Today I want to take a moment to discuss risk in real estate investing. So often when the topic of money or investments come up, the potential returns are highlighted and the potential risks are barely mentioned. Investing real estate, like anything else, can be a risky endeavor, although I would argue that in many ways it is less risky than many other forms of investment at a macro level.
Before we go any further I’d like to point out that life is full of risks. Every moment of every day you take on a plethora of risks just by being alive. When you get up to make your morning coffee you risk slipping, falling, and cracking your head open. When you step outside you risk getting hit by a bus or a texting driver. Even just lying in your bed at night there’s a risk that you could have a heart attack and die, or that a plane flying overhead could malfunction and land on your house. Now some of these are not very likely but they’re all still possibilities.
Financial risk is no different. If you invest in a low risk asset like US government bonds (often called the safest investment) there is still the risk that the government could collapse through war or domestic unrest (with current events this doesn’t sound so far fetched anymore!). If your money is in a savings account there is still a risk the bank could fail and although your deposits are FDIC insured, the government could still collapse. There might not be a high possibility of this but it’s still a possibility.
The truth is, there is no such thing as a risk-free investment. The issue at hand is not whether or not you are going to take a risk, but rather which risks you are willing to take. Your rate of return on your investment depends on which risks you are willing to take.
Many people are afraid of financial risk and some people turn and run the other way the moment it’s time to discuss risk and who can blame them? You worked hard for your money. You don’t want to lose it on an investment gone wrong. The problem with this thinking is that over time, the value of your dollar will decline. Currently inflation is just under 2% per year and your savings account interest rate is far lower than that. Over time, you will lose buying power. This in and of itself is a risk because what happens when you are too old to work and keep adding to your nest egg. What happens when you have to start spending your nest egg to live and then outlive what you saved? With new advances in medical technology this is becoming the reality for more and more people.
The best thing you can do is to accept that risk simply cannot be avoided. If you accept this simple truth you can start managing risk. While you can never completely eliminate risk, you can take steps to lessen the amount you take on. When you drive, there is always a risk that you could crash and be seriously injured or killed, but the chances of this are much less if you’re not texting or eating while driving. Slipping in the shower and hitting your head on the tile is always a risk, but you can lesson the risk by putting down a mat that provides some friction for your feet to grip onto.
The same holds true with investing your capital. The most common piece of advice we hear about mitigating financial risk is to diversify your investments across different asset types and classes. In real estate we would say to diversify across different markets as well. Beyond this sage advice, you can also mitigate risk by investing with people you trust. As I mentioned in my last post on investing in real estate remotely, your team can make or break you in a remote market. Having a good team will lessen your risk because a good team will be able to adapt and handle any potential issues that come up.
Another way to mitigate risk in real estate is by doing some work up front and being honest about your risk tolerance. Some people feel comfortable taking huge risks in anticipation of huge payoffs. Others want slow and steady returns. Knowing your personal risk profile will protect you from one of the largest, but least talked about, forms of risk: emotional risk.
Emotional risk is the risk of you as an investor making poor investment decisions out of fear. This can take the form of selling off your stock portfolio during a market dip, or selling off a rental simply because you weren’t able to find a tenant immediately. Making rash decisions out of fear can have a significant impact on your financial health. Anyone that sold their stock portfolios at a loss in 2008 and didn’t buy again in 2009 can tell you that.
The best way to mitigate emotional risk is to learn your risk tolerance and make investments that best align with your risk tolerance. The next best thing you can do is to have a healthy reserve account to help you get through any rough patches and believe me, there will be rough patches. If you have a healthy reserve account, you’ll be able to ride out a rough patch without worrying about further loss.
I’d like to end with a word about the risk profile of real estate and why I believe that real estate is actually a less risky investment than many make it out to be. I’ve outlined two main reasons below
Real Estate is a limited commodity. There is only so much viable land for human habitation on planet earth. They’re not making more land but they are still making more people and these people will always need shelter.
There is a tangible asset behind your investment and its value is unlikely to go to zero. Real estate may decline in value due to many factors, but the chance that your investment will be worth nothing at all is very slim. In contrast, companies go bankrupt all the time leading investors to lose big.
At the end of the day, only you can know what your risk profile is and what kind of investments you want to make. As always, if you are interested in investing in real estate feel free to reach out to us at IronGall Investments with any questions. We’d love to hear from you and find out how we can help you achieve your investment goals.