Real Estate Investing: Ways to Mitigate Risk in a Rising Market

by FI Fighter on March 18, 2014

in Real Estate Thoughts


Investing in real estate is in vogue these days. Everyday, I come across more and more investors who are looking to get started in building up their own real estate empires. That’s a wonderful thing, and I’m totally for that!

Unfortunately, buying in today’s market isn’t quite as easy as it was just two years ago. Or even last year, for that matter. Purchase prices have been increasing steadily… along with interest rates. That’s a double whammy! Add in the fact that there are less and less short-sales and foreclosures out there, and the odds of a novice investor jumping in and landing a smoking deal are slim to none.

The pros will ALWAYS find their deals… in any market, and in any environment. That’s why they are the experts in the field. Many of these professionals have access to networks and capital that the rest of us can only dream of.

If you are just starting out, odds are good that you are simply trying to locate something worthwhile off the MLS. Or, if you are trying to purchase out-of-state because your local market returns leave a lot to be desired, you’re probably looking at using a turnkey company.

In any event, you probably want to invest in a rental property to help generate semi-passive income. When times are good and the market is rising, you have to remember to be extra careful. As the old saying goes, “when others are greedy, you need to be extra fearful.

These days, I am very fearful. Here are some things you can do to help mitigate risks in a surging real estate market:

Refuse to Overpay

In my own local market (Bay Area), we’ve witnessed a buying frenzy these past three years. Investors have been going crazy, bidding up prices on EVERY home, no matter how undesirable the living conditions are. These investors seem to be so hell bent on winning a bid that they will pay ANYTHING!

Please don’t lose perspective, in spite of what other people around you may be doing. A lot of these investors (foreign) have tons of cash to play with. To them, overpaying for a home is no big deal because they have plenty of $$$ to spare.

If you are still stuck in the rat race, I’m guessing the same does NOT apply to you. As part of your due diligence, always make sure to run your own numbers analysis to determine whether or not it makes sense to bid up a property.

Here is an example of the going rate for a 2/1.5 townhouse in Santa Clara (this is the listing price as of March 17, 2014. When all is said and done, don’t be surprised if there is in fact someone who “overpays” even more for this property:


Here’s what the numbers would look like if you won at listing price:


There you have it! Once you factor in 8% for Property Management, 5% for vacancy, and 10% for maintenance, the cash flow numbers don’t look so pretty. In fact, the numbers are NEGATIVE, so you should probably be worried. 😉

When looking at investments, I always run a Doomsday Scenario — If the market crashes, assume that the investment property loses half its value instantaneously. That means that you cannot head to the exits… Further, assume that you lose your job because layoffs will be running rampant in a downed economy. Can you still make ends meet? In the above scenario, if you are -$500/month in cash flow, that would be impossible. When the market tanks, you should probably even assume that the monthly rent you charge will have to be reduced.

The above investment property would get you in trouble real quick. The only folks who will invest in such a property are again the ones that have too much cash sitting on the sidelines… These people can afford to take risks… They are most likely playing the appreciation (speculation) game.

But if you don’t have tons of cash to just toss around for fun, don’t speculate. Instead, ignore what everyone else is doing around you. Don’t fall into the hype. If the numbers don’t work, move on and find another investment property where the numbers do work. If you still insist on playing with fire, though, don’t be surprised if you get burned.

Put More Money Down

Let’s say that you ONLY want to invest in prime real estate. That is, you won’t settle for C neighborhoods, and you NEED your properties to be located in fabulous locations.

The above example fits that bill. The property is located in Santa Clara, in the heart of Silicon Valley. You could literally post a Craigslist ad in the “for rent” section and have 10+ offers that very night.

There’s a reason why properties in Silicon Valley are so overpriced. The demand to live here is exceptionally high! Job growth/prospects are among the best in the country.

But like most things in life, you can’t have it all. Silicon Valley will get you almost everything, except cash flow. However, if you are willing to sacrifice cash flow today for the opportunity to own prime real estate, you can do so while still reducing your risk.

The above example shows that the cash flow numbers don’t work for a traditional 25% downpayment. Again, if you are willing to accept reduced returns on your capital, you can make the cash flow numbers work by putting down a larger downpayment.

Let’s run the numbers again with 60% downpayment:


If you are investing in real estate to maximize your cash-on-cash returns, a 1.34% yield (today) probably doesn’t get you very excited. But if you want to invest for the long-term and speculate on appreciation while removing the potential for risks found in a Doomsday Scenario, putting in more capital upfront may be what you need to do. This way, even if the Doomsday Scenario were to manifest, you would be sufficiently cash flow positive to weather the storm.

