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Crack the code of Rental Income Calculator Challenges And Risks as well as Real estate investment risks and countermeasures.
If you are interested in starting a real estate investment but are unsure about it, or if you want to know more about the risks of real estate investment, please read this article to the end.
Many people consider real estate investment as one of the options when they start building assets for the future.
Compared to investments such as FX and virtual currency, real estate investment seems to have a relatively low hurdle, but when researching it, you often come across the words “you should stop.”
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However, the most important thing is to understand the advantages and disadvantages before considering investing in real estate.
Rental Income Calculator Challenges And Risks
Why do people say “Don’t invest in real estate”
When making any investment, not just real estate investment, you are required to acquire knowledge about investments and be involved in managing them yourself, rather than simply depositing your money in an investment destination.
First of all, real estate investment is an investment method in which you purchase real estate properties such as land and buildings, rent them out, and manage them to earn rental income, or sell them to make a profit on sales.
The basis of income gain in real estate investment is rental income.
It is said to be highly stable because you can expect a fixed amount of monthly or yearly rental income over the long term.
However, there is a risk that this rental income will not be recovered due to various factors such as vacancies, non-payment of rent, deterioration of the building, natural disasters, etc.
If rental income is not available, the property management costs and the loan repayment costs at the time of purchase will have to be covered from your own funds.
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The longer the period without income continues, the greater the burden becomes, and in some cases, people may end up having to give up their property or file for bankruptcy.
Although there are voices citing the disadvantages and saying that real estate investment should be “avoided,” any investment comes with risks.
Compared to the high-risk, high-return FX and stocks, real estate investment is said to be middle-risk and middle-return, and by acquiring the right knowledge and adapting to social conditions, it is easier to reduce risk and lead to success.
Middle risk/middle return means something between high risk/high return and low risk/low return.
Real estate investment risks and countermeasures
To avoid failure in real estate investment, you should first learn more about the risks.
Real estate investment involves unique risks because it is based on physical assets such as buildings and land.
Risk details Countermeasures
Vacancy risk
・Lower rental income due to vacant rooms
・Income deficit
・Choose a property with high rental demand
・Choose a rental management company with a high occupancy rate
Risk of falling rent
・Income decline due to falling rent
・Decrease in yields
・Reduce the risk of vacancies
・Choose a used property
Risk of rent arrears
・Reduction in income due to overdue rent
・Legal troubles
・Tighter screening procedures at the time of moving in
・Use a rent guarantee service
・Contract a fixed-term lease
Risk of building deterioration
・Repair costs due to deterioration of buildings
Choose a durable and long-lasting property
・Choose a property that has a repair reserve fund plan
Risk of falling real estate prices
・Lower profits from sales due to falling real estate prices
・Income deficit
・Investigate the surrounding environment and the profitability of the property
– Be sensitive to economic trends and social conditions
・Maintain asset value through careful management
Risk of rising interest rates
・Increase in total loan repayment amount due to rising interest rates
Choose a fixed interest rate
Shorten the loan period
Risk of management company going bankrupt
・Lower rental income due to the management company going bankrupt
・Find a reliable company
・Check the cancellation conditions
Natural disaster risk
・Repair costs due to natural disasters
・Lower rental income due to vacant rooms
・Check the hazard map
・Choose a property that is less susceptible to damage
・Join insurance
Below we take a closer look at each of these risks and how to address them.
Vacancy risk
The biggest income gain from real estate investment is rental income.
In real estate investment, profit is the amount of monthly rental income minus loan repayments, management fees, and repair costs.
If rental income decreases and the balance is in the red, the deficit must be made up from your own funds.
Of course, there is no rental income without tenants.
However, it is difficult to completely avoid vacant rooms, as tenants will inevitably move out at some point.
Therefore, the key points are how to reduce vacancy rates and shorten the period between moving out and moving in.
Vacancy risk countermeasures
There are two main ways to mitigate the risk of vacancy.
The first is to choose a property with high rental demand.
Properties with high demand due to their location, accessibility, surrounding environment, and facilities are easier to find tenants for and keep vacancy periods short.
For example, in Nigeria, where the population is increasing, Lagos is expected to see a concentration of population and rental demand in the future.
