What's the worst thing than can happen in Real Estate Investing?

[Ava G.]

I have been investing in the stock market for quite some time and since I'm in for the long-run and I'm not obligated to pay monthly dues, I have some peace of mind. If, for some reason, I stop working and don't have a monthly income, it's no big deal. I can add more investments when I'm earning again. I can also take out my money anytime I want with just a click of a button.

Now, I began to take interest in REI but the prospect of being tied up to a 20-year debt (just an assumption, can be 15 or 30 instead) seems scary as a lot of things can happen in a span of 20 years.

But to make my fears clear, I'll give an example scenario. (Please bare with my me as I'm a total newbie and just familiarizing myself with the terms.)

Say, I bought a property worth $100,000 and put a DP of $20,000. Now, I owe $80,000.

Assuming fixed-mortgage, let's say, I need to pay $900 monthly for 20 years (mortgage + fixed expenses). These scenarios can happen (1 - being the best, 5 - being the worst):

1: I will have tenants all the way (with minimal vacancy) and great cash flow (at least 10%).

2: I will have tenants all the way (with minimal vacancy) and low to average cash flow (2-8%). It's as if I invested in money market / bonds / average return of the market.

3: I will have tenants but negative cash flow. Say, the market's rental rate is below what I need to have a positive cash flow. Therefore, I need to come out with some cash from my own pocket.

4: No tenants. I have to come out with the full amount monthly from my own pocket.

5: No tenants. No money out of my own pocket to pay the mortgage. Doom and gloom!

(Note that the above scenarios don't account for long-term appreciation, as I've read, it's not so predictable.)

Thinking about it, I can bear No. 3 scenario and I do think there may be periods when in this can happen. As with No. 4, I can just consider it as transferring my money to an illiquid bank (like forced savings). In the end, I still have a house worth $100,000 (+ whatever interest I paid). Now, it's the No. 5 that truly scares me. What if No. 5 happens in Year 10, for instance.

Again, going back to stocks / bonds, as long as I buy an index (local and foreign), there's very little possibility that everything I've invested would disappear (at the cost of a smaller returns). Worst thing that can happen is there's a total collapse of the entire market (like the Great Depression).

But when it comes to REI, the possibility of losing everything seems more likely as there are many foreclosed properties.

My question is, how do I avoid having the rental property foreclosed and losing everything I put into it?

Anyone can give their thoughts, especially those who have been doing this for very long? I may have a very shallow and highly unrealistic analysis as a newbie, that's why I need help from more experienced investors here.

[J Scott]

Originally posted by @Ava G.:

My question is, how do I avoid having the rental property foreclosed and losing everything I put into it?

The two keys are education and then applying that education to ensure you buy a property that has good numbers. No different than a value investor in the stock market, other than the fact that you have much more control over your asset than a market investor does.

While it's possible that your rental will suddenly become unrentable in year 10, it's not probable...like the stock market, unless there is a crazy turn of events, the real estate market doesn't generally make right turns (or U-turns). If there is a real estate collapse (like back in 2008), there are some risks...but even back in 2008-2010, most landlords I know who weren't over-leveraged survived and are still in business today (thriving).

The bigger risk is that the area where you buy sees a major turnaround. For example, if you buy in a city where employment is based around one large company or industry and that company/industry suddenly goes away -- that's one of the big risks in this business.

The other large risk is poor management. If you don't do a good job of finding responsible tenants, maintaining your property, ensuring you know what's going on at all times, having a good property manager (and managing him well), etc., then there are certainly some risks. Being a landlord is pretty simple, but it's certainly not easy.

In general, if you have a property that is cash flowing 10-20% at the beginning, you're not over-leveraged, you're not in an area where employment and population are highly sensitive to a single company/industry and you are good at managing your property (or your property manager), my experience tells me that real estate investment is much less risky than stock market investment.