There have been many successful real estate investors who have amassed tremendous wealth through long-term appreciation gains. Some are even willing to go cash flow negative for the first 5-10 years (I’m not one of them)… These investors do so because they believe that if they buy in the very best locations, the rents will either eventually catch up (very likely if you go with 15 or 30 year fixed mortgage), or they will be able to sell for a tidy profit somewhere down the line. This strategy can be seen as more risky, so you should only consider it if you are absolutely convinced that you are buying into the right location.

If you come across any investors who bought up houses in San Francisco 10-20 years ago, I’m guessing the odds are quite high that these folks are retired today… and very happy with their investment decision. 🙂

Now, is $265.74/month in cash flow really the best use for your $238,800 of investment capital? That’s for you to decide…

Keep the Appraisal Contingency

If you are scared of overpaying for a property, keep the appraisal contingency. With the appraisal contingency intact, you will always have the right to walk away from a deal, or renegotiate the purchase price with the seller.

When I purchased Rental Property #1, I made sure to keep the appraisal contingency in place. I realized that we were in an upmarket, and the probability of the property appraising were pretty low. As it turned out, I was right. The purchase price was $8000 above the appraised value ($315,000), so I told the seller I would walk away if they didn’t come down in price (I was bluffing).

When you get that far in the closing process, chances are high that the seller will want to close the deal with you ASAP. In other words, they won’t want to start the entire selling process all over again (especially when loans are involved), so as a buyer, you are actually in a better position of power than you might realize.

In my case, the seller was desperate to sell since she wasn’t from California and had already stayed around longer than she wanted. I used that to my advantage and it helped me secure a better deal. I’m very thankful I elected to keep the appraisal contingency, even though many others around me were waving it to make their offers look more competitive.

In a seller’s market, people do some crazy, irrational things. You have to keep your senses even if those around you lose theirs…

Invest In a Better Cash Flow Market

As the first example showed, cash flow in the Bay Area when using a conventional 25% downpayment is almost nowhere to be found these days.

Rather than fret about it, I’ve decided to move on and tap into other markets around the country that do offer the reward of positive cash flow.

Here are the numbers for Rental Property #5, which I won in February of this year:


The cash flow numbers for Rental Property #5 look a lot better than they do for the Santa Clara example above, don’t they? In fact, I could buy two of these Chicago properties for roughly the same downpayment… Instead of cash flowing -$500/month, I would realize over $1000/month… If passive income is the name of the game, then in today’s market, Chicago has the Bay Area beat, no question.

An a real estate investor, I believe in the following for an upmarket:

“When times are good, avoid the coasts. Instead, give the Midwest a toast!”

When housing prices start to appreciate, they almost always surge most rapidly in the highly volatile (expensive) areas. It really didn’t take long for the Bay Area to go from bust back to boom. I would say that 2011-2012 was the absolute bottom, and now that we’re in 2014, housing prices have basically recovered back to the 2006 peaks, and in many cases, even exceeded those numbers (all-time high now).

So, buying in high-priced regions no longer makes sense from a cash flow point of view. Why not move on and infiltrate markets that haven’t rebounded as fast?

My ultimate strategy is to actually make use of the vast deltas that exists between different markets… For instance, my Bay Area properties have appreciated about 40% since 2012… In an expensive market, 40% is a huge amount of capital gains (say from $315,000 to $441,000). But in a cheaper location, a 40% gain on a $90,000 house still only raises it to $126,000. So, why not take the extra ammunition gained in an expensive area and re-invest it into a cheaper market?

Buy low and sell high. A 1031 exchange will let you tap into any appreciation equity without the consequences of having to pay taxes. This will do wonders in helping you maximize on cash flow returns.

Negotiate Purchase Price or Concessions

Always remember that buying a rental property involves two parties — buyer and seller. Any piece of real estate is negotiable. Even in a seller’s market, you should have room to talk down the purchase price. If the seller you are considering working with won’t budge, you can always move on and try someone else.

In the end, the return on investment must work for you. If you can’t negotiate on purchase price, try getting the seller to throw in some concessions. If your inspection reveals out-of-date mechanicals (e.g. water heater, roof, furnace), get the seller to either replace it with a brand new one, or return back closing costs for future replacements.

When it comes to turnkey properties, I’ve often tried (and succeeded) in getting the seller to throw in perks such as: 1 year rent protection guarantee, 1 year maintenance guarantee, seller paid closing costs, seller paid for insurance policy for 1 year, etc.

