal. If you study some of the most successful investors around, you’ll notice that there are times where they take on massive amounts of risk in order to reap the rewards. But you’ll also notice that they have a knack for avoiding dumb risk. They know how to protect their investments and make the most out of every situation. The more you’re able to do the same, the better off your real estate investing portfolio will be.

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