By Jason Epps, CFP®, CRPC®
Financially savvy people usually have a plan in place for investing, typically through 401(k)s or IRAs. But many are missing out on the opportunity to diversify their portfolio through the avenue of real estate investing. Sometimes this is because of fear of the unknown, or perhaps because it just sounds too complicated.
This article will help unmask some of the mysteries behind owning rentals and give you some things to think about as you begin delving into real estate.
Why Real Estate?
One very compelling reason to add real estate as an investment is diversification. When done carefully and thoughtfully, rental properties can be a stable investment platform with incredible return possibilities.
Historically, real estate has had low, sometimes even negative correlations to other investments and asset classes. If your portfolio is heavily weighted in equity and fixed income investments, investing in real estate can help shield you from sudden market downturns.
When looking holistically at your investment holdings, real estate can be an important part of a well-balanced portfolio.. But if you need another reason to take a good look, you should know that rental properties can be incredibly profitable.
Income generated by rental real estate can be used to save for future financial goals, or fund current expenses. You could use the income to help fund future college costs, supplement retirement lifestyle expenses, or cover the costs of your favorite hobby. Some owners choose to stockpile the earnings to fund larger purchases like vehicles or primary residence expenses.
However, this advice comes with a word of caution: you don’t want to spend every single penny that you get from your real estate income. Managing your property correctly means being prepared for expenses that may come up related to the property.
Ensuring you have an adequate cash reserve that can cover emergency repairs, turnover maintenance, management expenses, and other carrying costs is very important. And if you didn’t buy the property outright, you should be prepared to cover the mortgage and other expenses in the event of a prolonged vacancy, anywhere between 3-6 months.
Like all investing, there is an element of risk involved. Primarily, your risk comes from two directions.
First, a housing market or financial crisis that leaves your property vacant or with a tenant that can’t make the rent might leave you vulnerable. COVID-19 demonstrated that sometimes crazy things can happen that are just not predictable, turning a strong market into a scary one overnight.
You can mitigate this hazard by either paying off the mortgage on the property as quickly as possible, or you can have an adequate cash reserve, as previously discussed.
The second major risk is liability risk. If someone slips and falls on your property and they sue you, all of your assets might be in jeopardy if you haven’t prepared appropriately. Here are three things you can do to begin setting up protection against lawsuits and liability.
- Establish a limited liability company (LLC) that will technically own your property instead of you. From a legal standpoint, this provides separation between your rentals and your other assets, such as your home, cars, and 401(k). If someone sues, they are suing the LLC, not you personally. If the worst-case scenario happens, they can only get whatever assets the LLC owns, and not the rest of your assets.
- Have high-liability insurance coverage limits on your rental properties. In the case of a catastrophic situation, your insurance will absorb the blow financially instead of you.
- Obtain an umbrella insurance policy. This kind of insurance is appropriate when you have a high liability exposure as with rental properties. Just like the name suggests, umbrella policies cover all of your other insurances with an additional layer of coverage (usually not less than $1,000,000, and going much higher than that if you need it to). Whether you have a car crash, an injury on your property, or a frivolous lawsuit brought against you, all of your insurance limits have the added coverage from the umbrella policy.
Seek Professional Help
Getting started with real estate can be very rewarding if done properly.
While KFA Private Wealth Group does not buy or sell real estate for our clients, we can help you achieve your real estate investing objectives as part of your larger wealth management plan. To start receiving expert help today, email email@example.com or call 301-305-8875 to schedule an appointment.
Jason Epps is vice president and private wealth advisor at KFA Private Wealth Group, a registered independent advisory firm founded on the premise of providing conflict-free financial and investment advice. With over 15 years of experience, Jason possesses the unique knowledge and expertise necessary to provide his clients with the most applicable and beneficial financial guidance that helps them find confidence in their financial future. Jason is a CERTIFIED FINANCIAL PLANNER™ (CFP®) practitioner and a Chartered Retirement Planning Counselor℠ (CRPC®) and believes that a financial plan is only as strong as the advisor’s understanding of the core values and beliefs of each client. He serves a diverse range of clients, from young accumulators to pre-retirees and retirees, including business owners and professionals in a variety of fields. Jason is passionate about giving back to his community and volunteers with various organizations in the D.C. metro area. He also has coached youth travel and AAU basketball since 2009. When he’s not working, you can find Jason spending time with friends and family, traveling, trying out new restaurants, and cheering on local D.C. sports teams. To learn more about Jason, connect with him on LinkedIn.