It doesn’t hurt to ask. But if you don’t try, you won’t gain an inch. Especially in a seller’s market…

Shop Around and Be Patient

If you are having trouble finding good deals, sometimes the best move is the one you don’t make. When the numbers don’t work, it may be a better idea to shop around (different markets, or different strategies such as MLS, turnkey, distressed, etc.), or to simply remain patient, instead.

You should never feel like you have to make an immediate move. Real estate is cyclical in nature, and what goes up will eventually come back down again. It always does.

If you aren’t having much luck finding solid properties on the MLS, or through a turnkey seller, you might need to sit tight and wait for a distressed opportunity to come along. Having ample cash will make it easier for you to get in on these type of deals. If you can locate a seller desperate to sell, and provided you have the cash needed to close quickly, your odds of finding a good deal are high, even in an upmarket.

Also, remember that owning property is very different from owning stocks. Rental property is very illiquid, and can be rather difficult to sell. Sometimes it takes months to unload a property… and you will be out a lot of money in closing costs. Selling isn’t trivial at all, and you will owe a lot more than just the $4.95 transaction fee your stock broker would charge you. So, it’s very important you take your time to ensure you buy right, the first time around.


Real estate investing in an upmarket inherently involves more risk. The cash-on-cash returns, or return on investment (ROI) are not as high as in a downmarket. You have a lot less margin for error, so it becomes much more important to buy right. In a seller’s market, it is routine for properties to sell for above their appraised value. People get greedy, and can become highly irrational! Just like with stocks, when times are good, you will always have the speculative buyers who enter the fray, inflating prices even further uphill. It’s all fun and games until the music stops… then it isn’t. Bottom line, if the cash flow or ROI do not make sense to you, don’t buy. Always perform your due diligence, and take your time in thoroughly evaluating an investment opportunity. If you utilize the strategies above, you can reduce your risks in a rising market. For these reasons, you won’t see me investing in any Bay Area properties anytime soon… that is, until the next market correction.

{ 28 comments… read them below or add one }

1 Charles@gettingarichlifeNo Gravatar March 18, 2014 at 1:50 am

Great post as I’m doing my diligence with turnkey properties. I’m looking to put down 30K to cash flow in Texas or Midwest. I can’t buy in Hawaii because the numbers don’t make sense, although my last rental purchase was a good one. Without appreciation with just the mortgage pay down I’m looking at 14% CAR for 6 year holding, factor in appreciation we’re looking at 20+%. Some economists are predicting Hawaii to rise 7+%, at that rate I would return 30+%. Nice dream but I’m aiming low, in the mean time I’m looking farther away.


2 FI FighterNo Gravatar March 18, 2014 at 9:44 pm


Thanks! I’m also looking into the Midwest and Texas since the local returns leave a lot to be desired.

That’s a pretty sweet return you’ve gotten on your last rental… The principal paydown definitely contributes a huge portion of the return, and is one that is sometimes overlooked when running cash flow numbers.

I’ll keep you posted as I learn more about Texas.

All the best!


3 Retire Before DadNo Gravatar March 18, 2014 at 4:05 am

These are good things to keep in mind. I’m meeting a local agent today to talk about the market for investors. Patience is going to be key to finding the right property.


4 FI FighterNo Gravatar March 18, 2014 at 9:47 pm


Patience is definitely the key to finding the right property. It’s easy to get overanxious and feel the need to get into the game NOW… but it’s better safe than sorry.

Like every other investment, it’s never too late to get in… Markets go up and down all the time. It’s not always possible to time the market, but if the analysis doesn’t make sense, it doesn’t make sense. It does no good to force something b/c you’ll probably end up regretting it later.

Hope you had a good meeting with your agent!

Take care!


5 Income SurferNo Gravatar March 18, 2014 at 4:20 am

Great post FI. I have a post on buying a first house going up tomorrow, and mention how you’re buying in the midwest. Good work and again, great post


6 FI FighterNo Gravatar March 18, 2014 at 9:47 pm


Thanks! Looking forward to reading your post tomorrow!



7 SimonNo Gravatar March 18, 2014 at 5:28 am

Great article FI!


8 FI FighterNo Gravatar March 18, 2014 at 9:48 pm

Thanks Simon!