Choose an attractive location, such as an area with good access to the city center or terminal stations within Lagos’s 23 wards, an area within walking distance of the nearest station, or an area with a school nearby.
The second is to choose a property management company with a high occupancy rate.
Management companies with high occupancy rates have a wealth of know-how regarding property management and tenant recruitment.
Although occupancy rates vary by region, you should refer to the management company’s occupancy rate, aiming for around 98% if they deal with many properties in good locations in the city center, and around 95% if they also deal with suburban properties.
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Also, management companies that manage a large number of units are likely to be trusted by real estate owners.
When looking for a management company, pay attention to the occupancy rate and number of units managed, and ask to see evidence of these calculations.
Another criterion to consider is whether the property has made efforts to shorten the period between moving out and moving in, such as partnering with a cleaning company that can clean immediately after tenants move out, conducting a wide range of advertising, or introducing a system for early contract signing with new tenants.
In addition, it is said that one-room apartments are easier to secure occupancy for than family properties because there is only one decision-maker.
Since the room area is small, construction costs are easier to keep down, making it easier to differentiate properties through renovations.
Risk of falling rent
Fluctuations in rent affect the profits of real estate investment. If rent falls, not only will monthly income decrease, but the yield will also decrease, which may have a negative impact on the selling price when the property is put on the market.
In particular, new properties are popular and you can expect high rents, but they tend to peak when they are new and then decline at a rate of 1% per year for about 10 years.
After 10 years, the rate of decline slows and it is said to gradually level off.
Rent prices are determined by the balance between demand and supply of real estate properties.
In other words, in order to prevent rents from falling, it is important to consider not only the deterioration of the building, but also how to differentiate your property from competing properties and the rental needs of the area.
How to protect against the risk of rent declines
Since declines in rent occur when rooms remain vacant for a long period of time, reducing the risk of vacancies will help prevent the risk of falling rents.
In other words, the prerequisite for taking measures to prevent falling rents is to first choose a property with high rental demand.
The key is to choose properties in areas where future population growth is expected, and that have convenient locations, accessibility, and surrounding environments, and to avoid leaving vacant rooms.
In addition, the aging of buildings is inevitable. Furthermore, the facilities and environment that tenants desire change with the times. Managing your building through regular renovations, repairs, and the introduction of new facilities will make it easier to attract tenants.
When it comes to long-term real estate investment, being sensitive to tenant needs and trends is also key to success.
Another way to minimize the impact of falling rents is to choose a used property.
– Rents are most likely to fall in the first 10 years after construction and then tend to stabilize.
By purchasing a used property where the rent drop is small, it is easier to set management targets from the beginning.
In particular, properties that are over 20 years old are said to be less affected by fluctuations in rent as they experience almost no decline in rent.
However, since it is a second-hand property, it is necessary to choose an area with rental demand and to know in advance how much it will cost to repair and remodel old facilities and rooms.
Risk of rent arrears
One of the factors that worries many owners when investing in real estate is the risk of not paying rent.
If you are unable to collect rent even though all rooms are occupied, not only will your monthly income be reduced, but it could also lead to legal trouble with your tenants.
Delinquent payments caused by negligence, such as forgetting to make a payment or having insufficient funds in the account, can be resolved by communicating properly with the tenant, so it is not a major problem.
However, tenants who repeatedly fail to pay rent on purpose are tricky, and because tenants have legal rights, it is difficult to unilaterally order them to move out.
This can cause significant damage, such as a worsening of the balance of payments due to unpaid rent, and the time and financial hassle of filing an eviction lawsuit.
How to prevent rent arrears
There are three main ways to avoid the risk of not paying your rent:
The first is to have strict screening when tenants move in. In order to avoid problems related to rent arrears, it is necessary to select tenants who will pay their rent regularly and abide by the rules.
When a rental management company conducts a tenant screening, they will check the applicant’s annual income, past rent arrears, etc.
Other important check items include whether the applicant has previously moved in and out of neighboring properties and whether they have had any financial problems.
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This requires some ingenuity, such as setting strict screening criteria and having the owners themselves consider potential tenants.
The second option is to use a rent guarantee service.
Rent guarantee companies offer a service that guarantees rent in the unlikely event that rent is overdue.
