Avoiding Risk - What You Need to Do!

All types of investing involves risk, and investing in real estate is no exception.  There is no such thing as a “risk-free” investment.  You can learn to manage risk, and take steps to reduce risk – you cannot eliminate it.

According to conventional wisdom, higher risk is associated with higher rates of return.  New investors are encouraged to start with low yield, low risk investments until they get some experience.  This is good advice for two reasons.  First, new investors should take a cautious approach and determine their tolerance for risk.  Second, even a low, positive yield is better than a loss of your entire investment!

The most important step to managing risk is to identify and understand the risk factors.  Ask yourself “What could go wrong?”  One of the maxims of Murphy’s Law is that anything that could go wrong will go wrong.  Some factors are obvious – such as severe weather, vandalism, and tenants that fail to pay rent.  Other factors, such as changes in zoning laws or changes in local economic conditions, may be more difficult to predict but have equally devastating impacts on your investment.  The key to managing risk is to identify the factors and then develop a plan.

Get Educated.    If you are just getting started as a real estate investor, there is a lot to learn.  Unfortunately, most of the books in the bookstore and in the library were written and published before the recent housing crisis, and although they may provide some excellent background information, some of the methods they recommend are no longer applicable.  The best approach is to join a real estate investment association or club that focuses on education, not sales.  For a small fee, you can attend seminars and programs that will not only teach you some of the basics, but will highlight recent developments and trends.  Perhaps even more valuable, you will meet other people like yourself, as well as interact with experienced investors.

Make a Plan.   Consider both your personal and your financial goals, and develop a Plan.  A good Plan will focus on your goals.  Goals should be realistic.  Your plan should be flexible, and contain an exit strategy.  Your financial goals should support your personal goals, not the other way around!  Remember, good investment plans take time – there is no single perfect investment!  If an attractive investment opportunity comes along that does not conform to your Plan, you can re-evaluate your Plan, but don’t be too quick to abandon it.  The “deal of the Century” happens every week!

Due Diligence.  Every experienced investor will emphasize the importance of doing “due diligence.”  This means different things to different people, but in all cases, it involves learning as much about the proposed investment as you can before you write a check!  Some information is critical, whereas some is not.  It may depend on the type of investment, the location, or the structure of the deal.  Buying a single-family rental property involves different risk factors than joining an investment fund that concentrates on buying shopping centers.  The more you become educated about the different types of investment opportunities and the different factors involved, the better you will be able to narrow your focus and ask the right questions.

Research.  You don’t need to be a genius to make money in real estate investing, but you need to be smart.  And you can get smarter.  There are many different types of ways to invest in real estate – but keep it simple.  Only consider investments that you understand.  Talk to other investors, find out what can go wrong – learn from the mistakes of others.  Always double-check and confirm that you have the most current information, and don’t just rely on what someone says; fact-check.  Be careful to distinguish between facts and fantasy!  If the deal sounds too good to be true … it probably is!  Watch out for scams!

There are many sources of information – too many, in fact.  There are seminars, webinars, blogs, podcasts, more blogs, newsletters, podcasts, radio shows, and of course, the ever-present traveling real estate investment gurus who are coming to a convention hall near you.  Trying to sort through all of this can be overwhelming and time-consuming, not to mention costly.  Many of these so-called “free” programs are simply an opportunity to spend literally thousands of dollars buying CDs, books, and sign up for more programs.  Remember, your original goal was to invest in real estate, not CDs!

Real estate investment associations and groups, such as SJREI, hold regular meetings that you can attend for very low cost, and provide an opportunity to meet and interact with other investors – both new and experienced.  They feature speakers who are experts on different aspects of real estate investing, and who often have their own programs that you can attend or subscribe to for more detailed information.  Since every person is unique, and because there are so many different types of real estate investment products available, you should sample a few of these programs to find out what suits you the best.

Consult with Professionals.  This may seem obvious, but many people wait until after they’ve run into problems to talk with a professional.  Real estate investments involve making critical decisions that involve legal, tax and financial consequences.  Working with the right real estate, tax consultant, financial planner, and attorney may cost money in the short term, but the results may yield substantial savings in the long run!  Often, you will be able to use information from a qualified professional over and over, making it one of the best long-term returns on your investment!  Getting professional advice is one of the most effective ways to avoid risk!

Evaluate, Re-evaluate, Modify.  As you learn more and gain confidence, you may choose to modify your Plan.  Make adjustments to keep your Plan realistic and achievable.  Establish a realistic timeline for your financial goals.  Modify your Plan to help ensure that your Plan reflects changing circumstances.  For example, the “hot market” condition that enticed you to consider investing in one area may have cooled off, or gone into decline as a result of a change in local conditions (i.e., closing of a major manufacturing plant; severe flooding; or substantial new housing construction).  Review your Plan and modify it as necessary to adapt to these changes.  Always have an exit strategy!

Take Action.  Invest, don’t spend, your money.  You will learn by doing, so get started!  Invest in real estate, not sales pitches.  Don’t wait for the “perfect, risk-free opportunity” – it does not exist!  Getting started is important.  But getting started on the right foot is even more important!