Investing in real estate can be one of the best things you do for your portfolio if you’re handling it the right way. Real estate tends to offer some of the highest returns of any other form of investing, but it also has some of the most significant risks as well.
There are the risks that come to mind first when talking about real estate investing, such as being stuck with a piece of property that you can’t rent or sell. You have to carry the costs in the meantime. There’s also the risk of what happens if the market starts going down.
There are other risks as well. As legal and tax professionals like Anderson Advisors point out, what happens if you’re the target of a lawsuit? In a post on asset protection strategies for real estate investors, they raise the very valid point that real estate investors are actually prime targets for lawsuits for two primary reasons. First, as a real estate investor, you own assets. The second reason is because you engage the public, so they’re aware from the start that you have an asset they can take.
With all that being said, what are the steps you can take to protect yourself when you invest in real estate?
Going back to the situation addressed by Anderson Advisors, what’s the best way to protect your assets when you’re a real estate investor? One of the biggest mistakes an investor can make is putting their rentals into a corporation.
It can protect assets, but it’s inefficient regarding tax-related issues. It’s better to put real estate assets into a Limited Liability Company or LLC. It protects you, as an individual, from liability associated with your real estate and rental properties, but you’re also going to be able to take advantage of depreciation and losses on your own tax return.
If you’re going to be flipping, you may be better off going with a corporation to protect assets and also to reduce your tax liabilities. Your corporation is, in essence, the Dealer of the properties, while you stay the investor.
Understand the Economy
There’s a certain sense of glamour that people believe comes with investing in real estate. They envision they’ll be moguls, and they jump in headfirst. This can be dangerous. It’s better to take your time and educate yourself, particularly when it comes to the economy.
The macro elements of the economy play a huge role in protecting yourself and making the right real estate investment decisions, but if you don’t know about these factors, you’re just blindly making decisions.
You want to not only stay up-to-date on what’s currently happening in the economy, but you also want to learn enough so that you can start predicting headwinds. You always want to be strategic with your investment decisions, rather than buying based on a feeling.
Along with looking at the economy and the real estate market, another way to protect yourself when you invest in real estate is to always be researching location. You want to be looking forward to what the hottest, newest location might be, because buying in the right neighborhood can provide much better financial returns. As the saying goes, you might be better off looking for the worst house in the best neighborhood.
Do Your Research When It Comes to Financing
It’s important to make sure you’re choosing the right financing option when you’re going to buy a property. This may mean that you think outside of traditional financing options, or the most commonly used financing.
If you can reduce your interest rate, then you’re going to lower your payments, and you’re going to increase your cash flow on rentals. You’ll also be less burdened if your cash flow takes a hit for a period of time.
One example sometimes recommended is the use of an Adjustable Rate Mortgage or an ARM. This is something you can use if you know with a fair amount of certainty that you’re going to hold the property for no longer than ten years.
Hidden Property Problems
Finally, another big risk real estate investors face is that they’re going to buy a property that has hidden but very serious problems, such as structural problems. If this happens, it can be extremely expensive to repair or maintain the property.
It’s better to do your due diligence upfront and before you make a purchase. You want to do a home inspection and appraisal so you know you’re not going to buy a property, do some digging and ultimately find a huge problem that you’re going to have to fix.