If the tenant signs up for the rent guarantee service as a condition for moving in, the owner will not have to pay any fees.
There are also collection services that will collect rent and remind the owner to pay on behalf of the owner.
This will save you the trouble of dealing directly with tenants and make it easier to avoid problems, making rental management smoother.
The third option is to enter into a fixed-term lease agreement. A fixed-term lease agreement is a contract method in which a fixed contract period is specified.
In a conventional standard rental contract, you cannot refuse to renew the contract unless you have a valid reason.
In addition, even if a tenant runs away in the middle of the night, you cannot dispose of their belongings without permission.
Tenants have very strong rights.
On the other hand, with a fixed-term lease, the contract can be terminated without any eviction fee at the end of the term.
Since the agreement of both the tenant and the owner is required to renew the contract, the advantage is that it is easier to get problematic tenants to move out.
However, since the terms of the contract can be somewhat disadvantageous to potential tenants, it may be necessary to find ways to lower the barrier to entry, such as by informing them that they can renew the contract if there are no problems.
If you fall behind on your rent, it is important to act quickly and as soon as possible, rather than patiently waiting for payment.
Risk of building deterioration
Buildings are at risk of deterioration over time.
Owners must carry out regular maintenance and repairs to keep their buildings safe and attractive.
Typical examples include painting roofs, repairing exterior walls, replacing water supply pipes and drainage pipes, regular inspections of gas and electrical equipment, fire protection equipment and elevators, and room renovations.
Depending on how often, maintaining the building can be quite costly.
Methods for dealing with the risk of building deterioration
In order to minimize the risk of building deterioration, it is important to choose a durable and long-lasting property.
In addition, by entrusting the management of your property to a rental property management company with extensive repair know-how, you can receive advice on long-term repair plans and cost-effective repairs.
you set aside repair costs in advance and create a reasonable income and expenditure plan, you will be able to make the necessary repairs when they are needed.
When purchasing an apartment, be sure to check the important matters in the investigation report.
Risk of falling real estate prices
Profits from real estate investment include not only monthly rental income but also capital gains when you sell the property in the future.
By having a good exit strategy, you will be able to end your real estate investment successfully.
However, buildings generally lose value over time as they deteriorate.
If real estate prices fall significantly, there is a risk that the selling price will be significantly lower than the purchase price, resulting in a final balance in the red.
The main factors behind a fall in real estate prices are a decline in land prices due to population decline or changes in the surrounding environment, economic downturns, and a decline in the profitability of properties due to accidents or aging.
How to deal with the risk of falling real estate prices
There are three main ways to mitigate the risk of property prices falling.
The first step is to investigate the surrounding environment and the profitability of the property.
When purchasing a property for real estate investment, it is important to choose an area or building where rental demand is expected.
For example, areas with a growing population or areas where development such as commercial building construction and transportation planning is progressing are expected to have long-term real estate demand.
Also, when purchasing a used property, you should check whether there have been any accidents or incidents in the past, and take appropriate measures if you decide to purchase.
The second is to be sensitive to economic trends and social conditions.
Real estate prices fluctuate in response to policy changes by the Central Bank of Nigeria and the government, as well as social conditions.
For example, if down payment ratios and loan interest rates are raised, it will be harder to find buyers for real estate, and there is a risk that prices will fall.
On the other hand, if people value their living environment more due to lifestyle changes such as teleworking and increased time spent at home, real estate prices may soar.
By understanding the lending environment and housing market trends and predicting future trends, you can reduce the risk of price fluctuations and make it easier to make a profit on the sale.
The third is to maintain asset value through careful management.
A property’s profitability is primarily determined by its current rental income.
In order to maintain high rents, the property must have rental demand.
Real estate deteriorates over time, but regular maintenance and repairs can keep it in good condition.
Even if the property is old or the rent and management fees are high, if it is properly managed, it will be easier to attract tenants and the asset value will not decrease.
Risk of rising interest rates
When purchasing a property for real estate investment, it is common to take out a loan to cover any portion that cannot be covered by your own funds.
However, if interest rates rise, the final total repayment amount will increase, and there is a risk that income and expenditure will worsen.