9 TalesFromTheTapeNo Gravatar March 18, 2014 at 7:38 am

Hey FI, great article again, thanks. I have a question for you, pretty simple. Why not just buy REITS in the stock market? Ok there is a risk they go down but they have $0 cost in the sense of no property taxes, no need for maintenance and so on and you get a monthly income?
I’m sure i’m overlooking something totally obvious 🙂
cheers T


10 FI FighterNo Gravatar March 18, 2014 at 12:31 pm


There are many reasons to invest in rental property… The prime reasons for most are the 4 pillars:

1) Appreciation (most potent when using leverage)
2) Cash Flow (returns/yield will beat most stocks/REITS if you buy right)
3) Principal Paydown (someone else is paying off your mortgage…)
4) Tax Breaks and Depreciation (this is one is a HUGE benefit and one I haven’t yet discussed much about)

Hope this helps!



11 Done by FortyNo Gravatar March 18, 2014 at 8:03 am

As always, great stuff FI Fighter. That’s a great looking analysis for property #5! We may take a peek at Chicago…


12 FI FighterNo Gravatar March 18, 2014 at 9:50 pm

Done by Forty,

Thanks! Yeah, the cash flow numbers on #5 put Bay Area returns today to shame…

If you have any questions about Chicago, feel free to PM me and we can discuss more… I may make another trip out there again this year on my way to Memphis… 😉

Take care!


13 theFIREstarterNo Gravatar March 18, 2014 at 8:09 am

Interesting thought about putting down the larger deposit on the Bay Area property… I would have never have thought of that! Although clearly will not be going that route on my first rental property and will be looking for cash flow with a smaller deposit!

Would the larger deposit not get the buyer a cheaper mortgage rate just out of interest?

Also I asked a few questions on another post, so apologies if I missed the answer but here goes again:

What do you think of Interest Only mortgages? Do you even have these in the US? This seems to be the way Buy to Let investors go in the UK. Obviously this acheives a higher “cashflow” but you are not paying any off of the mortgage.

My other question was a bit of a silly one which was what on Earth is “Downplayment %”? Is this a typo or something strange REI term I have yet to come across? 🙂


14 FI FighterNo Gravatar March 18, 2014 at 12:20 pm


Yes, it’s very possible to get a lower interest rate with the larger downpayment.

I’m personally not a huge fan of interest only mortgages… seems more risky to me, but it has worked for many investors.

Thanks for catching the typo! It should say downpayment… although I guess for those with lots of $$$, a downpayment can feel like throwing around play money 😉

I will correct this after work tonight! I’m guessing this shows up in a few other posts as well since I’ve been copying the same template… sigh…



15 theFIREstarterNo Gravatar March 19, 2014 at 1:04 pm

Ha ha! It’s in every post with this template yes! It’s puzzled me for ages, and I even googled it and nothing came up. What a donut I am!

Thanks for your thoughts on IO mortgages. The thing is in the UK it would be nigh on impossible to get a property to cash flow anywhere above 5% if you went with a repayment mortgage. So I don’t think I really have much choice. On the plus side, I think the property market is much more stable (smaller country perhaps?) so I think this is why interest only makes more sense here. You buy, hold a property for 5 years and are almost guaranteed (yea yea… I know) the property will have appreciated in value. Plus obviously rental prices will have gone up as well so each year it is “cashflowing” a better amount.

In fact do you have a post about this? About future rental increases and how you calculate your future cash flows? Is it simply a case of re-working out the %age, or do you take into account inflation and opportunity cost of what that money could have been invested in, if you hadn’t put into RE (i.e. Stocks). I am guessing you should account for this in some way.


16 FI FighterNo Gravatar March 23, 2014 at 10:08 am


LOL! I’m sorry for causing you so much trouble… I had been using that template for so long that I completely overlooked the typo since my eyes are usually just looking at the numbers to the right of it.

Glad we got that cleared out. I’ve gone back and updated the older articles as well that had that typo 🙂

Up to this point, I haven’t done a post on projections and future rent increases… I tend to focus on today’s cash flow, and if the numbers don’t work, I tend not to buy…

It’s tough to say, but there are people out there who have become very wealthy buying right. They start out with negative cash flow, or put in a large downpayment to help bump it up, and accept lower returns in the short-term. Over the long-term, the rents either catch up or they sell for a huge profit… Again, you have to buy in the right areas and the market has to do what you think it will… Definitely more risky and speculative, but if you think you’ve found the right one, it can work out.

Take care!


17 theFIREstarterNo Gravatar March 25, 2014 at 3:31 pm

He he… no worries and thanks as always for the reply. Makes perfect sense. Cheers!


18 Dave @ The New York BudgetNo Gravatar March 18, 2014 at 9:51 am

Definitely good advice to be cautious! I do wish I had jumped into the game a couple of years ago, when prices were prime, but I am hoping to accomplish my goals in the current landscape anyway. But I do need to be careful!


