In the world of property investment, there are various points along the ‘just looking’ to ‘ready to sell’ spectrum. Protecting your investment takes on different hues at different points.

When first looking for property you have to consider the amount of ready cash available, the state of the current market, as well as your own level of experience with the many aspects of investing.

The first lesson of risk management is: know the law. Whether a novice or a savvy investor of long experience, few things can put your investment at greater risk than ignorance of the rights and requirements of regulations. No need to become an attorney, but a working familiarity is a must.

After investigating the current market — what’s available at what price, and what’s the current level of buyer interest — judging the likely future is required. Property values have been rising in most markets for several years. In a rising interest rate environment, that can’t last forever. No one knows with certainty how long the trend will continue, but you can look at some signs.

Is the economy in general still on the upswing? Are employment prospects good for most individuals? What is the rate of new home construction, relative to the last five years? All these and more are good indicators of whether property values are more likely to continue to rise, level off, or even see a correction.

Once you’ve purchased a property there are several ways to minimize the risk of seeing your investment wind up ‘under water’. At the moment of purchase, make every effort to invest in a large down payment. Seriously consider putting in at least 10%. You’ll create instant equity and usually get a lower interest rate.

That level of initial outlay decreases your liquidity — you have less cash after the deal is closed — but there are few alternatives that have the return rate, low level of risk, and degree of capital appreciation of a real estate investment.

When looking at funding options, consider how long you intend to keep the property. ARMs (Adjustable Rate Mortgages) get you in with less cash and an attractively low relative rate. There are 1 year ARMs, 5 year, even 7 year — the number signifies how long the offered rate is good for, after which the lender adjusts it according to prevailing interest rates.

But if you intend to keep the property longer than the initial period, you can see that attractive rate climb several percentage points. Unless you sell, or have paid down the principle substantially within that time frame, you can see yourself saddled with much higher monthly payments.

At the same time the ARM rate is going sharply up, property values are under pressure to level off or even decrease — because of the rise in interest rates. Your investment gets hit twice. Of course, it’s possible for rates to go down, but that’s less common and refinance is usually toward a fixed rate, in those cases.

There are insurance options that can cover the increase in payment in such scenarios but if you pay more than a couple of years of premiums, they are usually not worth the extra outlay. Better to use the extra funds to pay down the principal by making more than twelve annual payments, or paying more per month than the minimum.

If you can’t come up with a large initial down payment, weigh the value of continuing to rent versus any tax break you get from owning a property acquired with low or no down payment.

So, invest as much as you can up front, make at least one extra payment per year, lean toward fixed rate mortgages of the minimum length you can afford. A 15 year mortgage pays down the principle quicker, so you spend less on interest, increases your equity rapidly, and usually carries a lower rate.

Take a long term view; real estate is still one of the least risky, highest paying investments around.

Tips on Managing Risk

Investors have a hard life. Rising insurance rates, legal liability, security concerns and increasing interest rates may not be actually conspiring to give them early heart attacks, but it can seem that way. Managing risk is in large part about how to lower uncertainty by dealing appropriately with those and other stress factors.

Start by exercising common sense and gathering as much information about the local market and the general economy in addition to the specifics on an interesting property. Study the numbers on rates of new home construction and the ratio of new to existing property sales. Narrow down to your local market(s) by looking online at existing comparables, but also talk with other local property owners about their concerns and plans.

When building new structures, manage risk by reviewing trade area demand — by demographic and daytime population for commercial structures, for example. Look also at site characteristics and examine local competition and contrast with regional differences. Take some time to find out about upcoming environmental regulations.

Be sure to set aside the needed amount for insurance, and err on the side of too much insurance rather than too little, if minimizing risk is an important goal.

Go into a deal with the maximum available capital by not spreading your resources too thin. Keep borrowing low and avoid ARMs (Adjustable Rate Mortgages) unless they’re longer than three years and you expect to sell well within that period. ARMs are inherently higher risk, and the ‘interest only’ type even more so. Rates tend to rise more quickly than they fall, over the long term.

If you have an ARM and rising monthly payments occur, due to interest rate increases, while the market price is dropping (as may soon be the case), consider selling. Even stocks have to be sold sometimes during a period of declining prices. Capital preservation is important for long term investing, and part of that involves keeping liquid during a ‘market correction’.

Some lenders allow borrowing more than 100% of the value of the property. Unless you can use the extra cash in a way that more than compensates for interest and other charges, that’s burdensome debt.

Take the time to seek out trustworthy and competent people — don’t settle for an uncooperative or arrogant Title company or an unreliable contractor because you’re busy. Think in terms of long term relationships. Otherwise, the long term will involve counting financial losses.

Risk can be spread by forming partnerships and, in come cases, by incorporation. Incorporation can allow you to separate personal from business assets, protecting you in case of severe decline. But there are limits — you don’t automatically get to walk away from debts by being incorporated. Partnerships though, if you can find reliable and compatible individuals with whom you’ll feel comfortable over the long haul, can strengthen your position.

Partners can help fill in gaps in your knowledge and experience, provide additional capital and someone to bounce ideas off of. But choose carefully. Differences of outlook can lead to stagnation when it comes time to take action. Remember, risk can never be reduced to zero.

Related posts:

1. Real Estate: Insurance and Risk Management
2. Real Estate — Questions To Ask Before Investing
3. Real Estate Investment Strategies
4. Real Estate — Getting Started: Think First
5. Real Estate — Your First Time

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