For example, the difference in total repayment amount between borrowing 20 million naira at an interest rate of 2% and borrowing at a 3% interest rate will be approximately 4.5 million naira more, and the monthly repayment amount will also increase by more than 10,000 naira.
As of July 2022, interest rates remain at ultra-low levels, but given the global trend of rising interest rates, there is a possibility that Nigeria will also raise interest rates.
There are two main ways to mitigate the risk of rising interest rates.
The first is to choose a fixed interest rate.
When taking out a loan, you can choose between a fixed interest rate, which will remain the same for the life of the loan, or a variable interest rate, which will be reviewed periodically.
Although variable interest rates are set lower than fixed interest rates, there is a risk that interest rates may rise due to economic conditions, increasing the total repayment amount.
In addition, future applicable interest rates are not known at the time of the contract, and the total repayment amount is not fixed.
On the other hand, fixed interest rates do not pose the risk of interest rates rising during the selected period. The total repayment amount is determined at the time of borrowing, making it easier to plan your assets.
When investing in real estate, be sure to conduct simulations in advance and create a reasonable asset plan.
How to deal with the risk of rising interest rates
There are two main ways to mitigate the risk of rising interest rates.
The first is to choose a fixed interest rate.
When taking out a loan, you can choose between a fixed interest rate, which will remain the same for the life of the loan, or a variable interest rate, which will be reviewed periodically.
Although variable interest rates are set lower than fixed interest rates, there is a risk that interest rates may rise due to economic conditions, increasing the total repayment amount.
In addition, future applicable interest rates are not known at the time of the contract, and the total repayment amount is not fixed.
On the other hand, fixed interest rates do not pose the risk of interest rates rising during the selected period.
The total repayment amount is determined at the time of borrowing, making it easier to plan your assets.
Some real estate companies have partnerships with financial institutions and can provide loans at preferential interest rates.
When taking out a loan, understand the economic situation, the advantages and disadvantages of each option, and then choose the most suitable borrowing terms.
The second is to shorten the loan period.
Although it is difficult to avoid the risk of rising interest rates, the impact can be minimized by shortening the loan period.
In addition, by making planned prepayments, you can increase your tolerance to the risk of rising interest rates.
When investing in real estate, be sure to conduct simulations in advance and create a reasonable asset plan.
Risk of management company going bankrupt
There is also a risk that the rental management company will go bankrupt during real estate investment.
If you hire a property management company, they will also collect rent from your tenants.
If the management company goes bankrupt, you may not be able to collect rental income.
In addition, finding and signing a contract with a new management company will be a time-consuming and financial effort.
How to mitigate the risk of management company bankruptcy
In order to avoid the risk of the management company going bankrupt, it is important to find a trustworthy company from the early stages of your real estate investment.
Companies with a large number of managed units have a high income from fees and tend to have a stable business situation.
A large number of owners is also evidence that the service is well supported.
Also, if a company has been in business for a long time or is listed on the stock exchange, it will have a wealth of experience and know-how in rental management, making it easy to entrust the company to you with peace of mind.
Furthermore, no company is completely free from the risk of bankruptcy.
To prepare for the unlikely event of an accident, it is a good idea to check the terms and conditions regarding advance notice periods for cancellation and penalty fees before signing the contract.
Natural disaster risk
Natural disasters such as earthquakes and fires are risks unique to real estate investment.
The impacts of floods are not limited to the collapse of buildings but also include subsidence, liquefaction, the relocation of businesses, and a decline in population. In addition to the cost of repairing buildings, there is a risk of suffering significant damage due to periods without rental income.
Natural disaster risk countermeasures
There are three main ways to avoid the risk of natural disasters.
The first thing to do is to check the hazard maps.
By looking at the risk maps published by each region and checking the characteristics of the area, such as areas with solid foundations, areas with many wooden houses, and narrow roads that are difficult for fire trucks to access, it will be easier to choose an area with low risk.
The second is to choose a property that is less susceptible to damage.
Properties that meet the new earthquake resistance standards are expected to withstand shaking of a seismic intensity of 6 or higher.
In addition, reinforced concrete houses are less flammable than wooden houses, making it easier to reduce the risk of fire.
The third step is to take out insurance.
By taking out flood insurance and fire insurance, you can rest assured that damage caused by natural disasters will be compensated for.