19 FI FighterNo Gravatar March 18, 2014 at 9:53 pm


I like your optimism! There’s really no point in looking back since it’s all hindsight now. Although circumstances may be tougher today, it’s still possible to find cash flow deals that will help you accomplish your goals.

I’m pretty sure in 5, 10, 20 years from now, you’ll be so grateful you got started NOW.

Markets go up and down. If anything, it’s just a reminder to be cautious when going up and aggressive on the way down.

There will be more opportunities. The important thing is to be playing in the game.

All the best!


20 Tom @ FinanceandFlipFlopsNo Gravatar March 18, 2014 at 10:11 am

Good advice FI. As much as I would love to start investing in real estate, I’ve decided now is just not the right time to do it. Property values in my area have been increasing quite rapidly and everyone is saying “get in now before the prices really go through the roof!”. That alone makes me very skeptical to jump on an “opportunity”. It’s amazing how with real estate, once prices begin to rise no one thinks they can ever possibly go down again.

For me it’s just poor timing – I’d much prefer to have a decent savings (and student loans paid down) before diving into real estate. I would consider a turnkey in the right market, but I feel that my first property should be local to really learn the ropes. Couple that with a rising market and it seems like the right move for me to sit and wait. Sometimes the best move you make is the one where you do nothing at all.


21 FI FighterNo Gravatar March 18, 2014 at 9:56 pm


You have a great mindset towards investing in real estate. When everyone says “get in or it’s too late”, you’re right, you should be worried!

It is indeed funny how the human psyche works. When the markets are falling, everyone is yelling that the sky is falling down… It’s only been two years or so, and it seems like everyone has forgotten there was even a financial crisis.

I think it’s a good idea for you to take care of your loans/obligations now… There will be lots more opportunities to jump into REI later… it’s definitely not too late!

Best of luck!


22 MarvinNo Gravatar March 18, 2014 at 6:21 pm

Great tips FI, they seem similar to stocks as well but even more so in bonds these days. People are willing to pay anything to get some income and that is what’s causing the bond market bubble. It will be awful when it finally pops.


23 FI FighterNo Gravatar March 18, 2014 at 10:02 pm


Thanks! Yeah, definitely, whether it’s stocks or bonds or real estate, people lose their minds in an upmarket.

I think it’s even more crazy with real estate b/c residential properties are sold to homebuyers who get entirely too emotional with their buying decisions… Stocks and commercial real estate are bounded by the numbers game…

When things do finally bust, a lot of people will be kicking themselves for overpaying.

Take care!


24 No Nonsense LandlordNo Gravatar March 18, 2014 at 7:51 pm

One of the best ways to mitigate risk is to focus on great tenants. Your rent collection risk is almost nil with a solid credit score tenant. Behaviors are better, there is less likely to be an insurance claim that will be charged against you.

In the ‘old’ days, so called investors bought properties as a flip, and made money in spite of themselves. They might have misjudged the re-sell value, or the fix-up costs, but the market was moving 20% per year, and they lucked out.

In today’s market, if you do not cash flow from day one, you may never cash flow. Property appreciation is capped, as underwater homes become solvent, owners will sell. It creates an artificial price barrier. As values increase, so does supply.

Remember, it is near impossible to compete in price as an investor with someone who is buying a property to live in. Be patient, look for deals. Even if you only lock in a deal every other year, if it is a great deal, it is worth it. Keep your powder dry, for the deals that will come. Foreclosures may have slowed down, but they are always happening and will always happen.

When I am buying properties, I may have offers on several properties at the same time. I will only have one earnest money check out, and that is not cashed until the offer is accepted. I always have a “get out of jail free card”, with a homeowner’s inspection contingency, or a financing contingency, or a homeowner’s association contingency.


25 No Nonsense LandlordNo Gravatar March 18, 2014 at 8:42 pm

I should have said “or a property inspection contingency.”


26 FI FighterNo Gravatar March 18, 2014 at 10:03 pm


Great points, and those are a lot of other good tips on how to mitigate risk. I focused on the appraisal contingency, but it’s always a good idea to include the loan, inspection, etc. as well.

Take care!


27 IntegratorNo Gravatar March 23, 2014 at 9:14 am

I’ve certainly seen our own local property market heat up. The emergence of folks looking for places to flip is certainly on the rise. The detailed numerical analysis was great!


28 FI FighterNo Gravatar March 23, 2014 at 10:03 am


Thanks! Glad you found the numbers useful. Yeah, buying season is just about ready to start here as well.

All the best!


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