Losing Money Due to Vacancy

[Seth Firestone]

I live in the Northern Virginia area where most of the properties have about a $3,000 a month mortgage.  My partner and I are looking to buy our first property soon and we plan to house hack it for a year.  I think about the risk we take buying a place with a high mortgage.  Isn't it kind of silly to invest in such an expensive area? Let's say we cash flow around $270 a month, and then we are vacant for a month.  That would mean we pretty much lose all of the money we made right? Am I overthinking vacancies or is this something I should be prepared for?

[Russell Brazil]

@Ray Johnson Thanks for the tag.

@Seth Firestone Vacancy is absolutely a concern and risk in real estate investing.  Diversification in investing, whether in stocks, bonds, real estate, businesses...helps to spread out your risk over multiple assets.  So owning say 4 properties is less risky than owning one, because when you have a vacancy, the cash from the other units will help support that vacant unit.

There are 2 risk factors here though that you are also alluding to without necessarily thinking about it in these terms. In investing, again in any asset class, leverage increases your risk.  That risk is completely independent of the risk of the underlying asset, and the more leverage you take on, the more risk you take on. (Now of course in real estate, most of us accept that risk, because it is what makes real estate awesome.)  Then you have the underlying risk of the asset and or market.  And this is an incredibly important concept that so many people misunderstand, and even get backwards.  Yield measures risk in all investment vehicles.  So these properties throwing off tons and tons and tons of cash flow....thats an indication of high risk.  That huge cash flow (or huge dividend for a stock) is your reward for taking on that high risk.  Too many people convince themselves the opposite is true though, that the higher yield is safer. Make no mistake about it, that yield is higher because of the higher risk.  

So why does the Market (big M, conceptual market) view certain markets (small m, locations) as being less risky than others?  Its many factors including supply and demand, tenant base, low vs high vacancy. Higher demand markets tend to have outsized asset price growth, outsized rent growth, lower vacancies, higher class tenant base and the such.

A great example of this is one of my very first units I bought in Rockville in 2009,  I think I paid $270k or so, had an initial mortgage payment of $1700 and rent of $1900.  All my friends also though it was ridiculous Id buy this (while prices were dropping) for a measly $200 a month in free cash flow.  Well 10 years lated, my value is sitting in the $435k-$450k range (it went down in value the first 2 years), Ive refinanced and dropped my payment to $1300, my rent is now $2900. I have free cash flow of $1600 per month, Ive paid that note down over 10 years, and my value has risen $175k or so.  

If you are looking at the decision to keep renting or to buy...I look at that 2 ways. You can spend your monthly housing payment to help build your landlords wealth, or you can spend it to help build your own wealth.  Im ok with either, I need tenants paying my ridiculous rent amounts.

And also, dont mistake the word for risk with being bad.  All investing is (or should be) deploying capital to achieve a return based on your risk tolerance.  I find I get considerably higher actual returns in the lower risk properties, as they end up performing better than my proforma, while the higher risk assets Ive had perform lower than proformas. Nothing wrong with high risk, just dont convince yourself it s a lower risk investment because of the higher yield.